Why You Should Believe Bonds And Not Stocks (Again)

Equity prices - and more specifically valuations - are becoming increasingly disconnected from economic reality. As Bloomberg's Jo Brusuelas notes though the Fed may be driving up asset prices without achieving their end goal of improving economic conditions - based on a number of recent economic surprises. As earnings expectations and a global slowdown continued to point to recessionary outcomes (with industrial and consumer data weak), the probability of a fundamental mispricing in stocks and bonds grows. But when we look over the medium-term at how bonds and stocks react to negative and positive economic surprises over time, it is more than abundantly clear that not only is the bond market more sensitive-to and reflective-of the economic state of the world (and its expectations) but the equity markets remain significantly less sanguine about reality (about 20% less!!).

 

Bonds are within 0.5bps of the change we would expect given fundamentals...

 

but stocks appear around 20% mispriced relative to economic expectations over the past six months...

 

As Brusuelas notes:

The relationship between economic surprises and bond yields is straightforward. As new economic information arrives, investors adjust their expectations about likely economic growth, which is followed immediately by changes in fixed income order flow. As those economic growth expectations shift, equities prices may later adjust.

 

Charts: Bloomberg Briefs