The bond market and the stock market are the two most important pieces of the capital market. While the stock market is mostly known as a barometer about where the economy may be headed, the bond market is highly regarded as an indicator about how the economy is doing now. The stock market as an equity market focuses primarily on predicting future earnings of corporations and the bond market as a debt market cares more about current interest rates that are the concerns of many market participants beyond corporations. The size of the bond market is several times the size of the stock market, which can be attributed to the different structures and perceived risks of the two markets.
Debt vs. Equity
Companies issue more debt than equity on a continuing basis. The underwriting process for debt issuance is simpler than for equity issuance. Issuing debt concerns mostly a company’s ability to pay interest and repay principal at maturity, and thus involves basically credit analysis of certain debt-related financial ratios. On the other hand, issuing equity requires the complete evaluation of a company’s net worth so that new shares of equity can be appropriately priced. The higher demand by companies on debt than equity results in the larger size for the bond market than the stock market.
While only corporations can issue stocks, governments and any organizations and agencies, along with corporations, may all issue bonds. Furthermore, not all companies are publicly traded; many companies are privately held, and their equity is not counted as part of the stock market. On the other hand, almost all entities borrow in the debt market. Some borrowings may be done on a rolling basis through refinancing, effectively maintaining an entity's relative borrowing size, whereas in the stock market, companies implement share buybacks from time to time, reducing their market size.
The bond market is a massive, decentralized network of market participants, while the stock market is a highly centralized marketplace consisting of only a few exchanges and a limited number of tightly controlled over-the-counter markets. The differences in market structure provide different incentives for bond issuers and stock issuers. To issue bonds, issuers need not apply to a market, whereas to issue stocks, companies face stringent stock listing requirements by their chosen exchange. As a result, more bonds can easily come through the market than stocks, contributing to the larger size of the bond market.
The different levels of perceived investment risk for bonds and stocks also have an impact on the size of the bond market vs. the stock market. Bonds often are referred to as fixed-income securities that pay an agreed-upon, periodic interest and return investment principal at maturity, presenting relatively low risk to investors. On the contrary, stocks provide potentially the most returns but also with higher risks. Given that investors in general are risk averse, more investors would like to invest in the safer bonds than the riskier stocks, especially in unsettling market conditions, requiring a bigger bond market to accommodate the higher investor demand.