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By Matthew Coffina, CFA | 05-28-2014 02:00 PM

How to Handle the Markets' Mixed Messages

The stock market remains very bullish on the economy, but the bond market is telling investors to be cautious.

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. Are the stock and bond markets sending mixed signals? I'm here with Matt Coffina, editor of Morningstar StockInvestor newsletter, to take a look at this topic.

Matt, thanks for joining me.

Matt Coffina: Thanks for having me, Jeremy.

Glaser: Let's start with the signals that the bond market is showing right now. What has that market looked like recently, and what do you think that means about what the bond market expects for the economy?

Coffina: I think going into 2014, a lot of people expected a steady rise in long-term interest rates. We ended 2013 at about 3% on the 10-year Treasury, and we've seen the exact opposite so far in 2014, where at this point the 10-year Treasury is yielding about 2.5%.

In other words, investors have changed their mind and decided that instead of gradually rising long-term interest rates, long-term interest rates have been falling, and keep in mind that long-term interest rates really reflect investors' expectations about future short-term rates.

So to the extent that long-term interest rates are down, that means that investors think that short-term rates maybe aren't going to start rising as quickly. They're not going to be as high three, four, and five years from now as they previously expected.

Glaser: What does that mean then?

Coffina: I hate to say it, but I think it's not good. It means that the bond market is telling us that interest rates are not going to be higher in the future, which presumably means that the economy is not going to be all that strong. You'd expect if the economy really started to pick up strength, inflation pressures would start to build and sooner rather than later the Federal Reserve would be in a position where it would have to start raising short-term interest rates.

I think the bond market is telling us that inflation still isn't a concern, and economic growth is going to be fairly weak for the foreseeable future.

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