Should Stock Averages Be So High?

I often like to compare the 10 year treasury rate to the SPX or other major index to see if things are flowing as they should. I've long believed that rates and stock averages should be correlated as a strengthening economy lifts not only stocks but the demand for money. Thus interest rates. But this is not what we have been seeing.

Rates on the 10-year treasury topped out in April after breaking through the 4% level. The surge was short-lived and for the next three months, rates have dropped hard. First it was the European crisis that caused a "flight to quality" and a run on Treasury securities, pushing rates lower. But since then we have seen the Euro currency trade back up to 130 against the dollar from 119, nearly a 10% jump. Yet interest rates have hardly budged to the upside.

I first started observing this correlation back in 2005 and noted in a different blog how the two were sorely out of line. When stocks crashed though, the SPX came back down to meet the TYX 10 year rate! Again, we see quite a divergence in pathways. Again, is the rate chart reflecting the true reality of the market? Is the world-wide treasury market a more convincing indicator of what is truly going on? Or should we buy into stocks, that rally without much conviction in terms of volume?

I suppose that it's best to be short both the Treasury Market as well as the Stock market. At some point, these two chartlines will again meet up, either by the falling stock market, dropping to meet the low level of rates, or with rates rallying (and Treasuries selling off) to meet the higher stock market average. Or will it be a combination of both?

In either case, such a divergence will probably render the traditional stock/bond diversification methods null and void. With Treasuries already so high, yielding a scant 3% on the 10-year, how much more can they rally should the stock market again collapse? Will we wind up like Japan? with low rates and no growth? This can't last much longer. Which market will give it up the most? I don't know. I remain short, more so the treasuries than the stocks, but none-the-less, I have little confidence in either market.