Are Bonds Spoiling the Party?

The stock market has been hosting a party to which bond traders weren’t invited. For stocks, the festivities have been occurring all year, and more buyers joined the party this week following positive news from the first round of the French election. General discussions of an impending tax cut from the Trump administration provided an additional tailwind that helped the Nasdaq reach a new all-time high on Tuesday. Much to the surprise of many however, the bond market has not cheapened much, despite the strong risk-on sentiment in stock markets and recent Federal Reserve (Fed) rate hikes. So which market has it right, stocks or bonds?

Stock volatility, as measured by the CBOE Volatility Index (VIX), has been low all year, signaling that investors aren’t very worried about near-term volatility in the S&P 500 Index. Consequently, Treasury prices moved lower through mid-March. This typical reaction of lower bond prices in response to strength in equities reflected the bond market’s belief that the administration’s pro-growth agenda was on course. Yields, as measured by the benchmark 10-year Treasury, rose from 2.45% on January 1, 2017, to 2.62% (year-to-date high) on March 13, 2017. However, the higher yields were short lived as the yield curve, somewhat counterintuitively, flattened immediately after the Fed raised rates in mid-March, partly in reaction to the Republicans’ withdrawal of the health care legislation reform bill, signaling to traders that the pro-growth agenda would be delayed. Since then, many bond market participants have been skeptics, and although the stock market is rallying, bond prices have not declined.

To see, look no further than Tuesday’s 2-year Treasury auction for a sign that the bond market is shrugging off the stock market rally. Despite the party in stocks and uncertainty regarding when the Fed will raise rates again, the auction saw record demand. International participation reached its highest level since 2009 (Treasury data). One auction does not make a bond market, however, and Wednesday’s 5-year note auction was not as well received, leaving investors to focus on today’s 7-year note auction to provide another test of demand. If this auction is not well received, and the debt ceiling debate passes without incident, perhaps this would signal an invitation for bond traders to join the party. Only time will tell.

IMPORTANT DISCLOSURES

Past performance is no guarantee of future results. All indexes are unmanaged and cannot be invested into directly.

The opinions voiced in this material are for general information only and are not intended to provide or be construed as providing specific investment advice or recommendations for any individual security.

The economic forecasts set forth in the presentation may not develop as predicted.

Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values and yields will decline as interest rates rise, and bonds are subject to availability and change in price.

Government bonds and Treasury bills are guaranteed by the U.S. government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value. However, the value of fund shares is not guaranteed and will fluctuate.

The Standard & Poor’s 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

The VIX is a measure of the volatility implied in the prices of options contracts for the S&P 500. It is a market-based estimate of future volatility. When sentiment reaches one extreme or the other, the market typically reverses course. While this is not necessarily predictive, it does measure the current degree of fear present in the stock market.

This research material has been prepared by LPL Financial LLC.

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