Of Stocks And Bond-age

By , Staff Writer of The Christian Science Monitor

What's going on here is an unusual change of events.

For years, we've been conditioned to the notion that lower interest rates make stocks go higher.

And with good reason. When long-term rates have fallen in recent years, stock investors banked a bundle. With low rates, companies spend less on debt, leaving more for profits.

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These rates also signal direction for inflation. High rates, high inflation. Low rates, good business.

A quick note. Long-term rates are attached to what traders call the "long bond," a US Treasury bond that matures in 30 years. And with bonds, falling interest means rising price.

And, as we said, they often take the driver's seat when it comes to moving the stock market. But in recent weeks, T-bonds pulled the car over, got out, and walked the other way.

Some of that is because investors figure that the current 6 percent rate minus 2 percent inflation means a 4 percent real return - an excellent way to lock in several years' stock market profits, given the wobbly legs currently supporting this bull market.

Investors have started switching out of stocks and into bonds, sending prices higher and rates lower.

But there's more to it.

Rates have snowballed since August, and free-fallen since mid-October. Remember August?

That's when the Dow hit a record high. Remember October - the big slam?

Long-bond rates back in mid-October were parked at 6.4 percent. This week, they fell to 6.1 percent, a walloping big gain in the price of bonds (remember: when bond rates fall, their prices rise).

Prices popped more than 4 percent, not exactly like investing in Microsoft in 1990, but a big jump for something considered the safest security in the known universe - backed by the full faith and credit of the US government.

But while T-bond prices have soared, stock prices have sunk - some 13 percent from the Dow's August high to its low on Oct. 27, and down about 8 percent this week.

So, is this just a temporary spat, or is the relationship over?

Much of the big change in bond prices goes to optimism about inflation. It currently runs about 2 percent annually; and the markets don't see an increase.

That would suggest a boost for stock prices. It still might happen. They could play a quick game of catch-up.

But some strong sentiment says otherwise. T-bonds are perhaps the most international of all investments. And investors all over the world, unnerved by the meltdown in Asian markets, are trampling a path to them. The demand is driving prices higher, rates lower.

Experts call it a flight to quality.

Gold once occupied that hallowed ground, but T-bonds have taken over.

What's curious, though, is that the US stock market has received none of the benefits. It is the world's biggest and safest, riding the strongest economy anyone has seen, anywhere, for a long time.

But there is a near universal expectation that the US economy, and market, will feel some Asian discomfort.

We've essentially seen a shift in confidence. Investors lack faith in stock markets, worldwide. They feel comfortable with US Treasuries, and not much else.

Shopping for a mortgage? Good news. Rates on 30-year mortgages follow the long bond, and this flight to quality slices a big chunk off your monthly payment.

Shopping for stocks? You're probably scratching your head. You might hold off until bonds and stocks sort things out.

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