Good Morning. On Monday, one of the primary reasons given for the Dow's early 248 point dance to the downside was that bond yields were spiking again. If you will recall, when the opening bell rang on Monday morning in New York, the yield on the 10-year printed at 2.657% (the week prior, the yield had opened at 2.17%). While bond prices did improve throughout the day and the stock market did come off of the lows, the bottom line assumption in the market was higher yields were bad for stock prices.
So what happened on Tuesday when the yield on the 10-year rose once again, finishing at 2.589%? The Dow rallied 101 points, of course.
If this course of events causes you to scratch your head, join the club. I received a handful of calls from colleagues yesterday, most of which involved the phrase, "what gives?" Figuring out what drives the stock market is tough enough during normal times, but the apparent flip-flop on what is good news or bad news for stocks was causing more than a little confusion.
Unless you're a seasoned veteran of this game, the idea that good economic news can be bad news for both bond and stock prices is hard enough to comprehend. In short, in an environment when the Fed's next move is in question, good economic news is equated with "bad" moves by the Fed. In this environment, an improving economy (the good news) means the Fed could stop buying up every bond in sight and start thinking about fighting inflation and exiting their mind boggling stimulus programs that have been in place since 2008.
Speaking of good news, there was an abundance of it on Tuesday. Consumer Confidence came in at its highest level since January 2008. Durable Goods Orders were up for a third straight month. And the various reports on housing were quite strong. For example, the Case-Shiller Home Price Index sported the biggest monthly gain on record as prices surged 12.1% on a year-over-year basis.
As expected, bond yields rose in reaction to the news. Although the yield on the 10-year didn't take out Monday's intraday high, it did manage to rise another 4 basis points and close just below 2.6%. And while the action in the bond market has definitely been wild and wooly lately, this move seemed about right. Good news meant higher yields. Simple, right?
The complicating factor yesterday was the fact that the stock market decided to advance as well. This flies in the face of the idea that traders are petrified of what Ben Bernanke's bunch might do next. If traders were truly concerned about rising rates and the Fed starting to taper sooner rather than later, one might have expected to see some selling after the best Consumer Confidence numbers in five and a half years, and all those surprisingly strong housing numbers. And while the idea of the DJIA finishing with yet another triple-digit move wasn't exactly surprising, the fact that the digits were green at the end of the day certainly was.
PIMCO's Mohammed El Erian opined yesterday that stocks managed to go up in the face of rising yields and good economic news because investors got "something extra" overnight from the Peoples Bank of China. The man who coined the phrase "the new normal" suggested that the PBOC stating that it would be sure to smooth out the cash crunch that is developing in China was a clear positive for equities. The bottom line here is this means that China isn't about to send the globe into another financial crisis.
Another excuse for the divergent moves in stocks and bonds was the idea that bond traders may have skipped the Fed's journey and moved straight to the "destination" of the Fed beginning to exit. In short, the thinking is that a 100 basis point move in the yield of the 10-year just might be a tad overdone. Therefore, as the thinking goes, while rates did inch up yesterday, the recent fervor that had plagued the markets was missing.
And the final excuse given for Tuesday's action was the fact that two noted inflation hawks, neither of which are voting members of the FOMC this year, came out and said that the Fed had NOT gotten more hawkish and that tapering QE is NOT the same as tightening. And with a handful of Fed governors due to speak on Thursday and Friday, the thinking is we will hear more soothing words from the Fed before the weekend arrives.
So, while it may be naive and/or premature to think that an improving economy will be good for corporate profits and in turn, the stock market one day after traders appeared to be freaking out over another spike in rates, this is probably the end game. It's just that the timing for this scenario remains a huge question mark.
For now then, we need to continue to watch the action more closely than normal in an effort to try and ascertain the market's driving forces. To be sure, this will include a daily review of whether or not good news is to be considered good or bad. Should be interesting.
Turning to this morning... Improving consumer confidence in Europe and a report from Citi lifting Spanish banks has buoyed the mood across the pond. However, the same can't be said for the gold and metals market this morning. Gold is currently being trashed and futures are lower by more than $43 in the early going. Stock futures in the U.S. are currently pointing to a positive open on Wall Street.
Here are the Pre-Market indicators we review each morning before the opening bell...
Major Foreign Markets:
- Shanghai: -0.43%
- Hong Kong: +2.43%
- Japan: -1.04%
- Germany: +1.61%
- France: +1.98%
- Italy: +2.14%
- Spain: +2.48%
- London: +1.03%
Crude Oil Futures: -$0.17 to $95.15
Gold: -$43.20 to $1231.90
Dollar: higher against the yen, lower versus euro and pound
10-Year Bond Yield: Currently trading at 2.576%
Stock Futures Ahead of Open in U.S. (relative to fair value):
- S&P 500: +9.92
- Dow Jones Industrial Average: +79
- NASDAQ Composite: +20.05
"The excessive increase of anything causes a reaction in the opposite direction." - Plato
Positions in stocks mentioned: none
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