The stock market gets A LOT more attention than the boring bond market. If one didn’t know better, you’d think that the stock market was much bigger and more important than the bond market. More on that below. First, an extremely short primer on stocks and bonds:
- If you own shares of stock in a company you are a “Owner”. You have an equity ownership interest in the company. You have a right to the residual profits to the extent distributed and you have the lowest tier liquidation rights of the company. Publicly traded stocks trade on exchanges. Stocks can (and overall usually do) appreciate in value.
- If you own a bond you are a “Loaner”. Bonds are debt instruments issued by corporations and governments. Each bond has a maturity date and pays interest. Bonds do not generally trade on exchanges, instead they are traded directly between financial institutions. Corporate bond interest is generally required to be paid and bondholders have distribution priority over stockholders in the event the company is liquidated. Bonds to not appreciate – you get back par value (in absence of default).*
The market value of the bond markets are MUCH BIGGER than the stock markets. 2016 Values from the SIFMA Fact Book:
U.S. Publicly Traded Stocks: $27 Trillion
U.S. Bonds: $40 Trillion
Global Publicly Traded Stocks: $70.1 Trillion
Global Bonds: $92.2 Trillion
It is often said that the Bond Market is smarter than the Stock Market (with good reason). The bond market is viewed as providing good insight into the future state of the economy by the shape of the yield curve (which is the conglomeration of bond yields at various maturities). An inverted yield curve, which means short-term rates are higher than long-term rates, has correctly predicted the last seven recessions going back to the late 1960’s. The last two times the yield curve inverted was in the years 2000 and 2006 before each of the last recessions.
The stock market, while also somewhat of an economic indicator, is a more emotional and volatile market and mid-cycle sell-offs, which are common, are easily confused as signals of impending recession. Great quote by David Rosenberg: “Did you know that the stock market has predicted 27 of the past 11 recessions?”
*You can sell your bond at a gain or loss before maturity – usually determined by interest rate movements and/or changes in the credit quality of the issuer – but that is a different concept than appreciation.