Better Bet for Second Quarter—Stocks or Bonds?

Stocks are expected to outperform bonds again in the second quarter, even if the equity market turns in just a slightly higher or flattish performance.

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Businessman with crystal ball

But analysts don’t expect to see the major asset reallocation trade, predicted by many to happen when rates start to rise and investors throw in the towel on Treasurys.

The S&P 500 was up 12 percent in the first quarter. In the same period, Treasurys lost 1 percent, while corporate bonds, including investment grade and high yield, were up just above 3 percent, according to Bank of America Merrill Lynch indices.

“I think stocks are still going to win the quarter. It probably won’t be as blow-away as the first quarter was. We’re still on the lookout for a pullback, just like everyone else is at this point,” said Andrew Burkly, market strategist at Brown Brothers Harriman. “I think you end the quarter at least where we are now or even a little higher.”

For the most part, strategists said they see stocks with a positive bias in the second quarter, but as most everyone in the market says, a pullback is likely as stocks head into the seasonal “sell in May” period.

“I think stocks will do better because valuations remain superior…but on a timing issue, I think we may, as the spring advances, have a double dip scare and I think it will hurt stocks,” said Milton Ezrati, senior economist and market strategist at Lord Abbett.

Ezrati said the S&P, up 26.2 percent since October, could lose 8 to 10 percent in a pull back. Yet, he expects the market to finish the year about 15 percent higher from its current level. The S&P was at 1418 Monday, up 10 points.

“I think the strength of the economy was overstated in the first quarter. I don’t think the economy is going into a double dip, but the scare will return. I think some of the numbers are going to disappoint, particularly in housing,” said Ezrati.

“I think it will be pretty short-lived—six weeks or something like that. I think Treasurys will do pretty well them, but that will be a trap,” he said.

A high level of uncertainty about Europe, especially with the French presidential election; the question of how big a slowdown China faces, and the potential that U.S. data could disappoint, should keep a bid in bonds this quarter, said John Briggs, RBS senior Treasury strategist.

“There’s also the question of whether we see more QE (quantitative easing) on the monetary side. Fiscally nothing’s going to get done…None of it tells me we’re at risk for upward yields unless the (economic) data accelerates,” said Briggs.

He expects to see the 10-year yield remain between 1.70 percent and 2.5 percent this year. The 10-yearwas yielding 2.19 percent Monday.

The Fed will also be a major factor for markets this quarter, whether it decides to continue extraordinary easing programs or not. Traders are watching the release of the Fed’s last meeting minutes Tuesday to see if they will provide any tips on whether the Fed intends to end or continue its ‘Operation Twist’ bond program, or whether it will undertake another round of quantitative easing.

The Fed is currently buying longer dated Treasurys and selling shorter term in an effort to keep rates low. That program ends in June.

After its last meeting and Congressional testimony by Fed Chairman Ben Bernanke, the 10-year yield rose toward 2.4 percent because the market interpreted his comments on the economy as more bullish. But that trade reversed somewhat, and Bernanke rekindled some expectations for easing in a speech last week, where he described the problems in the labor market.

Fed easing has helped boost stocks, so stocks could gain, even if it sends buyers into Treasurys, driving yields lower.

“The bond market already is not competing with the stock market when viewed in terms of Treasurys,” said Kevin Ferry of Cronus Futures. “You can see that high yield and investment grade were the key. You’re up 2.5 percent in investment grade and 5.5 percent in high yield. Those are very respectable quarters in what’s viewed as a zero interest rate world.”

But Ferry says, even as “a bond guy,” he thinks stocks are the place to be. And he has said he believes the bond market has seen its low yields.

“I’d rather own equity and monitor your position through the bond market. When you see trouble there is when you start to reduce your exposure in the stock market because it will catch up to you soon,” said Ferry.

Ezrati said a strategy for investors may be to dollar cost average into the equity market this quarter. “Most people have deserted the equity market and failed to put money in. They should dollar cost into the equity market,” he said.

He said said the gains have likely been made in investment grade corporates, which are vulnerable to an uptick in Treasury yields. But high yield investments may continue to provide opportunities.

Follow Patti Domm on Twitter: @pattidomm

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