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195 comments on DrumBeat: July 17, 2007

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Darwinian on July 17, 2007 - 9:21am Permalink | Subthread | Parent | Comments top

Expectations for stocks and bonds don't have to coincide.

Gad, how could you possibly be more wrong? Expectations of the stock market and bonds always coincide. People move into the credit market when they expect equities to fall and vice versa. That is the way it always has been and until the market dissolves into chaos, that is the way it always will be.

That is, if investors expect a greater return from bonds than from stocks, the money will move their investments into debt instruments, both of the government and industrial variety. This always happens when people expect the stock market to fall. But if they expect the equities market to keep on booming, they will move from bonds to stocks, causing interest rates to rise as debt instruments must compete with equities for the investment dollar.

That is exactly what is happening right now. Interest rates are rising as they try to compete with the stock market. You might note that existing debt instruments are falling in price. This is because the price of an existing debt instrument must reflect the current interest rate regardless of the interest rate the instrument was issued at. That is if a $1000 bond pays 4%, then that bond must drop in price until that 4% is really 5% if 5% is the current going interest rate. Of course other things must also be considered like the amount of time until redemption date, at which time the bond will be worth exactly $1000, no more, no less. Your local broker will give you the formula for this and I am sure it can be found on line.

All this is covered in Economics 101.

Ron Patterson

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karlof1 on July 17, 2007 - 10:54am Permalink | Subthread | Parent | Comments top

Why is the word "investor" used when it's very clear the proper word is "speculator"?

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Darwinian on July 17, 2007 - 11:12am Permalink | Subthread | Parent | Comments top

Karlof1, traders in commodities as well as day traders and short term traders in stocks and bonds are usually referred to as speculators. However, by a wide margin, most equities as well as bonds, the buyers and sellers are usually investors. If you have a mutual fund then you are an investor. If you hold a stock or bond for over six months then you are referred to as an investor.

Clearly it is a matter of semantics but by a very large margin, most equities are held by investors and institutions owned by investors. Of course it probably would be better to say "investors and speculators" but if one chooses to use only one word, concerning equities, then investors is the better word.

Ron Patterson

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ferd mertz on July 17, 2007 - 11:31am Permalink | Subthread | Parent | Comments top

institutions may be long term investors, but shorter term price trends have increasingly been set by hedge funds and (per Bill Cara) HB&B- humongous banks and brokers, i.e., the goldman sachs of the "investment" world. stock margin is at an all time high on the NYSE, yen carry trade is enormous, derivatives growth is exponential, etc, etc, this is the engine of speculation. currently there are so many exponential blowoff stock charts it boggles the mind! the rational mind that inhabits TOD would probably agree that financial markets are and have been in a speculative frenzy. further, if inflation is running around 5% which even the Economist asserted, then longer term u.s. treasuries hold no value currently, particularly given the public statements of weimar ben.

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jbunt on July 17, 2007 - 2:05pm Permalink | Subthread | Parent | Comments top

jbunt

karlof - I guess that taking money from under the mattress is speculating!

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elwoodelmore on July 17, 2007 - 9:46pm Permalink | Subthread | Parent | Comments top

karlof, i "get" your post. given the current stock market bubble, it would appear that these "investors" are mostly of the greater fool variety.

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dVincent on July 17, 2007 - 12:56pm Permalink | Subthread | Parent | Comments top

Ron-

Although I thoroughly enjoy reading your contributions to the threads, I do not believe that your bond vs stock assessment is entirely correct.

There are times when stocks and bonds rally together, as in a time of 'soft landing scenario' expectations (Jun '06- Nov '06). There are times when bonds sell off and stocks rally ('99, '87- through Sept, '07). Here are two graphs, sorry i don't have better examples:

http://charts3.barchart.com/chart.asp?vol=Y&jav=adv&grid=Y&org=stk&sym=T...
http://charts3.barchart.com/chart.asp?vol=Y&jav=adv&grid=Y&org=stk&sym=S...

I also believe that the future of bonds is venturing more into uncharted water as it is in the best interests of our largest trading partners (China, Japan, etc) to recycle dollars back into the 'system' to enable their trade surpluses to continue. I believe that to be the lynchpin in the fragile balance as opposed to the theoretical 'investor' who switches between stocks and bonds.

Also, the market is ruled by funds who largely do not switch between stocks and bonds until the 'investor' redeems, and my experience has been that investors switch to bonds After stocks decline/begin declining.

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Darwinian on July 17, 2007 - 2:02pm Permalink | Subthread | Parent | Comments top

dVincent, what you say is often true but it is the exception rather than the rule. That is, the market will often move up despite rising interest rates. When this happens there is usually something else, something very bullish moving stocks.

Traders watch interest rates like rabbits watching a hawk. Witness the market everytime the Fed raises or lowers interest rates. When the announcement is made, sudden spikes usually mark his decision.

The stock market just loves low interest rates. This means credit is very easy to get meaning people will be buying houses, cars and all kinds of stuff. But if money gets tight, the housing market drops off, profits drop off and the market will plunge.

But of course all these things take time. In the short run, anything might happen. But in the long run, stocks and interest rates move in opposite directions.

Again, the market can move up in the face of rising interest rates but it does this despite the rising rates and not because of them. And if interest rates continue to rise this will eventually have a devestating effect on the market.

Ron Patteson

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jbunt on July 17, 2007 - 2:11pm Permalink | Subthread | Parent | Comments top

jbunt

Well, for every 100 people there are 100 theories. Mine is: If there is no cost for money, i.e., a zero interest rate, you will eventually get deflation. This is because it costs a business zero to borrow and expand. So, overcapacity of all material things occurs. See, e.g., Japan for the last 15 years.

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dVincent on July 17, 2007 - 3:11pm Permalink | Subthread | Parent | Comments top

Ron-
I agree, and am afraid rates will continue to rise despite all MSM market gurus that expect rates to fall. We are in the early innings of a structural shift away from high investment flows into financial assets and little into hard assets (rig construction, mine expansion, etc.) The cycle historically continues for over a decade and is accompanied with higher interest rates. This time it is likely to be the end game.

Regarding your comment on the next OPEC meeting (Sept) ... the call has gone out for more crude (IEA) and the backwardation of the oil curve expecting more crude from OPEC, what a meeting that will be!

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