The bond market versus the share market

Of course both markets cannot be right, but, investing is rarely a tidy or orderly process. It would be nice if all the salient factors that could possibly relate to or affect markets could be stacked into a neat equation that would then indicate exactly what would happen next.

We all know that this is not the way markets work and that investing success and forecasting markets comes from weighing up probabilities, digging deep into experience and often just gut feel or instinct.

Nonetheless, this short-term dichotomy between bonds and shares will be resolved some time in the future; the important question for investors though is which way?

Whilst the differing implications of each markets movements may cause some discomfort to investors they should not be surprised; historically markets have always tended to make the maximum number of participants as uncomfortable as possible at any particular time. Additionally we have all been through a remarkably similar experience very recently.

For much of 2002 bond yields and equity markets moved pretty much in tandem, with longer-term rates falling along with equities, as the fear that things would never get any better grew. Both made a low in October of that year and rallied for a few months only to fall back again through the first quarter of 2003. It was in early March that the US share market finally bottomed and started this latest bull market, rallying 25% over the next three months. At the same time as this equity strength was seen, bond yields continued to fall with ten year yields dropping from over 4% to an extreme low of 3.1%. Back then shares appeared to be climbing the proverbial “wall of worry” as the news backdrop was indeed bleak. There certainly seemed more reason for yields to fall, on the failing growth, deflation fear, than for equities to rally. Ultimately the recovery story indicated by equity markets proved more enduring, and right, than the gloomy deflation fear reflected at the time in bond markets.

Obviously the backdrop now is different from that experienced last year, but there are similarities. Over the last seven weeks US shares have enjoyed their best rally of the year so far and yet over the same period bond yields have fallen from 4.6% to almost 4%. It is unlikely that the resolution of this dichotomy will be as clean as last year’s given that we are now some way through this bull market.

Nonetheless it may pay to listen to the signal from equities with slightly more confidence than that from the bond market. Interestingly this seems to be the view of Mr Greenspan, although the bond market is still not so sure.

An excerpt from a recent ANZ Market Focus report

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