tag:blogger.com,1999:blog-6704573462403312459.post3653330470423012661..comments2024-03-28T06:53:23.473-04:00Comments on Moneyness: The bond-stock conundrumJP Koninghttp://www.blogger.com/profile/02559687323828006535noreply@blogger.comBlogger13125tag:blogger.com,1999:blog-6704573462403312459.post-58716968515251109612015-04-01T19:05:58.352-04:002015-04-01T19:05:58.352-04:00"Perhaps, then, we could at least agree that ..."Perhaps, then, we could at least agree that the "pessimism" approach is intellectually inconsistent in the absence of market inefficiencies."<br /><br />Agreed. <br /><br />I think your observation is a good one, that's why I wrote the post. <br /><br />JP Koninghttps://www.blogger.com/profile/02559687323828006535noreply@blogger.comtag:blogger.com,1999:blog-6704573462403312459.post-69773509054847616252015-04-01T12:49:15.000-04:002015-04-01T12:49:15.000-04:00Perhaps, then, we could at least agree that the &q...Perhaps, then, we could at least agree that the "pessimism" approach is intellectually inconsistent in the absence of market inefficiencies. <br /><br />It seems the vast majority of economists, including Janet Yellen, toss around the "pessimism" argument without, apparently, giving much thought to the contradictory behavior of risk asset prices. So far I've only seen your attempt to provide a consistent explanation. I really appreciated it despite my objections. Diegohttps://www.blogger.com/profile/18084671738464414141noreply@blogger.comtag:blogger.com,1999:blog-6704573462403312459.post-88307349848730708752015-03-31T12:50:24.603-04:002015-03-31T12:50:24.603-04:00Diego, the problem here is most of the questions w...Diego, the problem here is most of the questions we are debating require data that cannot be observed. You mention break evens, but TIPS are a fairly lousy indicator of inflation expectations since the signals they generate suffer from the very same liquidity disturbances I am using to generate concurrent bull markets. That being said, I don't think a lack of data means we must assume an I'm with stupid approach, or some sort of mass inefficiency. It seems to me that at best we'll have to both stay silent on the concurrent bull market phenomena until we get more data.JP Koninghttps://www.blogger.com/profile/02559687323828006535noreply@blogger.comtag:blogger.com,1999:blog-6704573462403312459.post-68754748988687809572015-03-30T19:05:42.024-04:002015-03-30T19:05:42.024-04:00JP,
I think we're dealing with mathematics her...JP,<br />I think we're dealing with mathematics here. Stock prices doubled in the four years between mid-2010 and mid-2014. Small changes in inflation expectations cannot account for that mathematically; and, in fact, the 5yr b/e was 1.8% at the beginning and end of the period. Similarly, liquidity premia are not likely to be high enough such that their (unobserved) expected decline would drive a doubling of stock prices. <br /><br />I would say focus on the big picture: stocks doubled, bond yields are abnormally low. Cash storage costs, inflation expectations and liquidity expectations can theoretically account for movements in stocks and bonds; they cannot account for the movements observed. Diegohttps://www.blogger.com/profile/18084671738464414141noreply@blogger.comtag:blogger.com,1999:blog-6704573462403312459.post-40232343759260188072015-03-30T10:38:43.643-04:002015-03-30T10:38:43.643-04:00Good comment, by the way. :)Good comment, by the way. :)JP Koninghttps://www.blogger.com/profile/02559687323828006535noreply@blogger.comtag:blogger.com,1999:blog-6704573462403312459.post-31042850261086594732015-03-30T10:33:14.076-04:002015-03-30T10:33:14.076-04:00The use of a work-around is mainly a device to pro...The use of a work-around is mainly a device to provide a way to think of all the other gears that are operating behind the curtains. But we can bring real growth expectations back in.<br /><br />Falling inflation expectations can explain some of the stock bull market. A slight improvement in real growth expectations since 2010 could explain the other. This would otherwise cause a fall in bond prices, but the same decline in inflation expectations that helped drive the stock bull market could offset this effect. Improved liquidity in markets gets us closer to twin bull markets. <br /><br />(You may not be fond of this last effect, but keep in mind that an asset's liquidity return is an expected return, much like expected inflation or earnings, involving the discounted flows of liquidity returns far into the future, and is unfortunately not observable. We can only depend on anecdote so much.)<br /><br />Lastly, to get the large drop in bond rates that you describe, you need something like a supply shock to bond liquidity services, ie. austerity and QE. (ie. my second last paragraph). This may finally bring us into agreement, although you refer to this "distortive" monetary policy in your comment whereas I see it as just a secondary effect of monetary policy. JP Koninghttps://www.blogger.com/profile/02559687323828006535noreply@blogger.comtag:blogger.com,1999:blog-6704573462403312459.post-9949258320254402842015-03-30T08:23:11.739-04:002015-03-30T08:23:11.739-04:00Let's pretend that I work for the Federal Gove...Let's pretend that I work for the Federal Government and have some money to invest after paying all my obligations.<br /><br />I consider investing in either the bond market or the stock market. As a small investor, I am most likely to buy either a bond or stock that is being sold by someone else. I am bidding up the price of either the bond or stock sufficient to meet the sellers expectations. <br /><br />Because I am bidding up the price of both investment vehicles, I am driving down the yield of both instruments. <br /><br />I also reflect that to pay me the wage I receive, Government is borrowing and running a deficit year-after-year. This action year-after-year must result in more bonds and more money floating around in the entire macro-economy. Clearly, alternate investments such as real property and equity in stocks does not increase in supply as quickly as the potentially possible increase in supply of money and bonds. The discriminating investor might therefore consider that a potential inflation factor could be applied to real property and equity in stocks, but not to bonds or money. Bonds or money are the drivers for inflation, not the candidate for revaluation.