Why some aren’t sweating the so-called bond market warning

Many market participants have pointed out that the bond market does not appear to share the equity market's enthusiasm. But according to one strategist, that's no real cause for concern.

As the S&P 500 rises to record highs, the 10-year Treasury yield has remained at rather low levels, and is actually significantly lower on the year. This is all the more surprising given that short-term yields have risen as a result of the Fed's rate hikes, so that the "yield curve" has flattened meaningfully.

The bond market appears to be saying that economic growth will not be particularly strong, particularly in the medium term — an apparent rejection of the optimism that is being baked into stock prices.

It's certainly common to hear it remarked that the bond market is "smarter" than the stock market, which is one of the reasons macro investors often look to the signals that the fixed income world is throwing off. But not everyone is worried.

"The recent 'signal' [the bond market] gave us was terrible," Tony Dwyer, chief market strategist at Canaccord Genuity, acknowledged in a Thursday note.

Yet he turns back to the calendar to March, when the 10-year yield was above 2.6 percent, while first-quarter GDP growth was merely 0.7 percent.

"The bond market was overstating economic optimism early in the year, and now it is likely overstating economic uncertainty," Dwyer wrote. "The truth is the economy simply doesn't move that fast."

In other words, investors should avoid overreacting to what he sees as a likely bond market overreaction.

Of course, from a more practical perspective, low bond yields are good for stocks. The meager returns currently being offered in the bond market mean that equities look that much more attractive.

A common comparison between stocks and bond is made by comparing the S&P 500's earnings yield (earnings divided by price) to the 10-year Treasury yield. Such a comparison shows that stocks have been more expensive 69 percent of the time, according to a Wednesday note from the Wells Fargo global equity strategy team led by Stuart Freeman.

Freeman adds, however, that since he expects bond yields to rise, "the relative attractiveness of U.S. large-cap stocks versus Treasury bonds may deteriorate as we move through the balance of 2017."

If fact, he goes on to note that since "[d]omestic stocks are not nearly as attractively priced versus bonds as they were in 2011 and 2012 ... we moved our U.S. large-cap equity position to [even weight] from overweight earlier this year."

This might serve as a reminder that while rising yields may provide a more bullish signal, it is falling yields that provide the more bullish environment.