BOND YIELDS AND STOCKS TRENDED IN OPPOSITE DIRECTIONS PRIOR TO 2000 -- BUT THEY'VE BEEN TRENDING IN THE SAME DIRECTION SINCE THEN ... THE EMERGENCE OF DEFLATION AROUND THE TURN OF THE CENTURY CHANGED THE BOND-STOCK RELATIONSHIP

BOND YIELDS AND STOCKS BEFORE 2000...A lot of attention is being given to what falling bond yields mean for the U.S. economy and stock market.   I've written several books on intermarket analysis that explain the impact that bond yields have on the stock market (and eventually the economy).   In one of my  earlier books, I explained that the relationship between bond yields and stocks underwent a major change after 2000.   Prior to 2000, bond yields and stock prices usually trended in opposite directions.   As a result, falling bond yields were usually good for stocks.  After 2000, however, that relationship changed.  Since 2000, bond yields and stocks became more closely correlated.   That change meant that falling bond yields since 2000 have usually been bad for stock prices.   As I explained at the time, I believed that the emergence of deflationary pressures for the first time since the 1930s changed the bond-stock relationship.   Interestingly, the absence of inflation is one of the reasons that global bond yields have been so weak this year, which suggests that deflationary forces are still in play.   And why falling bond yields are still a negative sign for stocks.

Chart 1 compares the S&P 500 to the 30-Year Treasury Bond yield between 1980 and 2000.  That period begins just after the hyper-inflationary decade of the 1970s when surging commodity prices resulted in historically high interest rates and a generally weak stock market.   The two decades after 1980 saw a period of disinflation which was marked by falling commodity prices and declining bond yields.  That disinflationary environment resulted in two decades of rising stock prices.  The main point of Chart 1 is to show that falling bond yields usually accompanied rising stock prices.   The green down arrows during 1982, 1985, 1991, 1995, and 1997 marked downturns in bond yields.  Those downturns in yields were accompained by rising stock prices (rising black arrows).

The red circles, however, show three instances when rising bond yields resulted in lower stock prices.  They include the stock meltdown during 1987, during 1990 in the months leading up to the first Iraq war, and the so-called "stealth bear market" of 1994. In all three instances, a downturn in bond yields helped resume the secular uptrend in stock prices.

BOND/STOCK RELATIONSHIP CHANGES AFTER 2000...Prior to 2000, bond yields and stocks usually trended in the opposite direction.  Chart 2 shows them trending in the same direction during 2000 and the two decades since then.  A comparison of the first two red circles shows a downturn in the 30-Year Yield during 2000 preceding a similar downturn in the S&P 500 later that year.   [Yields peaked during January; the Nasdaq peaked during March; and the S&P 500 that August].   The second set of circles show bond yields peaking earlier than stocks during 2007 (yields peaked during June and the S&P that October).  Another downturn in yields during 2011 coincided with stock weakness.  And again during 2015.  The latest downturn started late last year, and the 30-Year Treasury yield has fallen this week to the lowest in history (last red circle).  So far, that has had a mildly negative impact on stock prices.  But if recent history is any guide, falling bond yields aren't a good sign for stocks.

THE DEFLATION SCENARIO...What changed the bond/stock relationship starting in 2000 was the emergence of deflationary pressures.   Starting in 1998, the word deflation was heard for the first time since the 1930s.  That happened because of the Asian currency crisis between 1997 and 1998 which contributed to a collapse in commodity prices to the lowest level in 20 years (see Chart 3).   That plunge in commodity prices raised fears that a period of beneficial disinflation could turn into a harmful deflation.

To quote from one of my intermarket books: "More than any other factor, the reappearance of deflation changed one key intermarket relationship that had existed through most of the postwar period.   That intermarket change was that bond and stock prices became inversely correlated.   What was good for bonds after 1998 became bad for stocks.   Falling interest rates during a deflationary period are actually bad for stocks".  (Trading With Intermarket Analysis, 2013).