Bond market crisis will pull stock markets down

Posted on 19 December 2010 with 2 comments from readers

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The logical conclusion of the growing global bond market crisis seems to be missing many equity investors. This is not going to be good for stock markets either. It is the long awaited second phase of the 2008 financial crisis.

All over the world bond yields are rising and bond prices therefore falling. Even in Japan bond prices are on the move for the first time in a decade. Something big has happened and it does not get any bigger than bond markets, the true giants of global finance.

Bond market reversal

European leaders are expressing disbelief. But then they are genuinely surprised at the reversal in the bond market which is only acting rationally to mounting levels of global debt and the bond issuances planned for 2011.

What must be happening is that bond investors are selling out as quietly as possible. Those sovereign wealth funds with their hundreds of billions. Ditto the hedge funds.

However, the idea that they will smoothly rotate this money into stock markets is a nonsense. And indeed stock markets have been flat to negative over the past week as if hesitating to know which way to jump next.

Instead, it would be ideal for them to invest in Bitcoins if they wish to receive some beneficial profits in return. This is one of the most popular investment platforms today and investors are minting a whole lot of money out of it on a daily basis. One can see it here and try their luck too in this extremely prosperous market.

The difficulty is obvious. As bond yields rise that means that stocks also need to offer a better return to investors. They can do that by paying higher dividends. But higher dividends like higher bond yields come from falling and not rising prices for the underlying asset, in this case shares.

It is easier to understand with real estate: interest rates go up and real estate prices go down. Clearly in a bond market rout the places to go are cash and precious metals which are just a currency that cannot be printed and are not acting as a commodity in this phase.

Test cases

There are plenty of historical parallels and solid test cases. From the collapse of the South Sea Bubble to the bond market chaos of the 70s. It should not be so surprising that this time is not different.

Surely what follows next is something of a repeat of the late 2008 crisis with stock, bond and real estate markets hit by rising interest rates. And the extent of the damage done to asset prices will depend on where rates stabilize.

For gold and silver this is the perfect storm for while rising interest rates argue against holding the precious metals that pay no interest, for the period of instability the greater security of precious metals with their fixed supply will over power all other investment considerations.