Why Equity rises when the Bonds fall? (Ref: 09-049)
Bonds and Equity always have inseparable relationship. They tend to go together - sometime one step back or forward. Rarely they act out of step with each other.
The reason is Bond prices rise, when the interest rates fall. If interest rates fall, the Corporate profit also tend to go up, so the equity market picks up the clue and it rises too. Bonds are the leaders, Equities are the followers.
Further, bond market is several times larger than equity market for the simple reason that large investors are interested in yield, that is rate of return by way of interest. Solid bond investors never touch equity by 10 feet pole.
Of late, however, the relationship is faltering. The equities are rising and bonds are falling - in other words - equities are trying to lead the bonds - but it never happens - at least history shows.
When the banks are marching up in never ending parade of declaring losses into billions, why the equities are rising. The reason appear to be - equities are rising by default.
The mortgage market is almost dead and still worsening, the bond market is still reeling under the stress of sub-prime crisis, the banks are considered the most risky bet to park one's money because no one knows which bank is under water and how deep they are?
The large investors, pension funds, mutual funds, are finding increasingly difficult to find a place to park the money. They know that -
- Bonds are worst bets due to credit defaults.
- Market interest rates are rising. (do not look at FED rates) - not good for bonds as well as equity
- Mortgage markets are still faltering. It used to be one of the world's safest investments - but now - no longer
- Treasuries are not considered attractive, because of perception that FED is done with reducing interest rate. if the rates rise, the treasury yield rises ( or the bond prices start falling)
- Commercial Paper market is also dead.
- Banks are considered unsafe because no one knows how many skeletons are inside the closet.
- Gold, commodities, and food grains have gone up almost twice or thrice - making them risky bests
- the only remaining fort is "equity" so money flows down to equity.
How long this inverse relationship will last? No easy answers. If the credit crunch eases, the bonds will rebound and money which is parked in equities for so long, will flow back into bonds from equity.
So next time, when the bonds begin to rise, the equity may fall, although the equity too has to rise if history is the guide.
This time around, the history will not repeat itself. The excess money now found in equity will begin to flow into bonds from equities. So, when the general expectation is for equity to rise with the bonds, almost reverse will happen. That is called "Market Surprise"
Kalidas, Hong Kong
15/5/2007 |
Online
Moneycontrol 
