Out of Bonds and into Stocks?

February 14th, 2013

by Dominic Cimino

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This chart is a weekly bar chart of 30yr U.S. Treasury yields. The resistance at the 3.2% area is shown as the lower, thicker horizontal red line. The horizontal red line above that is the 3.5% resistance area, and the blue downward sloping line above the market is the trend channel resistance line. The 100 week moving average, shown in purple, provides resistance just above present yields at the 3.26% area. 30yr Treasury yields are currently testing solid resistance at the 3.2 to 3.26 area. If this area is breached, the next resistance level is up at the 3.5% area. Then after that, it's major resistance at the trend channel line – probably around the 4% area, given the current trajectory.

I believe it's now as critical as ever to watch Treasury yields and the stock market's reaction to them. Stocks have certainly benefitted from a low interest rate environment. But given that stock indices are trading near or at all-time highs during a period of not only historically low Treasury yields, but also of low growth and high unemployment, it could be that the market expects the record amount of money that has lifted the Treasury market for nearly 30 years to begin rotating into the stock market. Therefore, since any future breach of resistance levels on the 30yr yield chart might occur in conjunction with this long awaited rotation of money, the potential side effects from higher Treasury yields should be closely observed.

For instance, if yield resistance levels are breached and reports suggest money does begin flowing from bonds into stocks, watch to see if the stock market rally continues in spite of the rising yields. If this were to occur, it would confirm that the stock market views any inflation as tame, and any U.S. credit concerns as something for the future. This could give impetus to a seemingly already overextended stock market rally.

On the other hand, beware if under similar circumstances, stocks begin to rise but then falter even as money continues to flow out of bonds, that could suggest that the long-heralded transfer of funds was possibly the final hoorah for stocks. For instance, if bond selling continued but stock investors at some point lost their zeal and instead became concerned about inflation, a higher cost of credit for business, U.S. credit ratings, anemic growth, or any number of other conditions, that could be cause for concern and perhaps repudiate the rally, while further suggesting a continuation of the secular bear market for stocks, and thereby offering vindication for the stock market bears.

In conclusion, there are many hypotheticals that I have considered. There is no guarantee that any of them will happen. Treasury yields may not move higher from here, and the bull market for Treasuries may continue. Therefore, I am not recommending any portfolio adjustments for anyone. I am merely presenting scenarios to consider if Treasury yields begin moving higher.

Dominic Cimino

Registered Representative, Securities offered through Cambridge Investment Research, Inc., a Broker/Dealer, Member FINRA/SIPC. Investment Advisor Representative, Cambridge Investment Research Advisors, Inc., a Registered Investment Advisor. Preferred planning concepts, LLC & Cambridge are not affiliated.

© 2012, Dominic Cimino of Preferred Planning Concepts, LLC (You can explore the services offered by Preferred Planning Concepts by viewing us on our website at www.ppcplanning.com) Any redistribution, reprinting, or reference to this chart or content is allowed so long as reference to the author and source is acknowledged.

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