The 10-Year Yield is Over 5%

One of the classic warning signs of an overheated market is rising bond yields alongside higher stock prices led by gold stocks.
Here’s what happened from July 1986 to December 1987:

The blue line is the S&P 500. The gold line is the Philadelphia Gold/Silver Index (^XAU). To make the chart easier to read, both indexes have been adjusted to 100 as of July 1, 1986. The black line is the yield on the 10-year bond and it follows the scale on the right. It’s hard to believe that yields used to be that high.
Notice how the rise in gold stocks is highly correlated with higher bond yields. This means that investors were selling conservative assets (the bonds) to buy riskier assets (the gold stocks). Many market observers watch these two to get a feel of the market’s optimism.
Here’s the same chart since the beginning of 2005.

Same thing. Money is leaving bonds for gold. It’s not so much that gold is rising, but it’s that gold is rising at the expense of bonds. That tells us that investors are chasing higher returns and they’re willing to take on more risk to do it.
At the same time, more conservative stocks are being left by the wayside. Note what I said yesterday about health care stocks lagging the market.
I’m not predicting a crash, or even a bear market, but I’m taking notice that the market’s attitude is shifting. The yield on the 10-year Treasury broke 5% this morning, and gold is at $600 an ounce.
I thought the market’s reaction to General Electric‘s (GE) earnings report was interesting. GE is the bluest of all blue chips. The company posted earnings of 41 cents a share, two cents more than Wall Street was execting. Yet, the stock fell. The stock is trading at 17 times this year’s earnings, and that’s still too much for some investors.

Posted by Eddy Elfenbein on April 13th, 2006 at 9:41 am

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