Trading with Intermarket Analysis

CHAPTER 14

The Link between Bonds and Stocks

This chapter covers the important link between the bond and stock markets. It shows how the positive link between bond yields and stocks has existed over the last decade, and how falling bond yields have usually led to lower stock values. Falling bond yields, and lower stock prices, favor dividend‐paying stocks, many of which are considered to be defensive in nature. That includes consumer staples and utilities, both of which do better in a climate of rising stock market volatility. Not all bond categories are the same. High‐yield corporate bonds act more like stocks than bonds. It’s possible to lose money in bonds. The effects of Quantitative Easing and Operation Twist on markets and the yield curve will be studied. TIPS and gold often trend together. Stocks and bond yields diverge at start of 2012. The asset allocation pendulum favors stocks over bonds entering 2012.

■ The Two Markets Compete for Investor Funds

The relationship between bonds and stocks is a very important link in the intermarket chain. Those two markets continually compete for investor funds. When investors are optimistic about economic trends, they favor stocks. When they’re pessimistic, they favor bonds. Investment portfolios generally include both asset classes, but not always to the same degree. A standard portfolio usually allocates 60 percent to stocks and 40 percent to bonds. As one grows older, it’s advisable to reduce the stock portion and increase the bond ...