Bonds are a part of the market that most stock investors instinctively ignore. This is a mistake. The government bond market is the largest financial market on the planet and its movements form a kind of gravitational field in which stock markets move. Understanding the correlation between bond yields and stock performance is one of the most important analytical skills of any investor today. Particularly in an environment where the 10-year US Treasury note is yielding over 4.5% and the market is speculating on the next wave of inflation due to geopolitical shocks.

How bonds work

A bond is essentially a loan. The issuer, whether a government or a corporation, borrows money from an investor for a pre-determined period of time and agrees to pay a regular coupon, or interest payment, and to return the principal at the end of the maturity. The yield on the bond then reflects the total annual appreciation that the investor expects to receive for holding the instrument.

The fundamental mechanism…