Wednesday, May 28, 2014

How Low Can Yields Go?

Stocks are trading slightly lower in early trading following the S&P 500 making new highs yesterday.  So far the selling action is pretty mild, and if the bears aren't able to push the market lower we could see some rally attempts into the close as the bulls regain the upper hand.

One surprising move today is the drop in bond yields.  The 10-year yield is lower by 7 basis points to 2.44%.  This is close to a one-year low in yields, which remains surprising given that the economy is supposed to be improving and inflation picking up.

One explanation is that bond yields are moving lower around the globe.  In Europe, bond yields continue to fall as deflation remains a concern, the ECB hints at cutting rates, and economic growth remains sluggish. 

Another theory is that so many people are short bonds here betting on higher rates that each of these moves lower in yields causes pain on that short trade and results in waves of short covering on those wrong-way bond bets.  This is the theory put forth by Jeffrey Gundlach of DoubleLine, and so far this year he has been right.

The notion that the drop in bond yields means the economy is slowing flies in the face of another stock-based indicator, and that is the move to new highs in the transportation index.  The $TRAN is making more new highs today, and the strength there would lend itself to the notion that the economy continues to gain strength.  Go figure.

Asian markets were higher overnight.  The Chinese press is discussing rate cuts in the face of a slowdown in the housing market.  Europe's markets are modestly higher.  Germany's GDP held at 6.7% and Swiss GDP rose 2.0%.

Trading comment: While some have been looking to 'Sell in May' and await the summer correction, the market continues to hold up well.  If the S&P 500 can consolidate its move to new highs without quickly giving up the 1900 level it would be a good sign for the bulls.  Its hard to get overly bullish heading into the normally volatile summer months, but as Jeff Saut stated yesterday, we are in a bull market and in a bull market surprises often occur to the upside.  Well said.

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