A recent Morningstararticle offers insights regarding the divergent responses to the coronavirus pandemic by stocks and bonds.
During the second quarter of this year, the article notes that global stocks “rose sharply even as economies suffered record declines,” but bond yields have plunged and stayed low, with the 30-year Treasury yield plummeting dropping from 2% in February to its current 1.25%.
The article offers three possible explanations:
- Equity investors evaluate long-term cash flows, bond investors don’t. “Thus, while stock shareholders have already looked past Covid-19’s existence, bond investors continue to view their assets as they did when the pandemic arrived—as a place of safety during a pandemic.” It argues, however, that such a view suggests, incorrectly, that bondholders are “remarkably stupid.”
- “A second possibility is that stock fundamentals have remained intact, but bond prospects have been permanently altered.” The article characterizes this as unlikely since corporate earnings can hardly be expected to “chug onward for the next few decades as if the coronavirus never struck” if inflation rates and bond yields change considerably.
- Treasury investors are “noneconomic buyers” that own securities for specific reasons and will maintain their positions regardless of market prices. “This is the likeliest of the three scenarios,” the article says, “but even so, it seems a stretch. One would think that if the behavior of stocks and bonds diverges so sharply, that arbitragers would enter on the other side of the trade, to move those asset prices more closely together.”
The article concludes that, while the rational and calm response of equity investors to the this year’s market turmoil suggests a continued and reassuring focus on business fundamentals, “it is difficult to reconcile that comforting interpretation with the performance of high-quality bonds. The two stories do not appear to sum.”