Mind the gap: why the bond markets are signalling a depression
Something potentially momentous has happened in financial markets in the past two months.
By Jeremy Warner
Published: 6:00AM BST 08 Jul 2010
16 Comments
FTSE 100
Virtually unnoticed, the yield on long dated pan-European sovereign debt has slipped below that on equities. So what, you might say; that's what happens when shares go down and bonds go up. But in fact this reversal in the traditional relationship between bonds and equities is an extraordinarily unusual event. It's happened only three times in the past 50 years. Alarmingly, all three of those occasions have been in the past decade. What are markets trying to tell us?
There are two ways of looking at the phenomenon. Either it is an aberration, and therefore a buy signal for stock markets, or much more worrying, it marks the final death knell for Europe's 60-year love affair with equities, and therefore the start of a generalised retreat from risk that will see the economy stagnate or worse for perhaps decades to come.
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We need shock and awe policies to halt depressionI'm an optimist, so I tend towards the former view, but even I would concede that the situation looks ominous; a double-dip recession in either the US or Europe continues to seem unlikely, yet the odds are shortening fast. If the economy starts to contract again, there are plainly highly negative implications for corporate earnings.
But before exploring these two scenarios in more detail, first some historical context. Rewind in time to 1947 and something equally momentous occurred. That was the year in which the Imperial Tobacco pension fund was advised to switch all its assets out of gilts and into equities. Thus was born, for the UK at least, "the cult of equity".
It took a while for the new religion to take hold, but by the late 1950s, it had become the prevailing investment orthodoxy. Over time, it was figured, equities would always outperform bonds because unlike bonds, both dividends and capital would appreciate with inflation and economic growth. As a consequence, the yield on shares has been lower than on bonds pretty much ever since. Investors have become very comfortable with that relationship and tend to regard anything else as abnormal.
On any longer term perspective, however, it's not abnormal at all. Up until 1959, the reverse had been true. For most of the last century and much of the previous one too, equities had consistently yielded more than gilts to compensate for their supposedly higher risk profile. It was only after 1945 that modern portfolio management turned this idea on its head by postulating that higher risk investments would also deliver higher rates of return over time.
Mind the gap: why the bond markets are signalling a depression - Telegraph
Hey..........Im 50 years old this year............first time in my life I am seeing any news of the possibility of a "depression"
. But what, me worry? After all, the k00ks say everything is so rosy!!!!!
