MBS Day Ahead: Age Old Fallacy That Sometimes Holds True

One of the greatest disservices to the average market-watcher is the age old notion of stocks being the opposite of bonds.  This phenomenon is referenced in many ways.  Of course there's the simple "buy bonds, sell stocks," and vice versa, as well as "the asset allocation trade" (referring to the real phenomenon of money managers adjusting their holdings to be more/less bond/stock weighted.  Then there's the similarly real, shorter-term phenomenon of the "risk-on/risk-off" trade where market participants can buy more risk (when things look good economically, for instance) by adding stocks.  Conversely, investors could "move out of safe-haven assets" like bonds. 

For the sake of speed and simplicity, our pet term for the phenomenon is "the stock lever."  I don't know if anyone else uses this term, and I'm not sure if it's that great.  It's more of a see-saw or teeter-totter, really, and even then, only when we're talking about "price vs price."  The "lever" concept is actually a bit confusing in that regard as we're almost always looking at bonds in terms of yield (unless we're looking only at MBS).  Bond yields and stock prices would theoretically move together if any of the above correlative concepts are in play. 

But they don't move together... In fact, if we start around 1980, both have rallied immensely.

But surely if we have a pet name for a phenomenon, there must be a reason, right?

Indeed there is.  When we zoom in to more narrow time scales, instances abound of stocks and bonds moving together.  The disservice to market-watchers comes from the fact that this relationship can completely break down at times, depending on what's moving markets.  This can leave folks scratching their heads saying 'surely, bonds should be doing better today because stocks are selling so much.'  If you've ever found yourself thinking/saying that, reference the previous chart.

One of the times where the stock lever seems to do well is during earnings week.  That's especially true when earnings week falls on a week with limited economic data.  This particular earnings week has been good enough for the stock lever that Treasuries and the S&P are hanging closer together than Treasuries and German Bunds.  Normally, the opposite is true.

All that to say that it does indeed make some sense to keep an eye on stocks today--especially with it being the biggest day of earnings reports so far this week.  One thing that could complicate the stock lever would be the issuance of corporate debt that tends to coincide with earnings season.  Let's say a big company or two releases sub-par earnings and stocks drop, but those companies (or other companies) also take the opportunity to issue a ton of new debt. 

That increase in the bond market 'supply' will put price pressure on the rest of the bond market.  In other words, Intel priced more than $6bln in corporate debt yesterday, and some investors bought that instead of Treasuries.  The point there is that big corporate issuance can rain on an otherwise pleasant parade.  Of course if earnings are strong and stocks are rallying, the parade might not be so pleasant.