The Myth of Diverging Markets

Economist James Hamilton makes a good, and what should be obvious, point:

I often hear stories along the lines of, "the bond market doesn't expect inflation but the gold market does." But this makes no sense. Markets are fully integrated, and there's no reason why somebody with a particular world view wouldn't try to grab spectacular returns wherever they might be found. If you think that U.S. inflation is going to be substantially above 2.5%, there's no question that you want to go long TIPS and short the nominals. If gold and bonds are sending conflicting signals, it has to be due to some fundamental differences in the conditions under which the two assets will perform.

For example, if you were worried about a surge in prices that was not that strongly correlated with the CPI-- perhaps a rise in the price of traded goods relative to nontraded goods-- that might do it. But the story then is not a fear that the Fed wouldn't do its job. On the contrary, bond yields are reflecting confidence that the Fed will keep the CPI proper under check. Or the gold market could be responding to concerns not about inflation per se but rather broader financial or political instability. Certainly there are concrete developments that could warrant heightened concerns about the latter over the last few months.

It's funny, people do say stuff like this all the time, often trying to discern meaning from one day of trading "The bond and stock markets gave different opinions today", which is ridiculous, though of course you'd never hear them say "The NASDAQ & S&P squared off today", on days when those indexes go in different directions.  It's true, as Hamilton points out, there's plenty of money that can slosh around from one asset class to another, that two liquid markets just shouldn't be signaling vastly different things, and if they seem to be, then it's probably time to check your assumptions.

Comments

[Daniel Wahl]

Isn't it possible that the salvo of cheap goods and services made available to the States from abroad, along with the rising influence of foreign central banks, are the main reasons for this seeming divergence of opinion--and signals--in the markets today?

I, for one, believe that we actually have had and do have now strong inflation--if we're to define it properly. But I am not and would not invest in TIPS--because of how, specifically, inflation is measured today (by a government no less that has a lot of reasons for keeping the reported inflation low).

TIPS protect you from only one sort of inflation--the inflation of, mostly, goods and services that today have limits on their rise thanks to China, India and all the other developing nations. They do not, in any significant way, protect you from the inflation of resources such as the wheats, rice, heating oil, gasoline, natural gas, and so on.

Thus, since I don't survive on Chinese chotchkas and I am not in the market to buy a new computer every year but, like other humans, need to eat and stay warm or cool, and like the pleasure of not having to rely on my feet alone for transportation, I am concerned about a different kind of inflation that investing in TIPS does not protect me against. This is why I and ten million others can be concerned about the possibility or presence of strong inflation and yet you won't see this reflected in the bidding for TIPS.

The same sort of thing is true in the U.S. bond markets. I believe these should be selling off dramatically--or should have had, whatever tense you want to use. But when you have strong buying of these bonds by foriegn central banks, a lot of support is given and complacency settles in. This isn't to say they're completely worthless, but the risk/reward ratio is definitely not going to show up in any future textbooks as an example of a good investment.

With the deficits, future liabilities, and so on--much less having Benny and the Feds in charge of the printing presses--you'd expect there to be a very keen focus on the risks inherent in buying bonds at such low rates. But the government says there is no inflation and demand for them appears to be strong--and actually, to a certain extent anyway, is--well why sell, why be a doom and gloomer and worry about the risks, etc?

You can have real concerns about inflation and not have them reflected in each and every market, then, because of what exactly inflation means in each market along with other factors--such as foriegn central bank bond-buying--which must be held in context.

[chanel outlet]

"Part of [achieving your dream is] not being afraid to take risks. I took a year off school [for the Olympics]. There were times when it was really hard. Just keep believin', keep truckin'."

— Elle Logan, rowing

[Impotence causes]

hello to all readers, When we talk about the gold,some opinions will be in our brain.the first I will think is medal.and you?please link my website about Jordan Spizike,you will like them. I promist it. Thanks for sharing this information with us.

[Cheap viagra]

Amazing! I'm really surprised, I did not expect much I liked this article, I read it because a friend recommended it to me, I assure you that when he told me to read not think it was so interesting. I congratulate the creators for the excellent job they did, I will continue to recommend to my friends this article is great!

[generic cialis]

Nice post, I would like to request you to one more post about that

[Coach Poppy]

All sentences are about a little something or another person. The a little something or anyone that the sentence is about is called the topic on the sentence. From your blog, I see that, and study a thing I'd like. Thanks for sharing.

[Cagr]

Price fluctuations are always a big headache but is o and even more important is knowing how to invest wisely in the stock. The stock market is a great place but one should be strong enoogh to brave any type of situation.

[Cash gifting leads]

Investing in stock market and researching on the unpredictable nature of the market are two very crucial topics. Research well before investing