Of Equity Bulls and Bond Bears

Throughout August, it was a case of equity bears succumbing to bond bulls. Well, the first day of trading in September basically reversed the game. It was the equity bulls who were back in charge, and the bond bears finally started to come out of hibernation. A quick look at the following charts will give you an idea of the kind of divergence we’ve seen in the market of late.

First off, we have a six-month chart of the S&P 500 Index. As you can see, we are right in the middle of a trading range from about 1025 to 1130. Today’s big surge nearly across the board has helped lift the market higher, and that’s good news for what was a really tough August for the bulls.

In contrast, the chart below shows the skyrocketing surge in Treasury bond prices, as represented by the iShares Barclays 20+ Year Treasury Bond (TLT). This fund — as well as the entire Treasury bond sector — really soared in August. In fact, the surge has many observers talking about bubble-like conditions in the bond market.

I think what we could be seeing is the beginning of a reversal of fortune for both stocks and Treasury bonds. Though one day does not a trend make, I certainly think that stocks are way overdue for an extended bounce — and bonds are way overdue for a pullback.

In terms of bonds, it appears as though the market already has priced in the so-called double-dip recession. But what happens if we don’t drop into double-dip territory? I suspect that interest rates (long-term bond yields) will go on a protracted run higher. And, because of the inverse relationship between bond yields and bond prices, that means that the value of funds like TLT could fall precipitously in the weeks and months to come.

My advice to you is that if you have a heavy Treasury bond allocation, then it behooves you to set stop losses on all of your invested positions. You don’t want to get caught in the throws of a busted bond bubble, and the only way to protect yourself from this very possible occurrence is to know exactly when to exit every position you have. The best way to do this is via stop losses, so if you haven’t done so already, now is the time to make sure your bond positions are protected against a pullback.