Research & Advice

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What is the bond market saying about the stock market?

Dalton — In June of 2007, when stock market indices were near all-time highs prior to the Great Recession, I started to short the market (i.e., buy investments that go up in price when stock prices go down). I made that first bet that stocks would go down not because of what I saw in stocks, but because of what I saw in bonds.

To be sure, we were tracking signs in both the economy and stocks before the bond market triggered action. The economy was great, and while breadth was deteriorating (the number of stocks going up were falling), the major indices were at or near all-time highs. But the bond market was getting a bit too wonky for my taste. The final straw was that I was trying sell a Ford bond online and the price wasn’t as attractive to me as I expected it to be. I called the Charles Schwab & Co. trading desk to see if there was something wrong with their online ordering system. Nope. I couldn’t get a good price on a Ford bond, a very liquid bond. And by “good price” I mean a few bucks off. There was no company-specific news to attribute it to. I asked them to get me prices if I wanted to sell or buy some other bonds, and those prices were also askew. Sure, liquidity was drying up as a massive amount of cash was either flowing to stocks or real estate, and decreased liquidity means more volatility. But the liquidity drought wasn’t enough to throw off bond prices overnight. So I shorted the market before the Great Recession and the rest, as they say, is history.

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