What the Bond Market Knows That the Stock Market Doesn’t

The U.S. bond market, after a strong rise that started mid-last year and ended in late November 2006, looks like it’s in trouble. Since December, the U.S. bond market, as measured by the popular 10- year U.S. T-bill, is down about 2%.

Hmm… The stock market is rallying, but the bond market is down. Don’t they usually move in tandem? Yes, a stock market rise is healthy when the bond market is rising with it. So, what does the bond market know that the stock market doesn’t?

If I had to guess, I’d say the bond market is now realizing the U.S. Fed will not be as quick to lower interest rates in 2007 as had been previously thought. The head of huge Pimco, the world’s largest bond fund, said earlier this year that the U.S. Fed would lower interest rates one full percentage point this year. Given all the recent talk from Fed governors on inflation, we will need to see if the interest rate cuts many analysts are expecting actually come to fruition.

The action of the bond market in the U.S. should be another warning sign for stock market investors. Yes, there is plenty of liquidity in the financial markets that’s sending stock prices higher (as I discussed yesterday), and you can’t argue with the trend. But if interest rates are not going to decline anytime soon, the bond market and the housing market will continue to languish. I don’t think the stock market will be far behind.

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Now to answer today’s question, “What does the bond market know that the stock market doesn’t?” It’s that interest rate cuts in the U.S. won’t be coming as soon as analysts and markets originally expected.

Three-month U.S. T-bills currently yield 5.11%. They’re not sexy, they’re not growth-oriented and there’s no capital gains potential. But, a 5.11% return is a lot better than what the stock market has been returning… especially when that 5.11% is guaranteed secure by the U.S. government. Yes, boring, but right now, a very good, very safe alternative to the general stock market.