Many stock market bulls have been correctly arguing that the long-term bull
market in bonds is nearing an end. However, they then come to the illogical
conclusion this event is somehow bullish for stocks. The simplistic argument
is that money will move from bonds to stocks. This two dimensional way
of thinking assumes that investors only have two choices, bonds or stocks,
and
that money coming out of the former must somehow end up in the latter,.
More importantly, such thinking ignores the historical fact that both bonds
and
stocks typically move in the same direction. They were both in long-term
bull markets which began in 1982; and though the bull market in stocks
ended in 2000, the bull market in bonds continues. However, while I also
believe
that the bond bull market is now nearing its end, I’m convinced that soon
both bonds and stocks will be in long-term bear markets.

To conclude that weakness in bonds will lead to strength in stocks one must
accept that rising interest rates are some how good for stocks, which is absurd
on its face. Not only will rising interest rates hurt the economy and depress
corporate earnings (interest expenses will rise while revenues will fall),
but the present value of those lowered earnings will be reduced as a result
of a higher discount rate.

Rather than selling bonds to buy stocks, investors will actually be selling
both. What will most likely occur is a long overdue loss of confidence in financial
assets in general, particularly those denominate in U.S. dollars. Financial
assets represent future claims to consumption. Instead individuals will prefer
present consumption. Money will flow from claims to wealth to actually stuff.
That is way commodity prices have been rising and will continue to rise no
matter what happens with Iraq. It will be just like the 1970’s, only a whole
lot worse.