Bonds are Too Strong

Sometimes you have to know when to fold them. I wasn't expecting this kind of bond market strength on such a normal pullback. The SPX sold off 6% from last Wednesday's open to this Wednesday's open. Normally, that would cause year yields to drop about 15 bps. These are not normal times. The 10 year dropped 40 bps over those 4 days. That is why stocks shot up like it was released from a cannon yesterday. It is also why I eventually closed my short position, albeit a few hours too late, getting too caught up in my long term thinking, instead of focusing on the current picture.
The current picture is a market that is aggressively pricing in low yields for an extended period, even with Powell reluctant to signal a lot of rate cuts.
A strong bond market is the best defense for equity market weakness. It provides a buffer for investors who are making money on the fixed income side to make up for a lot of the losses on the equity side of the portfolio. That makes investors less nervous, and less nervous investors don't panic. No panic, no big selloff.
Here is a summary of some of the SPX pullbacks and bond market reaction since 2018: Feb 2018: SPX 10% selloff, 10 yr +19 bps. Oct 2018: SPX 9% selloff, 10 yr -13 bps. May 2019: SPX 7% selloff, 10 yr -40 bps. Aug 2019: SPX 6% selloff, 10 yr -40 bps.
As you can see, the 2019 market is seeing the bond market strengthen considerably when there is equity market weakness. If that continues, that will make a big selloff very unlikely. But there is good news for the stock market bears: Bunds are trading at -0.56%, 16 bps lower than the current deposit rate. There is very little upside left for Bunds, if you consider that the ECB with an overnight rate of -0.40%, can probably only cut another 40 bps and then will start facing the barrier of alternatives to cash storage in vaults rather than in a bank account if banks start passing on the costs to customers.
Without the Bunds rallying, the Treasuries are on their own, and that requires a weaker US economy with recessionary signs. And strong recessionary signs is a much stricter condition than equity market weakness. So without explicit signs of an impending recession, the days of don't ask, don't tell bond rallies are mostly behind us. That makes the stock market more vulnerable to a big selloff going forward.
Like the first several months of 2015, selloffs are likely to be more frequent but less severe, as the weak global economy keeps equity investors from becoming too optimistic, which keeps the upside limited, at the same time, making the market less likely to selloff a lot, because of the more defensive positioning.