For investors, the current market boils down to a simple question: Who do you trust – stocks or bonds?
U.S. equity ETFs have held up remarkably well considering Treasury yields are hovering near record lows.
In other words, Treasury bonds are loudly signaling investor fears over deflation and the Eurozone debt crisis spiraling out of control. Meanwhile, stock ETFs aren’t mirroring the same level of anxiety.
Both can’t be right.
“If bond yields are overestimating the risk of a breakup of the European Union, then stock prices are likely to jump. Should stock investors be asleep at the wheel, however, they may be dreaming they are approaching a tunnel, rather than a shadow on the wall,” said Sam Stovall, chief equity strategist at S&P Capital IQ.
In the bond market, credit spreads rise during economic shocks like the collapse of Lehman Brothers in 2008. Spreads are moving higher again as investors fret over Europe’s debt crisis spreading to Spain and other countries.
“So when I see both a rising spread and stock prices, I think something’s got to give,” Stovall wrote in a note Monday.
“We believe that while it may be too early to say for sure that it is time to buy or bail, either bonds or stocks will soon likely alter their course,” he added. “Historically, when bond spreads have spiked, stocks have tanked. Yet this time, stocks have been reluctant to give much ground. Should equity investors ultimately be proven to be on the winning side of this game of chicken, prices should jump.”
The opinions and forecasts expressed herein are solely those of John Spence, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.