One of the more bizarre contradictions during the recent rally in equity markets is the complete refusal by the bond market to budge from its deflation/recession view. In most cases, the equity and bond markets trade according to the same economic outlook. If the market believes inflation/growth is on the way, stocks rally and bonds fall (yields rise). Conversely, when the outlook is for deflation/recession, equities fall and bonds rise (yields decline). However, there is currently a deep divide today as the stock market (and commodity market for that matter) trades like growth and inflation are on the way, but the bond market is holding to its deflation/recession view. Below is a 3 year chart which compares the 10 year treasury to the SP 500. You can clearly see that while the two can briefly diverge, they eventually converge on the same economic consensus. So the question is which market is right and which one is wrong? To be honest I really don't know at this point. I think the reason for the large divergence is caused by the Fed's buying of treasury bonds, which has distorted the market. What I do know is that when these two converge, you are going to see some large moves in these markets. If bonds stay where they are then stocks could easily fall back down to between 800-900 on the SP 500. However, if bonds are wrong we could see the 10 year at 3.5-4%, which would be bullish for stocks.
Click chart for larger image.
Black Swan Insights