Correlation Between 10-Year Yield and S&P500 Is All-Time High

and it's a good thing, according to Bloomberg.

Fear Feeds Greed With S&P 500 Correlation to Bond Yields Highest on Record (Whitney Kisling and Elizabeth Stanton, 6/27/2010 Bloomberg)

"U.S. stock prices are mirroring government bond yields more than ever, a signal to bulls that shares may be poised to rally.

"The Standard & Poor’s 500 Index and 10-year Treasury rates posted a correlation coefficient of 0.8412 in the 60 trading days through June 16, showing stock prices and bond yields were the most linked in Bloomberg data going back to 1962. The last time the relationship was almost this strong during an economic expansion was at the beginning of the 2002 to 2007 bull market, when the benchmark gauge for U.S. equities doubled.

"Rising correlations show investors are ignoring relative values among industries and assets and reacting to day-to-day signals on the economy, convinced Europe’s debt crisis will spur the second global contraction in three years. Invesco Ltd., Wells Capital Management Inc. and Chemung Canal Trust Co., who together manage $957 billion, say those concerns are overblown and shares will advance as the fastest profit growth since the mid-1990s restores confidence." [The article continues.]

The article notes that the correlation is also strong between the stock market and the commodity market.

Traders have noted that the stock market simply mirrors the forex market recently, particularly currency cross that involves euro (EURUSD and EURJPY mostly, and EURCHF occasionally).

Whereas the Bloomberg article says this strong correlation is a precursor to a strong bull market in the equities, Mark Steele, BMO (Bank of Montreal)'s Quant/Technical Research came to the opposite conclusion with his Focal Points he issued on June 2, titled simply "Go to Cash: Facts and Fiction".

Steele notes the high correlation between different markets- S&P 500 and Asia Dollar Index, Western European default risk and Asian default risk, Asian default risk and crude oil, forex market and default risk, CDS of Bank of America and Spain's Santander almost looking identical, etc., and he senses a danger. A big danger.

In the summary section of the "Plain English" version of the report, Steele says:

"We advocate switching out of equity positions and going to cash. The European sovereign debt crisis appears to be nowhere near over. The global credit environment is worsening. Cost of capital is going up and availability is going down. There are large gaps between where the credit market prices risk and where the equity market is priced. Equity is lagging the deterioration in credit conditions. Moves in currency, equity and commodity markets are mirroring the moves in the credit market. Global growth, in a credit-constrained environment, will slow. Profits will be squeezed by the higher cost of capital."

Who to believe? Clearly many retail investors, particularly after the 'flash crash and dash' of May 6, seem to have decided to stop worrying by yanking their money from the stock market, as seen by the mutual fund flows.

Tweet