2016’s puzzle: rising bond and share prices

Published on Aug 5, 2016
This week Tim Bennett looks at the forces that have kept bond and share prices rising together and sums up the key risks hanging over the stock market.

bond-yields

:11welcome to this killing explains finance video this week 2016 is puzzle
0:17at least it was a puzzle up the . this video was shot in July rising share
0:21prices
0:22why are they still rising can they keep on rising
0:26I don’t know the answer to the second one we can certainly take a look at the
0:28first now old versus new this is more like an old-fashioned headline if you
0:33like global shares rise bond prices for an investor optimism the old fed model
0:39holds that those two assets
0:40traditionally tend to go in opposite directions but that’s not what we’re
0:44seeing recently
0:45more like something the FT wrote need for yield whatever that is
0:49explain in a moment sends bond and equity prices in lockstep to record
0:53now that’s a bit weird equity then bonds rising together
0:57it’s been happening for some time let’s take a look at it now the Fed model the
1:02old looks like a textbook model says in theory when investors feel confident
1:06they buy equities and sell bonds
1:08all right and equity prices therefore rise and bond prices for or if you
1:12prefer this language bond yields rise while equity yields for and the opposite
1:17is true when investors feel nervous
1:20they tend to buy bonds as a safe haven accepting the lower income return the
1:23safety and dump equities which sends bond prices up and share prices down and
1:31that’s part of the reason why those two assets are seen as natural diversify
1:34fires because they are a bit yin and yang
1:37so bones for example low default risk lower predictable returns in terms of
1:41coupons and so on a steady income and relatively low volatility makes them
1:46quite a useful safe-haven asset equities on the other hand higher not high but
1:51higher default risk higher lesser returns variable income dividends can
1:56get chopped changed and cut and so on and higher short term but manageable
2:01volatility
2:02now recently what we’ve been seeing
2:05well it’s not a lock step back
2:07and you get the idea you can sort of see the two cleaner going up together
2:12up to the point this video is shot anyway so if we took the UK two percent
2:172025 guilt as a benchmark
2:19that’s the line in blue and compared to put you under the line in red
2:23we certainly don’t have the Fed model obviously in play when we do in a few
2:27places like there and there but the overall trend in both case this kind of
2:32upwards will be a whopper the line upwards
2:35now just to recap what’s happening bond prices why do government bond prices for
2:40example keep on rising and this is something that dealt with in other
2:43videos in more detail
2:44it’s a combination of very low inflation even deflation expectations record low
2:49interest rates they’re safe haven stages
2:52people always want to save Haven in times of breaks it
2:55russian geo political turmoil and so on and government buying government
2:59stimulus measures at record levels taking supply of the market question is
3:04what’s been pushing share prices up to
3:08I’m gonna suggest four or five ingredients none of these is probably
3:11the full explanation by itself but combine them and maybe we’re getting
3:14somewhere
3:15number one yield hunger investors need an income stream and let’s face it cash
3:20and bonds really not offering it i mean years ago- in some cases so maybe as The
3:25Economist put it stocks if you’re a yields eager and now the least dirty
3:29shirt on the washing line they do provide yield to release some of them do
3:33in the right hands low discount rates could be a factor to the technical
3:38factors just the fact that if you’ve got low interest rates and they stay low
3:43people suddenly starts a well actually the value of the future income generated
3:47by a company in the form of dividends starts to rise it becomes per se more
3:51valuable
3:52now very simple example if a company was only able to pay one dividend in its
3:56life
3:56a hundred pound
3:57in five years time and interest rate the ten percent and you were thinking let’s
4:01discount that back to what it’s worth today you have around 62 pounds if
4:06interest rates and more at five percent
4:08they’re not but if they were that same coupon is worth more like seven to eight
4:13pounds now so its value is going up a bit and if rates are only one percent
4:17then it’s worth 95
4:19so here’s the point low interest rates are expected to stay low push up the
4:25value of future income and maybe that is one of the factors in terms of pushing
4:30up for sustaining share price rises number three the central bank put people
4:35got used to the idea that central banks will bail them out of trouble breaks it
4:38may be the bank kingdom will reduce rates us growth slows fed reduces write
4:43something goes wrong in china central bank of china steps in something goes
4:45wrong in japan central bank of japan steps and you get the idea
4:49people become used to something called the Greens band put named after the X
4:53chairman of the Federal Reserve you can’t fight the fed and therefore go
4:57with them they’re always step in now how long that can continue for that kind of
5:01country trick if you like some people see it
5:03who knows but it’s worked to date then we have to really friendly
5:08the market kind of game few things were not quite as bad as with all and maybe
5:12people who are betting against shares betting on branches falling
5:15I got a bit fed up this year of constantly losing money
5:18so we’ve had china people thinking will join is slowing or actually maybe not as
5:23fast as we thought that we have breaks it all know what if the UK votes to
5:27leave the EU well it is that exactly what happened but the world hasn’t ended
5:31we have a couple of that relief base rallies and people betting on falling
5:35prices getting out the market
5:37maybe that’s contributed to the rally racing and then there’s the u.s. effect
5:42when the US needs the world catches a cold and people keep expecting us to
5:46sneeze on lower oil prices for example but it hasn’t so in june
5:50we have three pieces of data that reason be positive nonfarm payrolls
5:54manufacturing PMI is and consumers been you know these could turn around
5:58essentially the US doesn’t seem to have a cold at the moment in spike some of
6:03the expectation
6:04around Christmas now I could all go wrong
6:07every silver lining as a cloud so five things to keep an eye on if you like
6:10stocks are relatively expensive pens how you look at this
6:14some people disagree taking warren buffett’s all favorite market cap to gdp
6:18for the US for example or price to forward earnings
6:21yes there is a case for saying stopped look a bit papi
6:25number two uncertainty over China may have gone away a little bit this year
6:29but it could come roaring back again so watch that space
6:32the overall impact of low oil isn’t a hundred percent clear yet it’s still
6:36relatively early days in the kind of low or your world breaks it’s only just