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Bond Market Flashes 'Warning' for Stocks

NEW YORK ( TheStreet) -- The relationship between stocks and bonds is a useful way to gauge investor sentiment. Those two markets tend to have a negative correlation most of the time, but not always.

The debt market dwarfs that of equities. (Most people assume the stock market is larger.) So many times during intraday trading, I can "see" the tug of war between bonds/notes and the S&P 500. More often than not, I will side with the bond market because, in my experience, bonds tend to be "right" more often. Not only can monitoring these types of correlations help with intra-day trading, but they can also be useful for longer-term traders and buy-and-hold investors.

Current market conditions are a prime example. Although the S&P 500 has been holding around the 1,400 handle and bonds are off recent highs, the December 30-year bond futures have held an uptrend line when they bounced off the 150 handle on Friday's and Monday's sessions.

The market is also trading above all its key moving averages. Yields on 30-year bonds can't seem to break out above 3% and a move in yield back down near the 2.5% mark certainly is a distinct possibility should panic return to the markets over any one of a number of large issues (fiscal cliff, Greece, etc). Ten-year notes are stuck in a range from about a 1.6%-1.9 % yield, with yields threatening to break to the downside as well.

Now, what does this information tell us? Does the bond market indicate that all is well in the world? It certainly does not. Right now, Treasuries are flashing a warning sign that I feel should not be ignored. Does this mean you should start bailing on good equity positions? Of course not.

What it does mean, however, is that a very large market still feels there is a lot of danger right now when it comes to stocks and risk assets. This is certainly a piece of information that I feel investors ought to consider when looking at adding to positions at these levels or chasing the market higher.

I, for one, would certainly be a lot more comfortable with the prospects of higher equities if I was seeing any "real" weakness in bonds and notes. In addition, volatility in Treasury options is quite low right now, indicating to me that the market for the time being is "in balance" and a large reversal in the near future is unlikely.

This could potentially indicate the S&P 500 will run out of gas in the near future. After all, bonds have not broken with everyone chasing the S&P 500 higher, and eventually something will have to give.

The bond market is simply part of an overall road map to investing and, in my opinion, it is something that every stock investor should be in tune with. Pay attention to its signs, and your ride in the market may be less bumpy.

Futures and options trading is inherently risky and unsuitable for all investors. Past performance is not necessarily indicative of future results. Stop-loss orders intended to limit losses to certain amounts may not be effective because market conditions may make it impossible to execute such orders.

Commodity Futures Trading Commission disclosure for licensed brokers: This material is conveyed as a solicitation for entering into a derivatives transaction.
Matt Zeman is a trader at Kingsview Financial. He began his trading career as a runner in the grain pits at the Chicago Board of Trade before becoming an arbitrage clerk. Eventually he started trading equity options and stocks. Matt now is a full-time futures broker. He has been a frequent guest on CNBC, Fox and Bloomberg, and provides his views on the stock, bond and futures markets for financial media including Dow Jones, the L.A. Times and The Associated Press. Matt is a member of the Chicago Board of Trade, and carries series 3, 7 and 66 licenses.

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