Market Insider

Stocks versus bonds—One market could get pounded

Traders on the floor of the New York Stock Exchange.
Jin Lee | Bloomberg | Getty Images

Stocks and bonds could duke it out all summer, with both markets wooing buyers even as they flash different messages about the economy.

The stock market's daily drift to new highs and the low yields in the bond market are setting up an environment of complacency that some traders fear is setting up for turbulence.

But as much as some strategists look for an end to the low volatility at some point, they also say it could continue for a while and the summer doldrums may not turn into a summer slugfest without a real catalyst. They also point out that low rates are a positive for stocks, with low yields more favorable for corporate borrowing.

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"Does one have to be right, or can they both be right?" said George Goncalves, head of interest rate strategy at Nomura. "I don't know if it's even a battle. If it was a battle, it's like slow motion punches that miss each other."

The S&P 500 Monday rose 1 point to a new high of 1951, and the Dow rose 18 to a new high of 16,943. The U.S. 10-year yield was higher, meanwhile, at 2.61 percent.

Key to the next major moves will be the Federal Reserve and whether it sends any new message when it meets next week that traders can use to build on their outlook for rate hikes. The economic data is also important for what it says about the economy's pace of growth, widely expected to improve after a negative first quarter.

Watch retail sales

The big data this week is retail sales on Thursday, and there is also wholesale trade for April at 10 a.m. ET Tuesday. The NFIB small business survey is at 8:30 a.m., and the JOLTS survey on job openings and layoffs is released at 10 a.m.

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"If retail sales come in on the weaker side, then the Fed will have to acknowledge that growth will not be 3 percent, it could come in with a 2 percent handle," Goncalves said.

U.S. yields are being pushed lower along with yields on European bonds, which have fallen as investors react to moves by the European Central Bank to stimulate lending and battle low inflation.

The yield on the Spanish 10-year fell below the U.S. 10-year yield and was at 2.58 percent Monday afternoon, and the spread between the German bund and the 10-year widened.

"I think it makes all the sense in the world that one would naturally say I'll take the U.S. bonds at 2.61 percent," said John Stoltzfus, chief market strategist at Oppenheimer Asset Management.

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Stoltzfus says he likes stocks at this point, and the S&P may make his target of 2014 before the end of the year.

"I think stocks are a better value. I think the knee jerk reaction has always been back to bonds," he said, adding he thinks the rally in the small cap names is sending a positive message for the overall stock market.

He also sees the economy improving, and the stock market is responding in turn.

"I don't think it's contrived. I think it's recognition of the fact with things in as much transition as they are right now," said Stoltzfus. "You have the effect of (Fed) tapering stateside. You have (ECB President Mario) Draghi going to charge banks on the amount they deposit with the ECB overnight…It creates an environment that creates dislocations and dislocations are often times counterintuitive to what one might expect."