I recently straightened out my bookshelves at work to make room for some more books. As always, I leafed through some hardback volumes I hadn't looked at in awhile, including The Great American Bond Market: Selected Speeches of Sidney Homer. The late Sidney Homer was a bond market pioneer. The essays are enjoyable to read, but I've always found one especially fascinating--a 1967 talk on "Inflation and the Stock Market.

Imagine, in the 1950s and 1960s, stock investors cheered signs of inflation. Here's how Homer described conventional wisdom: "Inflation, as everybody knows, is good for the stock market." Homer strongly disagreed with the thesis, but he felt like a Wall Street heretic for questioning this "truism of finance." Of course, following the double-digit inflation and financial carnage of the 1970s, investors rightly fear an economy-wide increase in prices.

Now, let's fast-forward to today and talk about "Growth and the Bond Market." You could paraphrase the conventional Wall Street perspective this way. "Fast economic growth, as everyone knows, is bad for bonds." Well, here's another heretical idea. What if strong growth in the new economy is good for bonds?

For one thing, the federal government's coffers are flush, thanks to the strong economy. The Treasury is using some of the surplus to pay down the federal debt, which provides a measure of support to the bond market. Far more important is the productivity boom, a force for restraining economy-wide price hikes. In the new high-productivity economy, bonds will reward investors with decent returns because inflation won't take off when growth is strong. It's a buying opportunity if bond market yields soar when the economy accelerates.

 


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