Why What’s Happening in the Bond Market Now Is So Important to Stock Investors

Taper or no taper? When? How much? These are the worries that are currently driving tensions in the stock market on a daily basis. As I wrote in a previous article, no one seems to care that corporate revenue growth is muted and consumers aren’t spending. 

Last week, we saw jobs market data that helps support the Federal Reserve’s reasons to begin tapering its bond buying program. 

The non-farm payrolls reported the generation of 203,000 new jobs—better than the consensus estimate of 180,000 for the month of November. This represented the second straight month that more than 200,000 jobs were created, and while the jobs market has a long way to go, this is positive news. Jobs numbers were revised upwards in September and October. 

Now it may be true that the quality of jobs created could be improved upon, as much of the increase in the jobs market continues to be driven by the service sector and other lower-skilled jobs. However, the results do suggest some action may be taken by the Federal Reserve. 

The unemployment rate fell to a five-year low of seven percent, much better than the consensus 7.2% and October’s 7.3%. The rate appears positive on the surface. 

The Federal Reserve had said it wants to see the unemployment rate fall to around 6.5% before it considers raising interest rates, but with a seven percent rate, you have to wonder if the Federal Reserve is thinking hard about when to rein in its monthly bond buying and reduce the stock market’s dependency on cheap money. 

Yet I don’t think the Federal Reserve will begin tapering until the New Year. No matter if it’s under Ben Bernanke or Janet Yellen, the Federal Reserve likely wants to see more jobs growth before deciding on any actions toward tapering. Should the unemployment rate hold or fall below seven percent in December and January, I would think the Federal Reserve would take that as a signal to begin tapering. 

The consensus feeling is that the Federal Reserve will hold off on any tapering until some time in the New Year, maybe some time in March or June. The central bank wants to make sure the economic renewal is on solid ground prior to tapering. 

The strong third-quarter gross domestic product (GDP) growth of 3.6% reported last week will help to support tapering if it continues at this pace. The reading was well above the estimate of three percent. 

Overall, the stock market will likely continue to focus on when the Federal Reserve will begin tapering for the next months, and this will make for some nervous trading. 

The yield on the 10-year Treasury bond has edged higher to 2.84%, which could trigger some minor selling in stocks. Investors should be mindful of this. 

The chart of the 10-year U.S. Treasury below recently showed the decline in the S&P 500 when yields rose, as indicated in the chart below (the first two blue ovals starting from the left). We are now seeing bond yields rise, but stocks appear to be holding on (as shown by the third blue oval on the far right of the chart).

Chart courtesy of www.StockCharts.com 

If bond yields continue to rise as we move into 2014, we will likely see the stock market decline. You should be aware of this correlation and monitor the direction of the jobs market and bond yields; this will help you decide when to begin to take some money off the table. 

~ by George Leong, B.Comm.This article was originally published at Investment Contrarians