During periods of economic expansion, bonds and the stock market trade inversely as they are competing for capital. Selling in the stock market leads to lower yields as money moves into the bond market. Stock market rallies lead to rising yields as money moves from the safety of the bond market to riskier stocks. Under these circumstances, when optimism about the economy grows, money moves into the stock market as it is more leveraged to economic growth. Additionally, economic growth also carries with it inflation risk, which erodes the value of bonds.
Interest rates are the largest variable in determining bond yields. Rising interest rates and bond yields are bullish for stocks (and bearish for bond prices), as it implies an increase in the return that investors are seeking for their money. Conversely, falling interest rates are as bearish for stocks as they are stimulative for bond assets and their prices.
However, there are periods in time when bonds and stocks move together. This tends to happen early in economic recoveries when inflationary pressures are weak and central banks are committed to low interest rates to stimulate the economy. Until the economy begins to grow without the aid of monetary policy or capacity utilization reaches maximum levels where inflation becomes a threat, bonds and stocks move tandem in response to the combination of mild economic growth and low interest rates.
Investors and traders need to be aware of economic and market conditions to understand the constantly evolving relationship between bond yields and the stock market.