Most Popular
1. It’s a New Macro, the Gold Market Knows It, But Dead Men Walking Do Not (yet)- Gary_Tanashian
2.Stock Market Presidential Election Cycle Seasonal Trend Analysis - Nadeem_Walayat
3. Bitcoin S&P Pattern - Nadeem_Walayat
4.Nvidia Blow Off Top - Flying High like the Phoenix too Close to the Sun - Nadeem_Walayat
4.U.S. financial market’s “Weimar phase” impact to your fiat and digital assets - Raymond_Matison
5. How to Profit from the Global Warming ClImate Change Mega Death Trend - Part1 - Nadeem_Walayat
7.Bitcoin Gravy Train Trend Forecast 2024 - - Nadeem_Walayat
8.The Bond Trade and Interest Rates - Nadeem_Walayat
9.It’s Easy to Scream Stocks Bubble! - Stephen_McBride
10.Fed’s Next Intertest Rate Move might not align with popular consensus - Richard_Mills
Last 7 days
Stock Market Brief in Count Down to US Election Result 2024 - 3rd Nov 24
Gold Stocks’ Winter Rally 2024 - 3rd Nov 24
Why Countdown to U.S. Recession is Underway - 3rd Nov 24
Stock Market Trend Forecast to Jan 2025 - 2nd Nov 24
President Donald PUMP Forecast to Win US Presidential Election 2024 - 1st Nov 24
At These Levels, Buying Silver Is Like Getting It At $5 In 2003 - 28th Oct 24
Nvidia Numero Uno Selling Shovels in the AI Gold Rush - 28th Oct 24
The Future of Online Casinos - 28th Oct 24
Panic in the Air As Stock Market Correction Delivers Deep Opps in AI Tech Stocks - 27th Oct 24
Stocks, Bitcoin, Crypto's Counting Down to President Donald Pump! - 27th Oct 24
UK Budget 2024 - What to do Before 30th Oct - Pensions and ISA's - 27th Oct 24
7 Days of Crypto Opportunities Starts NOW - 27th Oct 24
The Power Law in Venture Capital: How Visionary Investors Like Yuri Milner Have Shaped the Future - 27th Oct 24
This Points To Significantly Higher Silver Prices - 27th Oct 24
US House Prices Trend Forecast 2024 to 2026 - 11th Oct 24
US Housing Market Analysis - Immigration Drives House Prices Higher - 30th Sep 24
Stock Market October Correction - 30th Sep 24
The Folly of Tariffs and Trade Wars - 30th Sep 24
Gold: 5 principles to help you stay ahead of price turns - 30th Sep 24
The Everything Rally will Spark multi year Bull Market - 30th Sep 24
US FIXED MORTGAGES LIMITING SUPPLY - 23rd Sep 24
US Housing Market Free Equity - 23rd Sep 24
US Rate Cut FOMO In Stock Market Correction Window - 22nd Sep 24
US State Demographics - 22nd Sep 24
Gold and Silver Shine as the Fed Cuts Rates: What’s Next? - 22nd Sep 24
Stock Market Sentiment Speaks:Nothing Can Topple This Market - 22nd Sep 24
US Population Growth Rate - 17th Sep 24
Are Stocks Overheating? - 17th Sep 24
Sentiment Speaks: Silver Is At A Major Turning Point - 17th Sep 24
If The Stock Market Turn Quickly, How Bad Can Things Get? - 17th Sep 24
IMMIGRATION DRIVES HOUSE PRICES HIGHER - 12th Sep 24
Global Debt Bubble - 12th Sep 24
Gold’s Outlook CPI Data - 12th Sep 24

Market Oracle FREE Newsletter

How to Protect your Wealth by Investing in AI Tech Stocks

Bond Market Math

Interest-Rates / US Bonds Jan 17, 2013 - 10:18 PM GMT

By: Fred_Sheehan

Interest-Rates

This is the year for stocks. So one would gather from the media. The Wall Street Journal offered a lukewarm endorsement on Monday, January 15, 2012, with the headline: "Investors Flock to Stocks - So Far."

The diffident prediction opens: "As 2013 gets underway, one of the biggest questions in financial markets is again bubbling: Will this be the year that investors dump bonds and return to stocks?" The question may have surprised some readers. The S&P 500 has risen 120%, or, at a 21 percent-a-year pace since March 2009. How did stock prices more than double since investors have dumped stocks and bought bonds? A second question: what might we expect of stock market returns if investors stop taking money out of the market and put it in - 40% a year?


Buy NowIn fact, the Wall Street Journal is on solid ground regarding flows between stocks and bonds. A more important question than the one posed, is how did stocks perform so well when they have been so relentlessly sold?

Fruitful as such a discussion may be, that is not the topic here. It is such an important question, though, that the investor returning to stocks should study this paradox before jumping in.

Today, two subjects are addressed. First, the loss of principle lying in wait for bondholders is underappreciated, but stocks will probably do worse.

The Journal mentions "a quirk of bond math" by which "losses are exaggerated when yields are low." This sounds as if bonds are planning a sneak attack, but mathematics has no opinion.

To see why rising bond yields at today's rates is of such importance, we will look at changes in bond prices at different yields. In 1981, when the peak yield on the (20-year) long bond at auction was 15.81%, further deterioration to 16.81% would have reduced the price from $100 (par) to $94.10. Today, the (30-year) long bond that matures on November 15, 2042 comes with a 2.75% coupon payment. It is trading at around 3.00%. This one-quarter percent change causes a similar loss of income to bonds that had sold off by one percent in 1981. If the 2042's were bought at $100, investors would be holding a 5% loss on principle now. (The bonds would be trading at $95.09). When the 2042's trade at a 4% yield, the price will fall to $78.34. At 5%, the loss will equate to a $35% loss ($65.31).

These are not unlikely scenarios. Humanity needs higher rates; "when" is the quadrillion question. Then too, where will the money come from if "investors dump bonds and return to stocks"? New World Records of issuance were set or approached in several bond categories last year. If the flows gobbling up CCC corporates and State of Illinois general-obligation, pension-funding bonds take a deep breath, they may decide a current yield of 4.00% (on the latter) is crazier than buying Webvan at its peak. The first wave may buy stocks but investors who miss the bond peak will be shifting much depleted funds.

The stock market will look unappealing, though. Any significant rise in yield will probably cause greater losses in stocks than in bonds. Historically there is much evidence of this but more important than precedent is the reason the stock market trades 120% higher than four years ago. We must acknowledge the bizarre belief that central banks can prevent markets from falling. They will, at an undisclosed date, lose control of the Treasury market. In fact, they lost control a long time ago. Their bond-buying sprees are at least partially motivated by the knowledge that the Fed is the last dependable buyer of Treasuries. Bernanke is poised over an air shaft.

By Frederick Sheehan

See his blog at www.aucontrarian.com

Frederick Sheehan is the author of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession (McGraw-Hill, November 2009).

Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

Frederick Sheehan Archive

© 2005-2022 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in