HotShot Blog

The Associated Press ran an article yesterday on corporate bonds. One of the things I find incredibly silly about financial market coverge is the single-minded focus on U.S. equities. The American stock market is one of largest in the world. But the bond market, including Treasuries and corporate bonds, is significantly larger and in many ways far more important for the U.S. economy.

Bonds are debt. American governments and corporations issue bonds, which investors buy. The bond then entitles the investor to a fixed interest payment each year for the life of a bond and the original amount given back at maturity. Bonds are issued because for example, when IBM needs to borrow $20 million to build a new plant, no bank is large enough to lend them that amount of money. Of course, the price of a bond, or how much you lend to the company/government, depends on the risk that you won't get your money back. When buying bonds from a company that is likely to go bankrupt, you will pay less than you would for US Treasury bonds that have the full backing of the US government. Since the risk of default is dependent on economic conditions, bond prices fluctuate with the economy.

The lack of media coverage has kept the investing public largely unaware that there are other investments than stocks, let alone how bonds work. Ask your average person on the street and they can tell you what a stock is - it's ownership in a company. Few people would be able to answer the same for bonds. The result is what finance people call "segmentation."

Corporate bond prices, however, could provide a more complete picture of a company's prospects. Unlike stock investors, who tend to jump on and off a company's bandwagon quickly, bond investors have a more long-term approach. And that makes bond trading data a sound tool for assessing a stock investment.

"The presumption is the bond market is smarter than the stock market," said Ken Tower, chief market strategist for Schwab's CyberTrader. "I'm not saying it's always true, but there's a reason that the bond market tends to lead the stock market."

The article mentions that the bond market seems to be smarter than the stock market. Probably true, given that most people, and likely a good chunk of stock market investors, don't seem to have a clue about bonds.