<br /><br />Returning to the post premise that bond prices and stock market prices are a prediction of future economic growth, I think the premise is incorrect. In my example, I am simply saving part of my wages in a vehicle that I hope will return more future money than zero (from saving but not investing in a vehicle). My action says nothing about future economic growth.<br />Roger Sparkshttps://www.blogger.com/profile/01734503500078064208noreply@blogger.comtag:blogger.com,1999:blog-6704573462403312459.post-31520882141589274462015-03-29T22:02:10.340-04:002015-03-29T22:02:10.340-04:00Okay, fine. See ya later...Okay, fine. See ya later...johnhttps://www.blogger.com/profile/01628063779348336042noreply@blogger.comtag:blogger.com,1999:blog-6704573462403312459.post-32200523112002955822015-03-29T16:08:19.047-04:002015-03-29T16:08:19.047-04:00I see your point on the "pessimism" argu...I see your point on the "pessimism" argument. Your post is a work-around. The first problem with the work-around is, in the bigger picture, the net movement in inflation expectations over the four years leading up to the oil price collapse was minor. Hard to point to this as a driver of a massive bull market. <br /><br />The second problem with the work-around is the level of real bond yields: they are around 200bp (or more during the four year period) lower than they were throughout Japan's "lost decade", and they are at historical lows barring other periods of Fed intervention in bond markets, or high-inflation periods. The "pessimism" argument is, first and foremost, an attempt to explain this anomaly. My response is this thesis must, by necessity, ignore asset price movements, or it would have to argue (illogically) for a massive market inefficiency to exist. Unfortunately, your post does not address how booming asset prices can correspond with real yields that are normally associated with a lack of positive NPV investment projects in the economy. For this, one has to turn to the distortive effects of monetary policy (although, I remain open to other explanations!). Diegohttps://www.blogger.com/profile/18084671738464414141noreply@blogger.comtag:blogger.com,1999:blog-6704573462403312459.post-61011009133584209012015-03-29T15:18:55.136-04:002015-03-29T15:18:55.136-04:00"Also, in your inflation discussion you state..."Also, in your inflation discussion you state the assumption of a constant real growth rate expectation. This is inconsistent with the "pessimism" explanation for low yields."<br /><br />That's the whole point. I'm generating twin bull markets w/o having to rely on growing pessimism (or optimism) over real growth. <br /><br />"Inflation expectations have remained range bound."<br /><br />In the US 10-year expected inflation has come down from over 2% to 1.7%. I'm sure its fallen more in Europe.JP Koninghttps://www.blogger.com/profile/02559687323828006535noreply@blogger.comtag:blogger.com,1999:blog-6704573462403312459.post-16095014745392509982015-03-29T14:59:56.727-04:002015-03-29T14:59:56.727-04:00"Depending on the duration of these legacy pr..."Depending on the duration of these legacy projects, their values should rise. It so happens that our largest companies often own near-permanent monopoly projects that have relatively small investment opportunities. These projects surge in value in a low-growth low rate world, since they are essentially high yield low risk bonds."<br /><br />So where were all the blue chip companies who's share price surged in fall 2008 and early 2009 when GDP growth was lowest + declining the fastest?<br /><br />"It would be more interesting to ask why risky and insubstantial equities are also rising."<br /><br />Part 2 of my post on inflation expectation's role in stock price formation can be used to explain the rise in both quality and no-so quality equities along w/ bond prices. JP Koninghttps://www.blogger.com/profile/02559687323828006535noreply@blogger.comtag:blogger.com,1999:blog-6704573462403312459.post-72648257722421124632015-03-29T13:28:12.024-04:002015-03-29T13:28:12.024-04:00JP:
"today's concurrent bull market patt...JP:<br /><br />"today's concurrent bull market pattern"<br /><br />I suppose it depends on what you mean by "today". Since 2010, stocks have boomed while yields have remained at historically low levels. Inflation expectations have remained range bound. Most of the liquidity improvements you cited in your earlier post occurred long before the current period. I challenge you to find an asset manager that believes market liquidity has actually improved in the past few years. Therefore, neither liquidity nor falling inflation expectations can explain the concurrence of low nominal and real bond yields along with a historically strong risk asset rally. <br /><br />Also, in your inflation discussion you state the assumption of a constant real growth rate expectation. This is inconsistent with the "pessimism" explanation for low yields. <br /><br />Unfortunately, I'm still left with either a massive market inefficiency (nowhere in evidence) or distortions caused by monetary policy. <br />Diegohttps://www.blogger.com/profile/18084671738464414141noreply@blogger.comtag:blogger.com,1999:blog-6704573462403312459.post-70275749443778377092015-03-29T09:12:05.085-04:002015-03-29T09:12:05.085-04:00It's easy to see why bond yields fall with inf...It's easy to see why bond yields fall with inflation or GDP. It is less obvious why also equities. <br /><br />It has to do with the fact that a company is a portfolio of projects and options on new projects. <br /><br />Low GDP is just saying that new projects are few and the yields are low. But coming into such a situation means that previous projects were made at higher rates and yields. Depending on the duration of these legacy projects, their values should rise. It so happens that our largest companies often own near-permanent monopoly projects that have relatively small investment opportunities. These projects surge in value in a low-growth low rate world, since they are essentially high yield low risk bonds. The lack of opportunities cause those yields to accumulate, as we all notice. <br /><br />It would be more interesting to ask why risky and insubstantial equities are also rising. It's not hard to understand why quality has done well. <br /><br />johnhttps://www.blogger.com/profile/01628063779348336042noreply@blogger.com