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Saturday, 15 January 2011

STI vs SGS bond yield

Just being curious

One of the common finance wisdom states when the economy is booming, funds shift from bonds to stock market for better returns (surging stock market and rising yields in bond market). During a recession, the opposite occurs where money exits stock market to seek refuge in the bond market, further depressing the meager yields.

Thus I was curious to find out whether this relationship actually holds true over a long run. If so, will there be a relatively reliable yield to serve as an indicator to enter or exit the market? i.e. going into the stock market when bond yields drop below a certain threshold and exiting when yield surge beyond another value? Even before I look further, I already knew things shouldn't be so simple, so its more for fun rather than a serious exercise to change my current investment strategy which already worked well for me.


Anyway, let's see how the graph will look like:

The above graph is made by plotting monthly STI closing value versus monthly average of SGS (Singapore Government Securities) 3 month T-Bills' yield. The STI closing values can be downloaded from yahoo finance while the T-Bills yield can be obtained from SGS website.


If the theory above holds true, the bond yield curve should track the STI index. i.e. when times are good, funds exit bond market to chase higher return in stock market, pushing up stock index and causing bond prices to drop and yields to rise, and vice versa. Looking at the chart, it seems to me this is only somewhat true during 1999 to 2009 and about 1% yield might be the indicator to enter the stock market while 2.5 to 3% yield could signal the exit. However, for both instances, one will either enter or exit the market too early, by as much as 2 years.

While no clear pattern between bonds and stocks seems to occur prior to 1999, what is surprising to me, is the divergent trend after 2009. Though the stock market continue to surge, the bond yield continue to stay severally depressed. This 'abnormally' can be dismissed as the consistent trend mirroring the current global low interest environment brought about by the quantitative easing in USA to stimulate growth and recovery from recent economic recession. It can also imply that with all the hot funds flooding the region from overseas, substantial amount flows to both stocks and bonds. So does that means the there is still much more funds being amassed in the bond market that can be liberated to push the stock market much further into a bubble bigger than the last? Only time can tell. Meanwhile, I doubt I'll be pumping in any more money as most of my businesses are quite favorably acquired at reasonable price. So its more of sit back, relax and accumulate profits and parked them away for the next burst.