Trading Nation

This chart will make you think twice about what’s driving the market

10-year hits lowest level since 2012

Even as Treasury yields plumbed record lows on Tuesday, stocks are managing to hold up nicely — a sequence of events that is all the more unusual given the tight relationship between stocks and rates of late.

In the first half of 2016, the daily moves of the and the 10-year yield have experienced a correlation of nearly 0.6, which indicates a very close relationship between the two.

In fact, the correlation between yields and stocks has risen dramatically over the past few years. In the average 100-session period over the past 20 years, a correlation of 0.2 has been seen. And in late 2013, the correlation was actually negative, meaning that on a day when bond yields fall, one should expect stocks to rise rather than slide.

For context, the moves of crude oil and the S&P have seen a correlation of roughly 0.5 this year.

The tight relationship between stocks and yields makes sense to the extent that concerns about economic strength should hamper stock prices and depress bond yields simultaneously. Unfortunately, 2016 has been chock-full of those concerns. China devaluation and the U.K.'s vote to exit the European Union are the two most prominent shocks that have added to the general state of agitation over long-stagnant global growth.

In addition, concern over when the Fed will next raise rates should also increase the closeness of the relationship. On the margins, a news item that makes a rate hike look less likely might be expected to push bond yields lower, and stock prices higher.

However, the close relationship between yields and stock prices should make investors think twice about at least one piece of conventional market wisdom. If marginal interest in stocks came primarily from exasperation with the low yields offered by bonds, then stocks should rise when yields fall. Instead, the opposite is happening.

In other words, the chart above could be used to make the argument that low yields do not appear to be the market's primary motivator — contrary to those who say central banks are fueling a bubble in equities.

Ultimately, the market makes more sense from a macro-technical standpoint when bond prices (which move inversely to yields) and stock prices are going in opposite directions. After all, investors who are buying the one are assumed to have raised that money by selling the other. From this standpoint, the tightening relationship might be seen as a sign of more normal market conditions.

Meanwhile, the takeaway for the bulls is this: If you're hoping for yields to slide even further, you'd better rethink your wishes.