It’s inevitable. Although the financial markets cover a broad range of asset classes, stocks always grab the headlines. That’s completely understandable considering that stocks are tied into the equity valuation of leading companies in the world. Yet investors should pay close attention to the bond market, specifically the bond yield.
Unlike stocks, it’s much easier with the bond yield to determine broader market sentiment. This is true because metrics associated with bonds change based on market and supply-demand dynamics.
For instance, bonds have both a market price and a yield, or the interest rate associated with the bond’s ownership. Own a bond for the stated length of time, and you will accrue passive income.
However, if a large and increasing number of people buy the same bond, its ticket price will swing higher due to demand. At the same time, its yield will decline due to the inherent safety in numbers concept. Conversely, this is the same reason why cheap bonds typically have high yields: the bond yield incentivizes the riskier purchase.
Naturally, conservative investors love established government bonds because such entities almost always pack back their debts. But what happens when long-term government bonds receive an influx of buyers?
In that case, the ticket price of those bonds swing higher, while their yield drops lower. Easy enough. But the more difficult – and troubling – component is deciphering their implications.
Bond Yield Is Like Gold
Undoubtedly, defensive motivations drive a significant portion of bond purchases. In this way, the debt market is like gold. My thoughts on precious metals have evolved over the years. Now, I see them not necessarily as intrinsically valuable assets but that other people perceive them as such.
I mean, gold doesn’t do anything by itself: you can’t eat it, you can’t grow plants with it…if the smelly stuff really did hit the fan, gold is almost as useless as cash.
That said, rising gold prices isn’t a great barometer for the broader economy. A healthy economy is one where investors bet on growth, not a coming recession.
In my opinion, the bond yield represents a similar metric or condition. The majority of investors shouldn’t gamble on debt. Bonds are tied to past liabilities. Why equities are exciting is because they largely are emblematic of the market’s potential.
What the bond markets are signaling, then, is that the economy’s next step is a marked decline. In their view, they don’t want to risk money on forward potential when it’s likely we’re headed toward a correction.
And that’s the real risk here when investors focus too much on any one sector.