Thinking About Thinking

This topic was raised to me today in a meeting, and after thinking about it, doing some research, and trying to put aside my biased interest in stocks – I think a stronger case can be made that the bond market is more important than the stock market.  There are a number of reasons for this, most notably starting with size.

The global bond market is about $82 trillion.  The global stock market hovers around $40–$50 trillion.  So, on pure size alone, the bond market is almost twice the size of the stock market.  That’s a substantial difference.  Point – bond market.

The bond market has a broader set of issuers as you have different segments: corporate, government & agency, municipal, mortgage backed, and funding.  Whereas the stock market is a construct for a limited set of corporations – for example, the US has 17,000 public companies.  Point – bond market.

The stock market is arguably more influential on sentiment.  What’s the key indicator of the stock market?  My guess is most would say S&P 500 or Dow.  What’s the key indicator of the bond market?  Probably most don’t know (e.g. indexes like Merrill Lynch Domestic Master).  That, in and of itself, gives the stock market a broader reach and voice.  Point – stock market.

That being said, and this may be a reach, but I think the bond market is more influential on the stock market than the other way around.  The primary reason is that the returns on bonds are more predictable due to the fixed yields.  If yields are very high, there’s no reason to invest in stocks.  The comparative risk-reward isn’t there.  But, if yields are low, that’s an incentive to move into risk assets like stocks.  It doesn’t work as seamlessly the other way around because returns on stocks are less predictable and more volatile.  Point – bond market. 

This is hardly a scientific analysis, but based on just off the cuff research, what’s more important – the stock market or bond market?  I’d probably have to go with the bond market.