Stocks gained Monday on their favorite combination of news -- lower oil prices and a flurry of M&A activity. Meanwhile, the bond market remained pessimistically positioned for an economic slowdown, no inflation and an end to
The tiebreaker in the financial markets' tennis match could be any of the week's important data points, including revised second-quarter GDP, July personal consumption, nonfarm payrolls and the August ISM manufacturing index.
Dow Jones Industrial Average
gained 0.6% to 11,352.01, while the
ended the day up 0.5% at 1301.78. The
closed up 0.95% to 2160.70.
Fueling the rally in stocks was news that Tropical Storm Ernesto will sidestep the Gulf of Mexico, which sent oil prices down 2.6% to close at $70.61 per barrel. Natural gas fell nearly 10%, or 69 cents, to $6.47 per million British thermal units.
The market was also cheerful about the robust merger activity, including
offer to buy
for $1.2 billion. Giant's shares jumped 14.5%, while Western Refining's slid 3.27%.
agreed to be bought out by a group led by its co-founder Richard Kinder for $15 billion plus $7 billion in assumed debt. The company's shares gained 2.5%.
soared 31% on reports that a unit of Australia's Woodside Petroleum wants to buy the company for around $883 million.
Outside of energy,
reached a pact with
to sell advertising on its international sites,
is buying Indian drug company Matrix Laboratories for over $700 million and
said it would sell part of its European foods business for about $2.2 billion.
eBay and Google each rose about 2%; Mylan's stock fell 1.6%, while Unilever's gained 1.1%.
As the stock market elevated Monday -- albeit in light volume -- the bond market remained blue about the economy. While yields inched upward ever so slightly, Treasury investors continue to bet on an economy slow enough to stamp out inflation and on a Fed not planning to raise rates anytime soon.
"The bond market is trading like it is bulletproof," says Bill Hornbarger, chief fixed-income strategist at A.G. Edwards in St. Louis. "I think the bond market is ahead of itself."
The 10-year and five-year benchmark Treasury bonds fell 3/32 to yield 4.79% and 4.77%, respectively, while the two-year note dropped 1/32 to yield 4.87%.
The problem with the bond market's view is that it doesn't leave room for any good news, and the economy is certainly not on an obvious highway to recession. Also, the reliability of the bond market's gloomy message may be complicated by both structural and technical factors, as well as the increasingly heated global economy -- the "X" factor that makes this economic cycle different from those that came before it.
"The bond market has rallied really far really quickly, and from a short-term perspective, I think we're overdone here," says Anne Briglia, senior fixed-income strategist in UBS Wealth Management. While UBS does not predict any more Fed tightening, "the risk does remain," she adds.
The fed funds futures market puts the odds of another rate hike in September at about 10%, but those investors put 50% odds on another rate hike by the end of this year. Another tightening "makes these levels look a bit rich," says Briglia.
The risks to the bond market are not just in another Fed rate hike. This week's data provides plenty of possible potholes for the market. A couple of indicators that surprise on the upside could turn the market on a dime, sending yields on the 10-year back to 4.9% or 4.95%, says Briglia.
James Paulsen, chief investment strategist at Wells Capital Management, writes that the bond market is not paying inflation signals much respect, but adds that the bond market has often misread inflation. In the late 1990s, core inflation was lower, he writes, but bond yields were over 6%, and in the early 1990s, core inflation was near current levels while bonds yielded over 7%.
"The actual core inflation environment has changed little in the last 15 years," he writes. "Rather, 'inflation respect,' reflected in the current level of bond yields, has diminished." Paulsen warns that a bullish bond market surrounded by rising inflation that gets no respect "may represent a dangerous investment."
Indeed, it is difficult to find anyone that thinks the bond market is right on target. Even perennial bond bull PIMCO's Bill Gross said on Aug. 4 that the 10-year note was a bit overvalued -- and that was when it was yielding 4.89%.
While many are quick to hold the inverted yield curve -- when longer-dated Treasuries yield less than shorter-dated maturities -- as a clear predictor of recession, its track record is not stellar, as
reported here. Over the past 60 years, parts of the yield curve have been inverted 52% of the time, according to Lehman Brothers. Last I checked, there haven't been 52 recessions.
Aside from that, long-duration Treasuries are being snapped up by pension managers who need to match their liabilities to their assets, and by foreign investors, just as the supply of long-duration bonds is shrinking. In 2002, the average Treasury bond maturity was nine years, and last year it fell to six and a half years, says Briglia. "Structurally, the curve is flatter than maybe it should be," she says.
Foreign buyers are also piling into U.S. Treasury bonds. The latest data show that foreign private investors bought $32 billion in U.S. Treasuries in June, up from $21 billion in May and compared with an $8 billion outflow in April, according to Treasury department data.
"Every cycle unfolds differently," says Hornbarger. "Global capital flows are this cycle's story."
Lastly, fund managers are re-benchmarking their portfolios this week to account for the reopening of the 30-year Treasury bond and its inclusion in the Lehman bond index. This means fund managers that benchmark against the yield curve will have to buy 30-year bonds, which will likely send its yields further down from Monday's 4.93%, says T.J. Marta, fixed-income strategist at RBC Capital Markets. Meanwhile, two- and five-year bond yields will likely climb, as the Treasury is issuing more bonds this week in those durations, he says.
That will result in a further steepening of the yield curve. It seems anyone's guess if that's really something to worry about.
In keeping with TSC's editorial policy, Rappaport doesn't own or short individual stocks. She also doesn't invest in hedge funds or other private investment partnerships. She appreciates your feedback. Click
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