The bond market is flashing a major buy sign for stocks, says Jim Paulsen

After a remarkable rebound off December lows, the market rally has hit a snag.

The S&P 500, Dow and Nasdaq just had their worst week of the year with all three down for a fifth day in a row. That's the first time all the indices have been down every day of the week since November 2016.

Worried investors searching for meaning in the bond market and its relationship to stocks may feel vindication after this week.

"The bond yields went down and they just have not come back up even though the stock market has recovered, commodity prices have come back. People wonder whether the bond market knows something that the other markets don't," Jim Paulsen, chief investment strategist at Leuthold Group, told CNBC's "Trading Nation" on Friday.

However, investors reading a negative message in the bond market moves would be wrong, says Paulsen.

Aside from the 10-year yield, he says corporate bond spreads have tightened, suggesting improving credit risk, 10-year inflation expectations have increased, and the MOVE index which tracks bond market volatility is down near its lowest levels ever.

"When you take the bond market's message as a whole, I think it's about as optimistic as the big recoveries we've had in stocks and commodities so far," he said.

Paulsen also sees similarities between the bond and stock market moves so far this year, even though stocks have roared off lows while the 10-year yield has remained below 3 percent. The price-earnings multiple in the stock market has risen back to early December levels, and the earnings yield has fallen; likewise, the price-to-coupon ratio in the bond market has increased while yields have fallen.

"What we're seeing… an upward valuation of both stock prices and bond prices, reflecting the fact that the economy has slowed, inflation pressure has lessened and accommodation by policy officials is back and that requires a higher valuation which is what we're getting in both markets," he said.

Rising valuations give Paulsen reason to believe a recession is not on the horizon. He expects that to become consensus by late summer this year with investors instead becoming more comfortable with a slower growth environment.

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Trading Nation is a multimedia financial news program that shows investors and traders how to use the news of the day to their advantage. This is where experts from across the financial world – including macro strategists, technical analysts, stock-pickers, and traders who specialize in options, currencies, and fixed income – come together to find the best ways to capitalize on recent developments in the market. Trading Nation: Where headlines become opportunities.

Michael Santoli

Michael Santoli joined CNBC in October 2015 as a Senior Markets Commentator, based at the network's Global Headquarters in Englewood Cliffs, N.J.  Santoli brings his extensive markets expertise to CNBC's Business Day programming, with a regular appearance on CNBC's “Closing Bell (M-F, 3PM-5PM ET).   In addition, he contributes to CNBCand CNBC PRO, writing regular articles and creating original digital videos.

Previously, Santoli was a Senior Columnist at Yahoo Finance, where he wrote analysis and commentary on the stock market, corporate news and the economy. He also appeared on Yahoo Finance video programs, where he offered insights on the most important business stories of the day, and was a regular contributor to CNBC and other networks.

Follow Michael Santoli on Twitter @michaelsantoli

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