Bond Market Provides Shelter During Grim Economy Period

Deflationary effect of harsh economic will push investors to take shelter in the relative safety of the bond market, Merrill Lynch said in a research report released on Friday, July 25, 2008. Investors should seek out safe yield in bonds as much as possible, whether in the Treasury market, the muni market or other high-quality fixed-income vehicles.

Despite current concerns about global inflation, U.S. economic prospects are so grim that deflationary pressures will prevail as commodities and stocks sell off is likely to take place during a painful economic period of recession. Back to the U.S. consumer recession of 1973-75, collapsing earnings and price-earnings multiples triggered a 40 percent peak-to-trough decline in the S&P 500 index.

U.S. households' bond exposure is not much more than 5 percent of their total assets, after the past two decades scrambles into stocks and then real estate. Consumers' rising inflation expectations as prices at the pump and the grocery story have surged in recent months have caused a bond market sell off.

In the late 1980s and early 1990s, the level of bond exposure was between 7 percent and 8 percent of total assets. Using that past level as a benchmark for comparison purpose, the current figure would imply the potential for incremental demand in bond, most of which would go to Treasuries and other higher-quality bonds as riskier corporate debt feels the pinch of a tough economy.