Tuesday, August 09, 2011

Global Debt Crisis: Rotation from Global Equities ($7.8 trillion losses) to Bonds ($132 billion gains)

The global debt crisis experienced another rotation: Global equity markets posted whopping losses estimated at $7.8 trillion as bonds gained $132 billion.

From Bloomberg, (bold emphasis mine)

The worldwide retreat from stocks and commodities following Standard & Poor’s unprecedented cut of the U.S. AAA credit rating has driven the value of the global bond market to a record high.

The market value of Bank of America Merrill Lynch’s Global Broad Market Index has increased $132.4 billion since the end of July to $42.1 trillion, the most in data going back to 1996. The index, containing more than 19,000 bonds sold by governments, banks and the world’s biggest companies, returned 1.09 percent this month as yesterday’s stock rout wiped out about $2.5 trillion in global equity values, extending total losses since July 26 to $7.8 trillion.

While S&P said the credit worthiness of the U.S. was diminished when it cut the rating to AA+ on Aug. 5, Treasuries have surged. The yield on the benchmark 10-year note dropped today to as low as 2.27 percent, the least since January 2009. Investors are seeking the safest assets amid growing concern that debt crises in the U.S. and Europe and a manufacturing growth slowdown in the world’s two biggest economies may cause the global recovery to falter.

Point is: there always will be a bullmarket somewhere. This functional rotation should also take into the context the actions of gold, the Japanese Yen and the Swiss franc whom have, like bonds, has served as ‘flight to safety’ assets.

Nevertheless, this puts into perspective the negative correlation of bonds and stocks.

Minyanville’s Howard Simons observed of this widening bond-equity correlation in June and wrote,

Interestingly enough a rolling three-month correlation of returns between the two indices shows we are at a level normally visited only during a bear market. As the bonds’ returns are rising and stocks’ have been falling, we must conclude the debt claim on corporate cash has become quite expensive while the equity claim has become cheaper. Who is the starry-eyed cheerleader now?


The present state of affairs can be restated as bond investors over-paying for the perception of safety and stock investors underpaying for a dollar of dividend income. Viewed on this basis, stock investors remain chastened while bond investors are eager participants in a bubble driven by excess financial liquidity.

I add my two cents

Asset correlations changes over time. Negative correlations between bond and equities become pronounced during sharply volatile markets (today-the equity markets).

I guess this correlation should apply with other assets such as gold too. This should give us windows to trade developing correlations or correlation trade.

Next, Mr. Simons’ observations resonates more today than in June where stocks have been heavily oversold while bonds have been sharply overbought.

Finally, if this has truly been about a debt crisis, then both bonds and equities should have been equally in a downturn. Bond vigilantes would have haunted debts of nations whose paying capability has been put to question.

Such dissonant actions tell me that financial markets are either confused (distorted by heavy interventions) or has not been telling us the entire story.

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