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September 18, 2007

The flight to quality

In the recent turmoil on the stock market many analysts have said that a flight to quality was affecting both the yield and the value of treasuries securities. N.C. State University economist Mike Walden explains what that means.

"It's not as complicated as it might sound," says Dr. Walden, a specialist with the North Carolina Cooperative Extension Service. "When we do have problems in the stock market as we have had, it's natural that investors want to move money to places they consider safer. And the safest investments -– and any investment person would agree –- ... are actually those issued by the federal government called treasury securities.

"These are safe for a couple of reasons," Walden continues. "One, the government has never missed an interest payment on these, and secondly the government has never missed paying off the principal on treasury securities.

"So generally what we see they are for is when you have a big drop in the stock market, money is moved out of stocks and into treasury securities. Now this does two things to those treasury securities: One it means that they are more popular, so the government doesn't have to pay as high an interest rate, so interest rates on those treasury securities fall.

"And you could see a couple weeks ago -- when we had the big drops in the stock market -- a big plunge in treasury security interest rates," he explains. "The second thing it does though is increase the ... market value -- what people would pay to buy treasury securities -- so there value or price goes up.

"Now what this means is that one indicator we can use to see if investor confidence in the stock market is returning is to watch treasury securities. If treasury security interest rates go up, that should be a sign that confidence is coming back and people are moving their money out of treasury securities and back into the stock market."

Posted by deeshore at September 18, 2007 08:00 AM