We've just had a notable divergence between the 10-year government bond yield and the U.S. stock market. Up until about the beginning of the second quarter of 2010, both appeared to move in tandem as shown in a chart from Citi's Robert Buckland below.
Yet since then, they've parted ways. Bond yields have plummeted, with the 10-year at sub-2.4% right now while the stock market has surged.
Yes, we know, quantitative easing (QE) is on the way... but don't forget that we already had a round of QE before, and back then we didn't see this divergence, according to the chart above. So QE isn't enough to explain this. Mr. Buckland thinks the divergence is unsustainable and will eventually have to come to an end:
Citi's Robert Buckland:
The recent rebound in equities seems logical enough to us. Valuations look cheap and concerns about a global EPS double dip appear overdone. As for the conundrum shown in Figure 15 (the break-down in the close relationship between equity prices and government bond yields) Citi equity and rate strategists’ forecasts suggest that, partly as a result of QE, bond yields are unsustainably low rather than equity prices unsustainably high. Indeed, our recent analysis shows that previous breakdowns in this relationship have been more often resolved through bonds correcting than equities correcting.
So one of the market's is 'wrong' and it's more likely the bond market, thinks Citi.
(Via Citi, Global Equity Quarterly, Robert Buckland, 6 October 2010)
Disclosure: No Positions