Michael Lewitt: Financial markets are experiencing a significant divergence in 2014 between the direction of stocks and bonds.
While the S&P 500 and Dow Jones Industrial Average have traded to new record highs, the yields on benchmark Treasury bonds have dropped sharply.
Normally, one would not expect stock prices to rise and bond yields to drop simultaneously because these movements suggest contradictory readings of the economy.
Higher stock prices indicate bullishness about economic growth, while lower bond yields suggest just the opposite.
However, the inconsistent signals being sent by markets are not as surprising as they seem, given the context of the post-crisis environment in which Federal Reserve policies have distorted normal market pricing mechanisms.
This situation could blindside investors who don’t see it coming…
Signs of Growth Are Appearing
Investors are being forced into riskier investments such as stocks and high-yield bonds in order to generate returns.
Investors have become confused about what constitutes risk.
They now believe that investments such as Treasurys and other government bonds, which offerminiscule nominal returns in a low-inflation environment and negative returns in a normalized or high-inflation environment, are low risk.
They are going to learn, to their detriment, that such investments are actually high-risk when central bank policies designed to suppress normal market functions fail to accomplish their goals, unleashing hyperinflation.
The latest government data shows that the U.S. economy shrank at an annual rate of -1.0% in the first quarter. Consensus estimates were much higher. While many observers are attributing slow first-quarter growth to bad weather, other factors contributed to poor economic performance.