Can The Bond Market Still Be Trusted?

There is an old saying among traders and investors, the bond market is always smarter than the stock market. We have seen throughout history that whenever yields start to get too high it is a signal that the stock market is in trouble. Traders can look at the recent spike in yields in many of the European markets to see how panic has hit this market when bond yields spiked. These days, the United States Treasury yields have never been lower. The 10 year Treasury yield is now trading around or under the 2.00 percent level since August 2011. Low yields have historically been bullish for the stock market as this tells investors that credit is loose and easy. It has been well documented that the Federal Reserve has kept rates artificially low with its quantitative easing programs and recent Operation Twist program. Can investors still rely on the bond market as a signal that the economy and the stock market are really improving?

The iShares Barclays 7-10 year Treasury Bond Fund (NYSEARCA:IEF) has been in a long sideways trading range since September 2011. The range on this fund is from $106.50 down to the $104.00 level, this is a tight range by anyone's standards. Traders and investors can look at the iShares Barclays 20+ year Treasury bond ETF (NYSEARCA:TLT) and see a very similar pattern. The trading range on the TLT is from $121.50 on the high end and down to $114.00 on the low end. Eventually these side ways ranges will need to break one way or another. If traders look at the current pattern on a daily chart it tells us that both the IEF, and the TLT are likely to make a sharp move higher before a significant break down occurs. These are two charts that traders must keep on the radar for 2012.

Low interest rate environments will usually cause inflation. Inflation is generally bullish for stocks, and commodities. Just look at how the stock and commodity markets have inflated since late December 2012. In 2007, every trader and investor learned that the stock market could not handle yields above the 5.00 percent level on the 10 year Treasury Note. These days the 10 year Treasury yield is trading around 2.00 percent. This tells us that the stock market really cannot handle any elevation or increase in yields. If the yields on the 10 year note begin to trade above the 2.15 percent area that could spell trouble for the recent stock market rally. On the flip side, if the 10 year yield begins to trade below the 1.70 percent level that could also spell panic for the stock markets. In other words the stock market is walking a high wire line balancing act. We can only wonder how long the central banks can keep this going? To their credit the central bankers have kept these markets together every time the stock markets have come unglued.