Pieces of the Puzzle - Asset Classes II
Fixed Income (Bonds or Treasuries)
The Bond Market is large, it's where Corporations, Municipalities and Sovereign Nations go to finance their goals thru Debt. The global bond market is estimated to be $119 Trillion as of 2021, and $46 Trillion is the US Market as per SIFMA.
A Bond is a promissory note issued by the borrower stating they will pay back the loaned amount and additional interest (Yield) to the lender in a given time frame. The Bond Market is talked about thru changes in Yields, in contrast the stock market is talked about thru price changes (market cap).
The Bond Yield is inversely proportional to it's price. If the price of a bond goes up, then the yield goes down and if the price of a bond goes down then yield goes up. This mechanism is because of market forces, If new bond in the market is yielding higher than currently existing bond, money sells the existing bond causing price to go down and money chases this new yield causing the price of the new bond to bid up.
The takeaway here is the inverse relationship between Bond Yield & Bond Price, this mechanism will be used to build up other frameworks that'll be covered in later posts.
The US Government Bonds, also known as Treasuries, are the most important to understand, because Treasuries are considered as Money in the Global Banking System. The Global Banking System uses Treasuries as Collateral and Money to settle Inter-Bank transactions. Treasuries range in Maturity rates from 4 weeks to 30 years and they have their own nomenclature.
Treasury Bonds mature in 30 years & have the highest interest payment.
Treasury Notes mature anywhere between 2 & 10 years, with lower yield than Bonds.
Treasury Bill mature anywhere between 4 weeks & 1 year, with the lowest yield.
The US Financial System is the epicenter of the global financial & Banking system due to USD being the reserve currency and the changes in Treasury markets provide answers to what's happening in the real economy and how the financial markets might perform.
The takeaway here is that Treasuries are considered Money in the Global Banking System.
Stocks or Equity
The stock market is the one that everyone has heard of. There are many ways to analyze and value stocks, but one of the fundamental ways to value is using the Risk Free Interest Rate. The Risk Free Interest Rate is an interest rate that you can get on your capital without any risk, this is typically the United States Treasury Note (T-Note) Rate. A stock's return for any given year has to be meaningfully higher than Risk Free Rate in order for Capital to be attracted to that stock.
If Risk Free Rate is low, then the incentive is higher for capital to go into stocks, vis-a-vis riskier assets, and cause stock prices to be bid up. Inversely, if Risk Free Rate is high, then incentive is for capital to not go into riskier assets stocks. This is the reason why Stock valuations are sensitive to Treasury Rates.
The takeaway here is that Treasury Rates affect Stock valuations.
Bitcoin (Crypto)
Bitcoin is considered to have no correlation to Stocks, Bonds, Commodities and hence one of the key assets to hold in a portfolio. Bitcoin and to extent entire Crypto universe is tied to interest rates, but there are few more dots to connect before digging into them. In my opinion, Crypto is where the entire world is moving to and Bitcoin forms the base of the new world.