Measured by amount outstanding, the global bond market exceeds the market value of global equities. This fact contrasts with how most individual investors allocate attention. Everyday discussion, news coverage and swings in sentiment concentrate on equities, while the larger bond market, with its more professional participants, enters general view far less often. The first channel of influence is the discount rate. Government bond yields form the benchmark for valuing almost every asset, serving as the reference for the risk-free rate above which other assets add their own risk premia.
When long-maturity government yields move, they transmit to equity discount rates and therefore to valuations, most strongly for assets whose cash flows sit furthest into the future. The second channel is relative attractiveness of capital. Bonds and equities substitute for one another in most institutional allocations. When bond yields rise to a certain level, some capital previously allocated to equities shifts to bonds, and the reverse applies too. This relative movement is enormous at the scale of large institutions, and it has nothing to do with corporate fundamentals, being purely a rebalancing of relative return. The third channel is information.
Participants in the bond market are predominantly institutional, and their pricing of macroeconomic conditions is generally regarded as cooler than the equity market's. The shape of the yield curve, movements in credit spreads, and the expectations implied by inflation-linked bonds are all widely used as references for macroeconomic conditions. Their movements frequently lead the equity market's reaction. The credit market deserves particular attention from equity investors. Corporate bond spreads reflect the market's pricing of default risk, and that pricing usually reflects deterioration earlier and more clearly than equity prices during periods of stress.
When credit spreads widen while equity prices have not yet responded, the divergence between the two has historically often preceded a subsequent equity adjustment. The size of the bond market also means its technical disturbances spill over. The bond market sometimes experiences liquidity strain, whether from a category of institution forced to adjust positions or from a supply-demand imbalance in a particular maturity. The effect transmits to equities through discount rates and capital flows. The source of such volatility sits inside the bond market while its expression appears in equities, which is easy to misread as information about equities themselves.
For investors, the practical use of the bond market is as a set of leading and cooler references. Tracking government yields, the yield curve and credit spreads requires only public data updated frequently, and the macroeconomic information they provide frequently precedes the equity market's reaction. Ignoring bonds and watching only equities means giving up the larger and better-informed half of the market. One reinforcing point is worth adding. The professionalisation of the bond market means its pricing is less subject to the immediate influence of retail sentiment, which raises its reference value for macroeconomic reading further. An equity investor who never looks at the bond market is discarding a source that is both larger and, on the questions that matter most, generally steadier.