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Stocks or bonds: Who wins?

Talking Numbers

Stocks and bonds have been trading together recently. But will it last? And, if not, which will come out ahead?

A curious thing has been happening to the markets these days: Stocks and bonds have been trading together. Stocks are near all-time highs but bonds are trading higher, too.

Normally, we'd expect the two to go in opposite directions. For example, when investors are worried about the market, they sell their stocks and run to the safety of bonds. Stock prices go down and bond prices go up. And when bond prices go up, interest rates go down, too, because bond yields move inversely to bond prices.

But, these aren't normal times.

One of the big reasons is the 800-pound gorilla in the room – or, rather, the $85 billion gorilla in the markets. That's how much the Federal Reserve Bank has been spending every month to buy US Treasury and mortgage bonds. Dubbed "quantitative easing" ("QE"), it has helped to prop up the bond market since the start of the financial crisis.

The idea behind QE is that the Fed buys bonds from financial institutions, thereby adding dollars into the financial system. Those dollars would then be loaned out businesses and individuals and stimulate the economy. At the same time, all that bond buying would lower interest rates. Everything will be great until inflation kicks in and Fed would be forced to sell bonds to sop up all those dollars they threw around in the first place.

Except so far, the economy hasn't been stimulated all that much. The Fed was expected to taper QE last month and, for much of the summer, bonds began a huge selloff in anticipation for it. However, the Fed decided against tapering because economic data hasn't been that great. Bonds are now up as investors know they're buying alongside a Fed that's buying every bond in sight. And, stocks are up, too, because they provide a better return on average than bonds right now. Plus, all those newly-printed dollars floating around in the economy have to go somewhere.

So, how much longer can stocks and bonds rise together?

Not for long, says JC Parets, founder and president of Eagle Bay Capital and co-chair of the New York Chapter of the Market Technicians Association. Parets says that while stocks have been at record highs, they've steel traded within a range since May. He believes bonds will ultimately move up, leaving stocks behind. Parets notes that sentiment is fairly negative for bonds as measured by data from Consensus, Inc. As of late, bond bulls are about 27% of the market (see chart below).

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"Sentiment is at ridiculously low levels," says Parets. "We haven’t seen this much hatred for Treasury bonds since early 2011, just before a 50% rally in the TLT [iShares 20+ Year Treasury Bond ETF]."

Parets also sees bond price momentum as a further boost. "As Treasury bonds were making 52-week lows into August, momentum was already turning higher," says Parets. "This is what we call a 'bullish divergence'. And, we've been rallying now for months. Higher lows and higher highs is the definition of an uptrend."

CNBC contributor Gina Sanchez, founder of Chantico Global, says the fundamentals tell a different story.

"I would say without a question bonds are far more overpriced," says Sanchez. "I think bonds are going to give out and they're going to give out in a fiery flare just the way they did the last time. It will be far worse for bonds than stocks."

To see Sanchez and Parets debate on fundamentals and technicals of stocks versus bonds, watch the video above.

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