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.

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