For the past few months, the stock market has been behaving like a reveler who's had just a little too much to drink, and the bond market has been behaving like the guy who wants to take away the stock market's car keys.
We should probably listen to the bond market.
The broad S&P 500 stock index has rallied 22 percent since early October, recently hitting its highest level since early July. The narrower Dow Jones Industrial Average recently hit its highest mark since May 2008. And the technology-laden Nasdaq Composite index recently climbed back to a level not seen since December 2000.
The stock market is suggesting that American investors are shaking off many of the fears that hammered stocks last summer and early fall -- namely, Europe's debt mess and our own shaky economic recovery.
The bond market, on the other hand, suggests those fears are alive and well.
The 10-year Treasury note is a key gauge investors watch to measure investors' appetite for risk. When bond prices are high, it means that investors are scrambling for the relative safety of U.S. government debt. When bond prices are low, that often means people are putting money in riskier assets, or at least that they're worried about an outbreak of inflation, which often accompanies stronger growth.
Bond prices right now are very high. One way to measure Treasury bond demand -- a way that most normal humans can relate to, anyway -- is by looking at the bond's yield. This is the interest rate you’re getting paid to lend money to Uncle Sam. When that interest rate is low, it means Uncle Sam is having an easy time getting you to lend money to him, which means lots of people want to own his bonds.
Recently the yield on the 10-year Treasury note was a shade below 2 percent, not far from the lowest levels since at least the 1940s.
When bond yields are low, it means that bonds are expensive to buy. It means investors are willing to give up some future interest income in order to get an investment that will hopefully not take all their money and set it on fire, as the stock market has a nasty habit of doing.
In fact, demand for Treasurys is so strong that investors in most Treasury debt are accepting interest rates that don't even keep up with the Fed's targeted inflation rate of 2 percent, as Bloomberg noted on Monday.
Bond investors apparently are not at all worried that a money-pumping Fed or some future sudden burst of strength in the economy will drive inflation through the roof and make their low-yielding bonds worthless.
The stock market may not exactly be priced for runaway growth, either, but it is priced for faster economic growth than the GDP growth rate of 1 percent to 2 percent that is likely in the first quarter of 2012, Lombard Street Research analyst Charles Dumas wrote on Monday.
The stock market is not a proxy for economic growth -- corporate profits can grow strongly even when the economy is sluggish, and that can help lift stocks. But market-watchers are increasingly worried that companies have managed to squeeze all the profit growth they can get by laying off workers and closing plants. That means they'll need actual sales growth -- which does depend on a stronger economy -- to keep profits, and the rally, growing.
This is not the first time the bond and stock market have sung different tunes about the economy. Last spring, a noticeable disconnect between bond yields and stock prices signaled the near-term top in the stock market, as Matt Phillips of the Wall Street Journal noted presciently.
The gap between stocks and bonds is far, far bigger today. It is also arguably wider than it was in late 2007 and early 2008 -- another period in which bond yields fell well in advance of stock prices falling.
The bond market could be sending a false signal this time. High bond prices today at least partly reflect expectations of another round of bond-buying by the Federal Reserve, as Bloomberg suggested.
But we won't get another round of bond-buying from the Fed without more disappointing economic data, and the bond market suggests we could be due for some disappointment.