Morning Note: Who to Trust—Stocks or Bonds?

The stock market is signaling that the bull run is far from over, but the bond market is warning monetary tightening could soon lead to a sharp sell-off. Which market is right?

That was a question for Fast Money Traders Thursday as markets hit new bull market highs and the majority of U.S. corporations reported profit growth for the eighth straight quarter. Technology companies have done particularly well with Apple reporting record profits and revenues last night.

The S&P 500 has risen about 95 percent since its March 9, 2009, low and is showing few signs of stopping. But, the bond market is also getting a bid. Both markets typically don’t rally at the same time given that bonds become attractive when investors don’t expect to receive higher returns from the relatively riskier stock market.

The bond market action shows some investors are anticipating a sell-off due to government budget cuts, explained Joe Lavorgna, Deutsche Bank Chief U.S. Economist and a CNBC contributor.

“The fixed income market believes there are going to be significant cuts in federal outlays in the next six to 18 months such that the economy is going to slow,” said LaVorgna. “Either the stock market is going to be right, or the fixed income market is going to be right.”

The Congress and the White House are debating stiff cuts due to the fast-approaching debt ceiling. U.S. Treasury Secretary Timothy Geithner has said the U.S. will reach its legal debt limit of $14.29 Trillion no later than May 16th, unless Congress raises it. Some in Congress are refusing to do so without significant spending cuts.

This week’s decision by Standard & Poor’s to cut the U.S. debt outlook to negative given its large debt level has also given the spending debate new urgency.

Lavorgna, however, was betting any austerity measures would not dent the stock market soon. “Nothing meaningful is getting done before the Presidential Election,” said Lavorgna. “The stock market is right.”

Lavorgna did urge investors to be cautious as the year progresses, however. Any signs that the Federal Reserve will raise rates will cause a sell-off. The market is pricing in a rate hike in the first quarter of 2012. Lavorgna believes a rate hike could come by the end of this year.

“I would get cautious on the market when the Fed is about ready to actually hike rates,” said Lavorgna.

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