The Most Surprising Winner in the Dow's Rebound

Hint: It's not a stock at all.

Feb 25, 2014 at 12:30PM

The Dow Jones Industrials (DJINDICES:^DJI) managed to overcome early losses and gain five points as of 12:30 p.m. EST, continuing the impressive rebound that has taken the average up 840 points from its lows earlier this month. Yet the most surprising thing about the Dow's rebound is that it hasn't come at the expense of the bond market, as the 10-Year Treasury Yield (TREASURY: TC10Y) hasn't risen nearly as much as investors expected.

Backward thinking
Coming into 2014, most investors believed that interest rates would steadily rise as a result of the Federal Reserve's drawdown of its quantitative-easing bond-buying activity. With 10-year rates having risen by half a percentage point between late October and the end of 2013, betting on a continuing trend seemed like a reasonable play.

Yet 2014's market correction led to a big turnaround for bonds. Yields plunged from 3% to 2.6% in January, leading bond prices to rise and giving bond investors gains at the same time that their stock-investor counterparts were suffering troubling losses.

As the Dow bounced back from its January losses, though, it would have been natural for bonds to return to their late 2013 levels. Yet at least so far, that hasn't happened, and even as the Dow inches upward today, 10-year yields are on the decline to hit 2.7% -- a tiny move compared to the magnitude of the recovery in the stock market.

What's behind bond yields?
The relative stability of bond yields points to investor uncertainty about the status of the economy. At least so far, stock investors have largely ignored economic data suggesting slowing growth in the U.S., blaming the weather and other temporary impacts and projecting a return to normal conditions once winter ends. That determination is a big part of why stocks have continued to climb even as much-watched indicators such as housing starts and sales would ordinarily raise much larger concerns.

At the same time, though, bonds appear to be giving those economic measures more credence. For instance, today's drop in bond yields came after the latest consumer-confidence reading fell more than economists had expected. Despite the Fed's determination to keep withdrawing from its quantitative easing strategies, bond investors believe the central bank won't want to sabotage ongoing efforts to return the economy to a more normal footing.

How to play low rates
For now, the Dow's biggest winners from low interest rates are likely big banks JPMorgan Chase (NYSE:JPM) and Goldman Sachs (NYSE:GS). Both have extensive exposure to bonds, both directly and in the business they do for their respective clients. A huge rise in bond yields would be dangerous for the banks, but even what could prove to be a temporary return of low rates could lead to a surge in activity among borrowers to lock in attractive financing one final time.

In general, investors shouldn't expect both the stock market to rise and interest rates to keep falling. At some point, bond yields and stocks will likely disengage from each other. So far, though, that largely hasn't happened, and that makes for the most surprising winner in the Dow's rebound this month.

Don't stick with bonds forever
Keep in mind, though, that bonds won't keep rising forever. It's critical to get exposure to the stock market as well, to avoid missing out on huge gains and putting your financial future in jeopardy. In our brand-new special report, "Your Essential Guide to Start Investing Today," The Motley Fool's personal finance experts show you why investing is so important and what you need to do to get started. Click here to get your copy today -- it's absolutely free.

Dan Caplinger owns warrants on JPMorgan Chase. The Motley Fool recommends Goldman Sachs. The Motley Fool owns shares of JPMorgan Chase. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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