A reader left a quote from Forbes about important it is to watch the bond market for early signs of trouble for stocks. The reader then goes on to ask how one watches the bond market.
I don't think the answer to this question can be simple. The first point to make is that the bond market is not always a stock market mover. There are all sorts of other markets that seem to take turns influencing stocks and at other times none of them really matter. This changes frequently and so the first thing I guess is to pay attention enough to know what, if anything, stocks care about right now.
As far as bonds specifically I tend to take a big picture, long term view. The starting point is that yields are generally low now and have been low for several years. Low yields means prices are high. If prices are high that is the wrong time to risk. Quoting yields on the treasury curve is easy to do. On Yahoo Finance the 13 week is ^IRX, the five year is ^FVX, the ten year is ^TNX and the 30 year is ^TYX.
Those four along with the Fed Funds rate tells you a lot. If you were alive in the 1990s and 1980s you know that today's rates are low by historical standards. So if rates are low don't take a lot of risk. Another thing I write a lot about is an inverted yield curve. An inverted yield curve means something is not right. It does not matter whether you can figure out what's wrong or not, an inverted curve means there is a problem and that is not a good time to take risk in the bond market.
One way to reduce risk when yields are low is to shorten maturity. Another way to reduce risk in the bond market is to have less exposure to emerging market or high yield debt. I am not saying zero exposure, just reduce it in case things do get ugly.
This now introduces the idea of credit spreads. This can be very complicated but the riskier the type of bond you look at the larger the yield advantage should be (simplified example) compared to a treasury of like maturity. The yield advantage is the compensation for taking more risk. When that compensation is poor (IE spreads are narrow) reduce exposure. When spreads are wider the risk taken makes more sense.
I follow the emerging market spread through the Jyske Bank Emerging Market Daily report. I don't really follow junk bond spreads, that is not vital in the current state of the portfolio.
Another place to get bond market info is Bloomberg's bond page.
With what I read and what I see on CNBC World I am on top of the yields of a lot of foreign countries. I fell like this creates a better context for me to understand what is going on in the US bond market.
The point of this post was to try to lay down some building blocks so that then more in depth study can be done by anyone who cares. I have always thought the bond market was very complex. I have learned a lot (relative to where I was starting from) in the last five or six years and would suggest anyone wanting to manage their own portfolio do the same.
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7 comments:
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This is a long, but very interesting read from a hedge fund manager. His take on subprime, CDO's etc.
Another good place for bond data is the markets data bank at the WSJ.
Not as good a a Bloomberg terminal, but pretty good for basic data.
It looks like the subprime mess is bigger than reported and will be with us for a while.
holy crap this article from bloomberg scares the hell out of me. Rodger I greatly appreciate you thoughts on this one.
http://www.bloomberg.com/apps/news?pid=20601109&sid=a0eWRcMYfbqg&refer=home
Commercial Paper Market Roiled With $550 Billion Due
Another dimension to looking at the bond markets are the credit spreads. To me that was the biggest tell (the narrow credit spreads)on the high probability of spontaneous combustion in the credit markets.
The accuracy of the bond markets per se must be held suspect, though. The bond market predicted lots of things last year (perennially expecting a rate cut when one was not to materialize) and was wrong each time.
re the bloomberg link. the numbers are scary, yes.
My own take is that however bad this could be, there will be demand (willingness to buy) some portion of what is coming do. That there would be literally no one willing to buy any doesn't seem right to me.
If so then it becomes an issue of magnitude. My take on all of these threats is that I am braced for discomfort as we have had thus far but do not expect armageddon nor do expect clear sailing either.
"[V]ery complex" as a bond market description would be an understatement. Considering the domestic bond market is the field where Wall Street's brightest play (IMHO), the average investor needs to understand they have no chance of competing there. Emerging markets might be a slightly better target, particularly if an investor has ethnic roots and a first-hand knowledge of the target country's inner workings. This is the only edge I can see that an individual investor may have. But such knowledge could backfire due to the "A little knowledge is a dangerous thing" maxim.
As another market indicator to which even the casual investor should pay attention, bonds are valuable. Looking at, and trying to understand, the bond market simply as an intellectual exercise can also be a great deal of fun.
Roger, more bond articles please. Maybe get a little technical and dirty and scare off your casual user base. I'd be very interested in to hear more of what you've learned over the six or seven years you've been looking at bonds and what were some of the surprises you learned (either the easy way or the hard way.)
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