Magazine article Modern Trader

All Alone: Bonds and Stocks Can't Move Themselves

Magazine article Modern Trader

All Alone: Bonds and Stocks Can't Move Themselves

Article excerpt

There is no doubt the bond and stock markets work in tandem to push prices in both directions. The question some analysts are asking is: Can the stock or bond market sustain momentum on its own?

Analysts at the Investment Research Institute studied that very question recently after a Salomon Brothers study showed bond strength preceded stock market advances. Specifically, when bonds performed above their 52-week moving average, the stock market advanced (see "Bonds and S&P correlation," right). The stronger the push in bonds, the better the rerum in the S&P. To most market watchers, the results were nothing new.

"Bonds most of the time lead stocks," says Mike Oyster, senior quantitative analyst at the Investment Research Institute in Cincinnati. "It's not because bonds and stocks move in conjunction with each other and there is a sense of persistence or inertia between the two. But rather, a good environment for bonds produces a low interest rate environment, which is good for stocks."

But in isolating the market, can the stock market keep moving upward due to its own momentum? Investment Research analysts looked at the Dow over 52-week periods from 1970 to 1997, focusing on the points where the index had been above or below the 52-week moving average (see "Dow inertia or bond strength?" below). The study showed the Dow did not continue to rally because of stock market strength over the prior year. In fact, it showed its strongest advances only after extreme periods of selling. Oyster says the price gains are like rubber bands attached to a moving average.


percentage                   SPX return
above moving               the following
average                         year

[greater than]10%                22%
5 to 10%                         18%
-5 to 5%                         14%
-10 to -5%                        8%
[less than]-10%                   6%

Source: Investment Research Institute

"The more the markets move above that moving average, the more tense the rubber band becomes, and it's more likely it will pull back toward that moving average," Oyster explains. …

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