As the world’s debt crisis threatens to push stocks into another meltdown, the bond market is going into what some people would call a “bubble.”

In light of the long-term trends — as the accompanying charts reveal — neither event looks to be immi-nent. Stock prices will have to drop a long way to destroy their long-term rise. Bond prices are simply reaching the tail end of just another bull bond market — the sixth or seventh in the past 250 years or so.

There’s no point in underestimating the stock market’s fear of sovereign debt failure or repudiation. It is a well-grounded fear. But it is easy to exaggerate the trend in bond yields. Long-term bond yields drop low as a bull bond market ends, so 30-year U.S. Treasuries trading lately just above 4% is unexceptional.

Market history reveals the big essential difference between stocks and bonds: stock prices can (in theory) rise forever, as long as economic growth continues and businesses pay dividends. Bond prices oscillate, reflecting the ebb and flow of interest rates over the decades.

This brings up another difference: stock markets have usually moved in four-year bull-and-bear cycles, although this pattern has been disrupted in the market’s recent turbulence.

Bond cycles are very long in comparison. Interest rates, for example, moved in a bull bond market for most of the 19th century, although U.S. rates interrupted this trend during the economic crisis of the 1840s and the Civil War of the 1860s. The current bull bond market, meanwhile, is a mere 29 years old.

The detailed history of long-term yields begins in Britain in the early 1700s, when records began to be kept consistently; the Bank of England began acting as a bankers’ bank and managing the government’s funded debt, and Britain merged its perpetual and long-term bond issues into perpetual “consolidated annuities” — or “consols,” as they became known as. The interest rate cycle crossed the Atlantic as the U.S. grew into economic leadership — and it has become the pattern for the industrialized world.

The authoritative account of this process is A History of Interest Rates, by Sidney Homer, first published in 1963 (revised in 1996; Rutgers University Press). Homer was the pioneer bond-market analyst, and this book remains a must-read for financial services professionals.

The long-run upturns in stock prices in the U.S. and Canada are clear when plotted on a logarithmic scale. The most recent phase of the uptrend in Canada may be in doubt — although, on a monthly scale, the S&P/TSX composite index would have to drop to 5000 to negate the rise from the lows of 1974 and 1982. Although anything can happen in stock markets, such a drop does look improbable at this point.

Wall Street’s long uptrend since the wartime 1942 low appears to be in similar order. On a monthly basis, the S&P 500 composite index is currently some 400 points above the trend that started in 1974.

All this suggests is that a stock market collapse of gigantic proportion would have to occur to forecast unprecedented economic woe. In Canada, we have the experience of stock markets and economies that have never failed. Outside of the U.S. and the Commonwealth, this has not always been the story. Markets have disappeared — often through war or revolution.

The trend in bond yields provides help in assessing the economic outlook. U.S. bond yields have remained low, thanks to foreign buyers over the past 20 years and the recent flight to perceived safety. With Britain liable to fall into sovereign debt troubles, as Argentina and Greece have in the recent past, there is no assurance British bond yields will remain low.

Central bankers have nightmares about deflation. It is a fear that could become true. Deflation would depress bond yields, so the current bull bond market could persist. Note how the preceding two bond bull markets ended with U.S. long-bond yields averaging close to 2% and British yields between 2% and 3%. These are possible targets for the end of the current bull bond market, implying a degree of deflation. (See Bond Watch, at right.)

The counter-forecast is high inflation, a result of money supply being pumped up to float more government borrowing and spending in the U.S., Britain and elsewhere. To signal such an impending event, long-term bond yields in the U.S. and Britain would have to rise to 5% or more. IE