During the second quarter of 2003, why did both bond prices and stock prices fall?

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justaguide eNotes educator| Certified Educator

Specifically, the fall in both bond prices as well as stock prices in the second quarter of 2003 was due to the political unrest in Iraq and the decision made by the US to go to war. The result was investors moving out of bonds as well as stock and the preferred asset class changing to gold and other commodities that were considered real assets of which physical delivery could be taken.

Generally, bonds, compared to stock, are perceived to be a less risky asset class for investment. When investors feel that stock prices are not likely to rise, and there is a possibility that they may fall, investors sell stocks and use the funds to buy bonds. This makes the price of bonds and stocks seem negatively correlated to each other.

Further, there is a different way of looking at the prices of stocks and bonds, one that presents a totally different picture. The price of bonds is negatively correlated to interest rates. A fall in interest rates increases bond prices and a rise in interest rates leads to a fall in bond prices. Interest rates also have a large impact on stock prices. A fall in interest rates makes it cheaper for corporations to access capital for operations and expansion. In addition low interest rates increase demand of products as prospective customers can easily borrow money and this increases their spending. These factors improve the profits made by firms and consequently lead to an increase in stock prices.