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 Federal Reserve rate hikes. 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. The Dow Jones Industrial Average gained 0.6% to 11,352.01, while the S&P 500 ended the day up 0.5% at 1301.78. The Nasdaq Composite 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 Western Refining's ( WNR) offer to buy Giant Industries ( GI) for $1.2 billion. Giant's shares jumped 14.5%, while Western Refining's slid 3.27%. Separately, Kinder Morgan ( KMI - Get Report) 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%. Energy Partners ( EPL) soared 31% on reports that a unit of Australia's Woodside Petroleum wants to buy the company for around $883 million.
Outside of energy, eBay ( EBAY - Get Report) reached a pact with Google ( GOOG) to sell advertising on its international sites, Mylan Laboratories ( MYL - Get Report) is buying Indian drug company Matrix Laboratories for over $700 million and Unilever ( UN) 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%.
"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%.
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.