Last updated: June 16, 2009 8:11 pm

Bond bear markets

Clinton administration éminence grise James Carville once quipped that he wanted to be reincarnated as the bond market because then he could intimidate everyone. Sometimes it is hard to tell though if it is baring its teeth or just smiling, as highlighted by the recent debate between Paul Krugman and Niall Ferguson. Focusing instead on the limited empirical evidence, it is at least clear that the economy’s most forward-looking economic indicator, the equity market, often gets the message wrong initially.

Taking the unofficial measure of a bear market for equities of a 20 per cent decline and applying it to long bond futures, those most sensitive to interest rate expectations, analysts at Bespoke Investment Group identify seven US bond bear markets since 1977. On average, by the time the trigger for the definition of a bond bear market had been reached, about two-thirds of the eventual fall had taken place and, time-wise, the bear market was already four-fifths over. The S&P 500 rallied by 13.9 per cent during the period in which bond prices fell the first 20 per cent, or 11.6 per cent annualised, on average. But the last fifth of the bond bear markets, time-wise, led to annualised equity losses of 13 per cent.

This bodes poorly for the sustainability of the recent 40 per cent rally in the S&P 500. As higher bond yields make financing more expensive and make earnings yields less attractive by comparison, investors have less reason to buy stocks. In turn, the bond bear then ends when a drop in asset prices encourages economic pessimism and expectations that the Fed will relax monetary policy. Today, though, monetary policy could hardly be looser. If yields are really rising due to fiscal jitters then the bond bear may not be sated unless a horrific equity market swoon prompts a new flight to safety back into bonds. Talk about intimidating.

To e-mail the Lex team confidentially click here
OR
To post public comments click here

The Lex column is now on Twitter. To receive our daily line-up and links to Lex notes via Twitter, click here

_________________________________________

Lex is the FT’s agenda-setting column, giving an authoritative view on corporate and financial matters. It is also one of the few parts of FT.com available only to Premium subscribers. This article is provided for free as an example. A Premium subscription gives you unlimited access to all FT content, including all Lex articles and the FT mobile Newsreader.

Subscribe now

If you have questions or comments, please e-mail help@ft.com or call:

US and Canada: +1 800 628 8088
Asia: +852 2905 5555
UK, Europe and rest of the world: +44 (0)20 7775 6248

Copyright The Financial Times Limited 2014. You may share using our article tools.
Please don't cut articles from FT.com and redistribute by email or post to the web.

SHARE THIS QUOTE