Many years ago stock and bond prices used to move in opposite directions. That is, as panic set in on the stock market, people would turn to bonds for safety, thereby actually driving down the yield.
Ever since 1974, when interest rates were astronomical, the assumption has been more or less that dropping bond prices (i.e. rising interest rates) will depress the stock market. The Fed has been using interest rates for many years as a way of helping to hold down inflation.
But what if we get a deflationary stock market crash? At some point all these folks with money in stock mutual funds, having seen them go down drastically, might turn to bonds, or at least to money market funds. This would push interest rates down, and bonds could actually rise in the face of a prolonged stock market decline.
In other words, at some point stocks and bonds could become uncoupled and no longer rise and fall in tandem.
The Fed is hardly likely to do anything to raise interest rates if the stock market is sinking drastically, and especially if business conditions (profits, sales) deteriorate. It will then be the "pushing on the string" time. The Fed is much better equipped to restrain things than to stimulate them. In Japan, I understand, there is an almost zero interest rate and it isn't helping stimulate the economy.
I never thought about this possibility until I heard that John Templeton was buying bonds. A couple of points decline in interest rates could produce some pretty nice capital gains in bonds, right in the middle of a terrible bear market in stocks. Especially when both monetary and fiscal policy remains mostly disinflationary.
But in the short term the perception still is that if interest rates decline the stock market has to go up, since that has been going on for 23 years. It may be time to consider the possibility of what has already happened in Japan, of stocks going down and interest rates coming down, too.
Che sera sera! |
