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With US stocks near record highs and Treasury bond yields near multi-month lows, the disconnect between equity and debt investors has rarely been as stark. Over the coming months, the economy is likely to show one of the groups has bet wrong.
The S&P 500 sits less than one per cent below an all-time high. After a wintry first quarter, stock investors are betting that economic growth is picking up, as evidenced by stronger spending figures and business demand. That’s boosted the cyclical stocks which react to rising demand, particularly energy shares.
“The data are suggesting this may be the year when we turn the corner,” said Quincy Krosby, market strategist at Prudential Financial in Newark, New Jersey.
“If data continues to gain traction you’re going to see investors turn to more cyclical parts of the market. And I think that’s already started.”
Bond investors are reacting to a different story. Yields on the 10-year note hit a five-month low on Friday and the 30-year note’s yield fell to its lowest since June after the April jobs report, which showed strong growth in payrolls but no growth in earnings and a decline in the labor force.
That data points to the conclusion that overall economic demand will remain tepid and that inflation won’t materialize as the Federal Reserve continues to pull back on monetary stimulus, analysts said.
“Fixed income investors are slowly waking up to the reality that as the Fed steps back from quantitative easing, there are no signs of inflation,” wrote Andrew Wilkinson, chief market analyst at Interactive Brokers in Greenwich, Connecticut, in a note.
Bonds are also gaining as concern about the Ukraine-Russia crisis heightens the safe-haven appeal of US debt, while some corporate pension funds are increasingly shifting to bonds as they seek to match their holdings to the liabilities they are going to face.
Still, the rise in equity markets doesn’t mean that investors are as confident about growth stocks as they were in 2013. The strongest sector in 2014 is utilities, which have gained 14 per cent and are generally associated with safety. Consumer discretionary shares such as Amazon.com are down 4.2 per cent, the worst-performing sector so far this year.
This may be changing. Data show that the latest internal rotation in stocks has seen the energy sector take the lead, with a 4.2 per cent gain over the last month.
Capacity utilisation, a measure of how much industrial power is being put to work, rose last month to its highest in nearly six years and is expected to have ticked higher in the April report, while Fed data showed last week that commercial and industrial loans grew at a steady pace in April.
This makes it entirely possible that the bond market — generally the more sober-minded of the two markets — may have it wrong.
“We believe that the current pricing in the Treasury market has insufficiently accounted for the potential for an explosion in GDP growth,” said Millan Mulraine, deputy head of US research and strategy at TD Securities USA in New York in a research note.
