Hey All! Some asked me a good question on the Trading Desk Thread and I thought it might prove useful on this thread...
"Dan, interest rates...we have had a lot of dupes but I dont think this one has been asked yet....the bond market and its relation to the stock market.
Lots of traders will tell you different things and a bond trader (which I am not) could tellyou best. As a sales,options principal and as head trader, I feel pretty confident in my answer below.
The bond market and the stock market (bonds and stocks, herein) are competing products for peoples money. As interest rates on bonds go lower, they become a less attractive investment. You would rather own a bond with a 8% yield than 5%. As interest rates go down, bonds become less attractive and money will go to stocks. Right now, bonds are very low and might not be considered a performing investment and so cash might flow more to the stock market. This also ignores the fact that some investors don't care about perfomance per se, 5 or 8%, they simply want security of their assets in the event of a downturn in the economy or worse. I guess this plays into performance. Whatever their motivation, as interests rate fall, the stock market will do better.
The stock market will also do better with low interest rates and companies can borrow cash to grow at lowerinterest rates, their interest expense is less and thus profits are greater. Investors are more comfortable borrowing to invest and borrowing to spend goods.
Basically, there is a long and endless arugment that some economist somewhere with glasses and a pen in her shirt wouldmake about the deep rooted effects that low interest rates have on theeconomy and the stock market.
As interest rates go down, the market should, not always go up.
Now, what about "bond market getting slaughter, the stocks follow suit". Lets start this way. THE BOND MARKET (the price of bonds) GOES INVERSE TO INTEREST RATES. Here we go....
Lets say you have a bond with a 6% yield. Now lets say interest rates tick up for whatever reason. New bonds are coming out with 8% yield. For the two, the 6 and 8, to be competitive, the 6 will have to be priced cheaper. Very similar to someone with a 1995 HOnda. It willhave to be priced cheaper to be as attractive as a new 1997 honda. Thus as interest rates go up, the bond prices and thus the bond market come down. So if you hear thebond market is DOWN, interest rates are up. If you hear thebond is up, interest is down. And since the stock market sometimes and very often tracks the bond market market, here is the following table you need: (caution it will a sometimes)
INTEREST RATES UP - BOND MARKET DOWN - STOCK MARKET DOWN
INTEREST RATES DOWN - BOND MAKRET UP - STOCK MAKRET UP.
Sometimes the stock market and bond market diverge but often they follow one another. Sometimes stock investors who are the same as bond investors are "interest rate" crazy. Remember the period a few months ago we hinged on Greenspans every words. The concern was inflation and that Greenspan would raise interest rates to curb inflation, hurting thebonds and ultimately the stock market.
Because of the intense relationship betwen the two, All GOOD INVESTORS and definately traders, should know and track each.
I thinkthat bonds quotes cost a lot, but you could use the symbols for the YIELDS on a few instruments. TYX, TNX, and FVX for thirty, ten and five year bonds. If this doesnt work, call the data vendor and ask them for the symbols for them. THIS IS THE YIELD. So if thenumber is red and getting redder (?) that means yields are getting lower and bons are going higher, positive for stocks. If you see it red and then turn green, that is a negative for stocks.
A few months ago, I made great amount of money simply trading stocks based on the bond market. I would watch the bonds whichwere incredibly volatile and when they moved higher, rallying, I would buy big cap stocks. Worked like a charm. I DO NOT DO THIS NOW. the market is not as keyed in on interest rates. They are important, but we dont have CBNC (break it down, tear it apart) with a Greenspan Fed watch every day.
Anyway, when I was at law school, I never ever wanted to be a bit of a teacher. I have always been more of a do-er than teacher, nonetheless, I enjoy posting up here. I hope you found this one good enough.
Regards,
steve@yamner.com |
