Thursday, November 13, 2008

Equities should follow bonds

It's all one big capital market, so it seems reasonable that whatever fear that afflicts the fixed-income side of the market should also afflict the equity side. This chart shows that the volatility of the fixed-income market does indeed track closely that of the equity market. If anything, the bond market might be a little faster to pick up on things than the equity market, judging by the fact that bond vol picked up a few days before equity vol did in September.

In recent days bond vol has subsided, yet equity vol has spiked (and today the S&P 500 plumbed a new intraday low). Spreads on corporate debt peaked on October 10th, the same day the stock market first collapsed, and it makes sense that both equity and corporate debt prices should have bottomed at the same time. But now we see that corporate debt spreads have fallen meaningfully in the past month (meaning corporate bond prices have risen), yet equity prices have now hit new lows. Maybe it's another example of the bond market leading the equity market.

The equity market typically gets all the attention, but the bond market is just as big and just as important. There's a potentially bullish signal here for the equity market: it should follow the lead of the bond market and chill a little.

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