Bond Vs Equity Market Action

The divergence between equities and debt is still striking. The disconnect between the two markets is astonishing. One of them is right and the other is wrong. My money is always on the debt market as it is run by professionals while the equities markets are run by armatures.

Debt markets in the last quarter of 2008 were shut and yields skyrocketed for any debt instrument expect for US treasuries while equities still reflected recovery in earnings in 2009. Debt prices correctly priced the deleveraging occurring in the world since beginning of 2008 while equities did not. Now it is almost the reverse. Debt has recovered and High yield and high quality deals are being made, in relative terms to no deals in late 2008. In addition yields on US treasuries have increased to above 3% recently from the lows of 2% in late 2008. Bond investors are beginning to look for buy more risk while equity investors are running from it.

There is a possible conclusion to draw from this is the bond investor is beginning to allocate funds to riskier assets classes as they are looking for things to normalize somewhat. The willingness to take risk by bond investors may indicate the sell offs in stock markets are overdone.

On equity valuation basis the market PE (adjusted for 10 year earnings and inflation) is around 12 now, far below the historical long term averages. However as noted before is some of my posts this can go to the single digit as market overshoot on the upside and the downside as well. From these levels it will not take much for the S&P PE ratio to be in the single digit territory, maybe another 20% from current levels.

The investing environment for the long term is looking better and better. Although there are many challenges, serious ones, I think selling or shorting now is a terrible risk/ reward proposition. I think it will take time for a return to a bull market but the market prices is setting the base line for favorable action for the long run.

The 10 year yield has gone up considerable from it lows in late December.

Please observe action of of the S&P 500 and the LQD, ETF for high grade corporate bonds. Equities have declined by more than20% while debt rallied by 7% over the same period. The same story can be found in high yield and bank loans.