Monday, April 5, 2010
RELATIVE VOLATILITY OF STOCKS & BONDS
This post concerns the volatility in the US Bond Market relative to the US stock market. In particular, why is it that volatility is currently higher in bonds than in stocks? Does this mean anything? To be honest, I am not sure, but I can lay out some possibilities.
First, the “flight to quality” as economic armageddon approached was significant, unique, and had never been seen before. Worldwide money flows initially went into US bonds and dollars, but I still think the level of uncertainty is high regarding credit conditions in the US. Given all the money that was pumped into the system the fear of higher inflation lingers. Others feel that anemic economic conditions will dampen inflation and inflationary expectations. My opinion is that most people do not understand or appreciate the magnitude and reality of what has really happened over the past few years. The bond market is also trying to figure everything out, thus the higher volatility.
Second, very little to nothing has been done. America just borrowed more money, threw it at the problem, and continued as if nothing has happened. America may have trouble financing its problems into the future. The bond market has noticed this and I believe it is another reason for its higher relative volatility.
Third, America needs to get its fiscal house in order. How we are perceived by the rest of the world is reflected in our markets. How we handle our economic problems matters. Markets are affected by many variables, but two of the most significant factors are confidence and perceptions. These are human emotions driven by many things, nonetheless, they can easily change. Lower confidence is a result of higher uncertainty. In my opinion, lower confidence and negative perceptions of the US have also contributed to the higher relative volatility of bonds to stocks.