Like a magician who uses misdirection to distract the audience from what really matters, the possibility of a government shutdown—still to be determined as of press time—took investors’ attention away from the slow rise in Treasury yields.

That’s too bad, because the latter might ultimately matter more for the stock market than the former.

Not that you’d know anything serious happened last week simply by looking at the benchmark returns. The Dow Jones Industrial Average gained 268.53 points, or 1.04%, to 26,071.72—just another all-time high—while the Standard & Poor’s 500 index rose 0.9%, to a record 2810.30. And the Nasdaq Composite climbed 1%, to 7336.38, also an all-time high. The S&P 500 has now closed at a record level 10 times this month, just one short of the record of 11 set in January 1964—with eight trading days to go.

Do you know what else rose to a new high, though not a record one? The 10-year Treasury yield, which closed at 2.639% Friday, its highest since July 2014. The stock market didn’t mind—obviously—and there are many who believe that yields can just keep heading higher without dinging equities, as long as increases are driven by growth and inflation. Others contend that it’s the speed of the move that will determine whether stocks rise or fall, if the 10-year yield does indeed break higher. “The market doesn’t like quick moves,” says Quincy Krosby, chief market strategist at Prudential Financial. “That gives it the jitters.”

Not everyone is so sure. Jim Paulsen, Leuthold Group’s chief investment strategist, notes that bond yields have been trending lower for the past 38 years, and have remained within one standard deviation—a measure of the dispersion of readings from the average—for 72% of that time. Why is this important? The 10-year’s 2.64% yield is now above the current one-standard-deviation mark of around 2.44%, he says. That’s occurred just 12.6% of the time since 1980, but when it did, equity returns were markedly lower than when yields were in the range: The S&P 500 has advanced an average of 2.7% during the 12 months following such an instance, versus an average of more than 10% when yields remain contained within the bands. “The perception of normal rates has come down so much that it might not take a lot to hurt stocks a bit,” Paulsen says.

David Ader, chief macro strategist at Informa Financial Intelligence, takes it a step further: He wonders if you can be bearish on Treasuries—bond prices fall as yields rise—and still be bullish on stocks. He notes that the difference between the 10-year yield and the S&P 500’s dividend yield has widened to about 0.6 of a percentage point in favor of Treasuries. The wider that gap grows, the more enticing bonds will become to investors who still need yield. “My target is 2.85% to 3%,” Ader says. “If we reach that, the equity market will go the other way.”

(Source: Barrons Online)

The perfect year is over, even if it ended on a note of imperfection.

The Dow Jones Industrial Average fell 34.84 points, or 0.1%, to 24,719.22 last week, not big deal. But the Standard & Poor’s 500 index fell 0.4%, to 2673.61, and the Nasdaq Composite dropped 0.8%, to 6903.39, their largest weekly declines since Sept. 8.

Despite ending on a sour note, it’s hard to argue that the year could have gone much better. The Nasdaq finished up 28% in 2017, while the Dow gained 25%, and the S&P 500 rose 19%. And the S&P 500 even managed to finish in positive territory each month on a total return basis—the first time that has ever happened. “You don’t get an easier year than that,” says Michael Shaoul, CEO of Marketfield Asset Management. As we said: perfect.

Following perfection is rarely easy, though the market has been pretty good at responding to big gains with more of the same. Including reinvested dividends, the S&P 500 has returned 20% or more 26 times since 1943, and followed that up with another positive year 20 times, says Sadoff Investment Management. The average return following a 20% gain has been 12%. But four of the six down years—1962, 1981, 1990, and 2000—had one thing in common: The Federal Reserve was “dramatically tightening credit,” Sadoff says.

While no one would describe the Fed’s current tightening as “dramatic,” it has been raising interest rates and would like to raise them a few times more next year. The market isn’t buying it yet, especially as inflation remains so low. But some assets are close to levels that may force investors to rethink their expectations, says Jim Paulsen, Leuthold Group chief investment strategist. He notes that the U.S. Dollar Index is approaching a three-year low—it closed down 9.7% in 2017 after declining 1.1% last week—while the 10-year Treasury yield closed the year at 2.41%, just 0.2 percentage point away from a three-year high of its own.

Even oil managed to close the year at its highest level in 2½ years. If they all break out, especially if they do so simultaneously, more inflation could be building than the market expects, and that would force investors to reconsider whether they want to pay 18 times forward earnings for the S&P 500, Paulsen says. “This year felt like a sweet spot,” he continues. “The question is whether that sweet spot can persist.”

What should we hope for? Not another 2017, says Jason Pride, director of investment strategy at Glenmede. With valuations as high as they are, another year of big gains could stretch them even more, even to levels that trigger a selloff. “We’d prefer to see 2018 be tamer for the market,” he says.

As if we have a choice in the matter.