Closing Market Report
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Lately, investors have not found refuge in either stocks or bonds
By Ellen Simon
Associated Press
NEW YORK » The bond market loves hard times.
Its conviction that they're coming fueled a bond rally during the past two weeks that helped push long-term interest rates lower, which in turn had the optimists in the stock market buying as well.
Then, this past week, both rallies hit a wall -- the bond market shuddered when the government's employment data was just too good, and stocks pulled back on a series of weak economic reports that cast some doubt on future corporate profits.
Welcome to Wall Street's weirdest marriage.
Usually, stocks and bonds move in opposite directions: Investors flee to the safety of guaranteed yields from bonds when they see dark days ahead for the economy. Stocks usually get pummeled in the process.
On the flip side, when the economic outlook is rosy, investors abandon dull bonds in favor of stocks, which offer a stronger return as the economy grows.
Recently, as both stocks and bonds performed well, many on Wall Street were left scratching their heads and asking which market was wrong. By week's end, when bonds and stocks had given up ground, market watchers were still wondering.
Stocks had a record-breaking October, with the Dow Jones industrial average shattering its previous records and the other major indexes also scoring big gains. Even as they stumbled this past week, stocks didn't pull back too far from their highs. And 10-year Treasury bills wrapped up their longest winning streak in three years, rallying for seven straight sessions before retreating Thursday and yesterday.
What did bond investors love? Signs of an economic slowdown -- a drop in home sales, lower consumer confidence, and softer manufacturing production.
Bond yields move inversely to their price, with the yields falling as the prices rise. The rally sank yields below 4.6 percent. That's quite a tumble, considering that yields had hit 5.24 percent as recently as June.
Those lower yields, in turn, are honey to the stock market, helping to stave off one of the equity market's biggest worries -- a sharp downturn in the housing market.
In the summer, bleak scenarios for housing were fueled by the idea that the Federal Reserve would continue raising its target for short-term interest rates, which would push mortgage rates higher. The result: homeowners with adjustable rate mortgages would see their monthly payments skyrocket, putting them at risk for default.
But the interest rate scenario didn't play out as expected. The Fed paused its interest rate hikes in August and bond yields have effectively eroded ever since. Since mortgage rates correlate to 10-year Treasury bonds, they've stayed fairly level.
"Lower rates will stabilize the housing market sooner and the economy in general," said Alan Levenson, chief economist at T. Rowe Price. "That's going to be good news for stocks over time."
As long as rates are steady -- and the fear in the bond market by week's end was that they might actually start rising again -- there's a good chance we'll see the bond market return to its upswing. The stock market might need a little more convincing before it's ready to join bonds, but the fact is, right now equity investors want to be buying.
Money made cheaper by falling rates has also supported stock valuations by encouraging companies to use debt instead of issuing new stock. New stock issuance dilutes the price of existing shares, but debt doesn't hurt those shares at all.
Citigroup fixed income strategists George Friedlander and Michael Brandes said in a Thursday note that because companies haven't had to burn cash on interest payments, they've had more cash on hand, plus borrowed money, to buy back shares, which they've done with abandon, helping to support the price of the shares that still trade.
Merrill Lynch estimates that buybacks have boosted year-over-year earnings per share in the Standard & Poor's 500 by 2 percent -- allowing companies to report the kind of performance that attracts investors to stocks.