Bonds, Stocks and Inflation

Discussion in 'Economics' started by trading1, Jun 19, 2009.

  1. Regarding the question of inflation (say inventorys supply continue to drop and demand picks up and theres a lag and inflation develops), you'd expect bond yields to go up, but also stocks to go up as pricing power returns. What happens when both stocks and bonds yields go up, as you expect them to clash with one another. Or, what did happen in the 70s. Any advice on this is appreciated.
  2. Firstly, doesn't the fact that bond yields are going up imply that bonds are, in fact, going down, rather than up? Secondly, where does it say in the Good Book that stock and bond prices can never go up together? I am not entirely sure what you mean by "clash". Finally, in an old old thread here I think I have posted a piece that looked at the performance of various asset classes during the previous periods of runaway inflation.
  3. Thanks for pointing that out, I meant yields.
    Stocks and bond yields going up together actually is my question, I am sure they can and do go up together, I'm just wondering about circumstances when they do both rise together. It is that performance of various asset classes during the previous periods of runaway inflation that I am interested in. I think its very topical at the moment, or will be.
  4. Daal


    Inflation will drive earnings up(and probably dividends as well) but usually interest rates rise(bonds go down) which means stock valuations(PE ratios) go down. This was the case in the 70's
  5. sjfan


    This will certainly happen in an inflationary environment (typically in the late expansionary phase of the economy). As you correctly pointed out, since companies can partially pass inflation on to its customers, equity is somewhat hurt by inflation. But bonds are clearly certainly harmed by inflation, so their yields will rise.

    This is quite a common situation that's not particularly shocking.

  6. Does a rise in bond yields in these circumstances attract investment funds away from stocks, and lower the stock market? Is there anyway to gauge the likelyhood of this. Or, is the diversion of funds from stocks into bonds not really an issue (perhaps because bonds are not really more attractive than stocks in these circumstances).
  7. I've thought about this a lot of times and I can't seem to understand why stock valuations should decrease in times of high inflation.

    Any asset should be valued as:

    Cash flows / discount rate

    The increase in cash flows for businesses should, on average, exactly offset the increase in interest rates whether or not there is an increase or decrease in the money supply.

    If there is 1 business in the economy and you double the money supply, the earnings should (ceteris parabis) double and the discount rate should also double since the price of holding onto any given dollar (instead of investing it in an inflating asset) has also doubled.

    My guess is that highly inflationary periods correlate with efficiency-hindering events (i.e., excessive government interference, protectionism, etc) and therefore we generally see price declines when there is high inflation.
  8. sjfan


    No. Because while yield is higher, chances are real return (yield - risk free, which has inflation built in) is diminishing.

    That being said, there might be retail flow into bonds at that point given mutual fund investors don't really understand real return. Or, investors may gamble that rates will drop in the future and go long at an attractive point.

    But overall, higher yield usually means outflows from bond, not inflows.

    And no, there's no clear cut consequence when bond yields and the equity market "diverges"

  9. I agree with the other posters here, esp what PI said about equities. The only thing that's quite clear is that nominal bonds are a very bad investment during times of high inflation, pretty much regardless of how cheap they become (yield rises). Other asset classes, such as commodities, equities, property, fare better, to one extent or another. You can look at a couple of specific cases in the piece I was referring to.