Bonds Will Rot, But Stocks Will Not

06/26/2007 12:00 am EST


Jim Jubak

Founder and Editor,

James Jubak, senior markets editor for MSN Money, says stocks are a better bet than bonds, because the factors that are hurting bonds might actually help equities.

Bond prices tumbled in late May and early June because outside forces, such as rising interest rates overseas and a falling US dollar, exposed the rot in the bond market. That structural rot ensures that bond investors will face repeats of this bond-market panic periodically through the rest of 2007.

But the big-picture trends that weigh so heavily on the bond market right now are much less negative for stocks. We're at one of those unusual times when bonds will suffer but stocks will do relatively well—at least for the next 12 months.
Here's my list of trends working against bonds:

  • Interest-rate increases from all of the world's major central banks, except, so far, for the US Federal Reserve.
  • Rising food and energy inflation around the world.
  • The end of the "Wal-Mart inflation bonus" as China, India, Vietnam, etc. shift from exporting deflation to exporting inflation.
  • A shift away from the dollar by overseas central banks.

To these, I'll add a fifth point: a quick resurgence in US growth from the 0.6% slump in the first quarter. Faster growth raises the possibility of higher inflation, and it pretty much puts the kibosh on hopes that the Federal Reserve would cut interest rates this year to get a slow economy moving again.

Some of these trends hurt stocks—as well as bonds. But most of the five macro trends that are so negative for bonds offer at least a bit of upside for stocks, and some offer quite a bit more than a bit.

Consider the shift away from the US dollar by overseas central banks. A weaker dollar, while it does raise costs for companies that source raw materials overseas, also results in a huge sales edge for US exporters. And a weak dollar also pushes up the earnings of companies that do substantial business in nondollar economies but that report their earnings in dollars.

Higher growth hurts bond prices, [but is] a boon to equities, since more growth often means more profits. Higher growth has an especially positive effect on equities at a time like this, when the consensus worry has been that growth was about to slow so much that company profits would stagnate or decline.

In [a previous] column, I compared the bond market to an old house where decay to the structure threatens the collapse of the whole building. But the problems in the equity market are, currently, limited to specific sectors or companies; they aren't yet sweeping enough to present a threat to the whole structure of the kind that I see in the bond market.

For this year, there's upside in the stock market at tolerable risk. The best bet to make, I'd say, is on higher-than-expected growth. And that means that prices of growth stocks should benefit as investor sentiment rediscovers growth.

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