The following comment by Joe Weisenthal via Twitter got us thinking about just who is the “smart money” these days.
With the junk bonds rallying, you don’t hear as much about how “smart” the bond market is, and how it leads stocks.
The point that Weisenthal is making is that the bond market is only “smarter” when it fits the bear case. When it fits the bull case, as it does now, the bears are silent. It is often the case that analysts only cite data that fits their case, i.e. confirmation bias. The Bloomberg story by Alexis Xydias notes how some strategists are interpreting the performance of corporate bonds.
For the first time in a long while, equities appear inexpensive relative to corporate bonds,” said Kevin Gardiner, the London-based head of investment strategy at Barclays Wealth, which lowered its rating on fixed-income securities to “neutral” this month and recommended owning stocks. “Valuations and the likely news flow over the coming period will inspire people to take more risk.
We are not sure of the exact origin of the myth that the bond market, specifically the corporate bond market, is “smarter” than the stock market. But one can bet that it has do with the fact that individuals, by and large, are absent from the corporate bond market. Whereas the stock market seems to be teeming with masses of individual investors. However to make the leap from the compositional differences of the two markets to make some sort of statistically-based statement on leads (and lags) between the two seems far-fetched.
In today’s capital markets there are vast pools of capital poised to jump on perceived valuation errors. For example, multi-strategy hedge funds have the ability to shift capital from strategy to strategy in pursuit of profits. Capital arbitrage hedge funds focus solely on generating returns from perceived mis-valuations amidst the capital structure of firms. One could argue there is a surfeit of capital seeking out just these opportunities.
The introduction of exchange traded funds (ETFs) on a broad range of asset classes, like junk bonds, has helped blur the line between the professional and amateur traders. Indeed these pools of assets are all now mixed up in the world of ETFs. Some asset classes, like commodities, were previously the province of only professional traders. However now that individuals and professionals are trading the same instruments it is less clear who is the smart money and who is the dumb money.
There may very well be smart money on Wall Street. However trying to tease out what they are doing from broad data like the performance of the bond and stock markets is likely wasted effort.
Update: EconomPic Data helpfully graphs the relationship between BB-bond spreads and performance for the S&P 500.