Bonds: Should Stock Investors Be Concerned?

By: Chris Ciovacco | Fri, May 30, 2014
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  1. While numerous bearish calls have been made for stocks based on the recent strength in bonds, history says stocks and bonds can rise in unison for extended periods.
  2. We found five periods 2004-2013 when stocks continued to rise despite the "bearish" signals being sent from a strong bond market.
  3. The article provides specific dates and performance figures, allowing you to assess the economic and market significance of recent demand for fixed income instruments.


Myth Busters Part III

Myth Busters

Is it logical for equity investors to be concerned about any of the following?

  1. Weakness in economically-sensitive small caps.
  2. A near-record low VIX "Fear Index".
  3. Recent demand for defensive bonds.

The answer is "yes". The three bullet points above are relevant to the stock market's risk-reward profile. However, the question is how relevant? We recently showed examples that aligned with the theory that "nothing says small caps cannot begin to find their footing again". After making an intraday low on May 15, small caps (IWM) rose 6.0%, telling us to keep an open mind about the possibility of a sustained rally in higher-risk/higher-reward stocks.

IWM Russell 2000 iShares NYSE + BATS


Building The Flexibility Case

In a detailed May 29 article, we showed it is possible for stocks to post impressive gains during a period when the VIX rises significantly from low levels. The purpose of the small cap and VIX articles is not to build a bullish case, but rather to emphasize the importance of respecting both the bullish and bearish cases for stocks; doing so allows us to maintain the always-important flexibility needed to remain aligned with the market's current profile.


Bonds: How Concerned Should Stock Investors Be?

It has been easy to find "bonds are saying be careful with stocks" articles in recent weeks. It is prudent to be concerned when demand for defensive-oriented bonds is strong. However, it is also prudent to ask:

Can stocks and bonds rise in unison for long periods of time?

As shown in the table below, the answer is yes. The S&P 500 (SPY), intermediate-term Treasuries (IEF), and long-term Treasuries (TLT) all posted gains in the periods shown.

Stocks and Bonds can rise in Unison 2004-2013

The chart below shows one of the periods in the table: June 28, 2006 to December 1, 2006.

IEF iShares Barclays 7-10 Year Treasury Bond Fund NYSE + BATS


But, The Economy Is Much Different Today, Right?

Yes, the economy in 2014 is quite a bit different than all the historical periods referenced above. The same argument can be made for any period we cite as potentially bearish evidence for stocks when bonds were strong. The point of the article is not to compare economic similarities, but rather to answer the simple question - Is it possible for stocks and bonds to rise in unison for extended periods of time? The answer is yes.


A Bar Is Worth A Thousand Words

Since a table of numbers does not provide a visual reference point, we have provided the bar graphs below showing the percentage changes of SPY, IEF, and TLT for each period in the table.

Percentage Change Stocks & Bonds 8/12/2004 - 2/9/2005

Percentage Change Stocks & Bonds 4/20/2005 - 6/17/2005

Percentage change Stocks & Bonds 6/28/2006 - 12/1/2006

Percentage Change sotcks & Bonds 10/12/2011 - 4/26/2012

Percentgae Change Stocks and Bonds 3/5/2013 - 5/1/2013


Investment Implications

How do we use all this? Small caps, the VIX, and bonds are all helpful in terms of managing stock market risk. However, there are more effective ways to monitor the big picture for equities. For example, stocks cannot morph into a corrective state until we see visible signs of a breakdown on the weekly chart below. The top portion of the image below shows what the early stages of a correction looks like; the bottom portion shows the market as of 2:24 p.m. EDT Friday.

$SPX S&P 500

If the 2014 chart above maintains its present look, it does not matter what small caps, the VIX, or bonds are doing; it is not possible for too many bad things to happen, especially a multi-month correction or new bear market. Therefore, until a breakdown in the major averages occurs, worrying about bonds may do nothing but sap productive energy from well-intentioned investors.

Ciovacco Tweet on Stocks

We use our market model to monitor the market's risk-reward profile and make prudent allocation adjustments. There is no such thing as a perfect market indicator. Therefore, our market model uses numerous inputs. Since weekends are a good time to review your approach to the markets, this October 2013 article covers the basics of "monitoring and adjusting" rather than "forecasting and hoping".

 


 

Chris Ciovacco

Author: Chris Ciovacco

Chris Ciovacco
Ciovacco Capital Management

Chris Ciovacco

Chris Ciovacco is the Chief Investment Officer for Ciovacco Capital Management, LLC. More on the web at www.ciovaccocapital.com.

All material presented herein is believed to be reliable but we cannot attest to its accuracy. Investment recommendations may change and readers are urged to check with their investment counselors and tax advisors before making any investment decisions. Opinions expressed in these reports may change without prior notice. This memorandum is based on information available to the public. No representation is made that it is accurate or complete. This memorandum is not an offer to buy or sell or a solicitation of an offer to buy or sell the securities mentioned. The investments discussed or recommended in this report may be unsuitable for investors depending on their specific investment objectives and financial position. Past performance is not necessarily a guide to future performance. The price or value of the investments to which this report relates, either directly or indirectly, may fall or rise against the interest of investors. All prices and yields contained in this report are subject to change without notice. This information is based on hypothetical assumptions and is intended for illustrative purposes only. THERE ARE NO WARRANTIES, EXPRESSED OR IMPLIED, AS TO ACCURACY, COMPLETENESS, OR RESULTS OBTAINED FROM ANY INFORMATION CONTAINED IN THIS ARTICLE.

Ciovacco Capital Management, LLC is an independent money management firm based in Atlanta, Georgia. CCM helps individual investors and businesses, large & small; achieve improved investment results via research and globally diversified investment portfolios. Since we are a fee-based firm, our only objective is to help you protect and grow your assets. Our long-term, theme-oriented, buy-and-hold approach allows for portfolio rebalancing from time to time to adjust to new opportunities or changing market conditions.

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