Blowing Bubbles, U.S. Treasury Bonds
Interest-Rates / US Bonds Sep 02, 2010 - 03:03 PM GMTBy: Charles_Maley
Common sense is the knack of seeing things as they are, and doing things as they ought to be done – C.E. Stowe
The American media is officially obsessed with sensational terminology when describing the financial markets these days. Nothing trends, it either explodes higher or melts down. We have “flash crashes”, a “new normal” and the frightening “double dip”. We also see bubbles about to burst everywhere.
I would like to know when we un-dipped in order to double dip. It seems to me very little has changed since we began this crisis. Regular folks still have a depressed house, a 401-k that’s cut in half or so, and less income if they have a job at all.
Also, let’s keep in mind that these people who are predicting the next big event are the same ones that were clueless when staring straight in the face of the real bubbles of the 2000 stock market top and the housing crisis.
In any event, in order to attract ratings and circulation something needs to happen for the media every day, even though in reality a crisis of this magnitude will take quite some time to unfold. According to them, we melted down, then recovered, and now are in jeopardy of melting down again. You could get dizzy, not to mention poor, if you don’t stay focused on reality. I wonder if there will be a triple dip.
The U.S. bond market is the “new bubble”, and although I personally would not buy bonds here, I certainly can see why they might continue to perform relative to stocks and real estate. It is not irrational.
If we continue to de-leverage, bonds will stay well bid for years, and even though low coupons are not exciting, there is still safety in a return of principal at maturity, and a positive real rate of return after inflation. As the Taipan Publishing Group points out “government bond yields were characterized as “rock-bottom” and “criminally low.” But those descriptions might have been too strong, as the chart below from Bespoke Investment Group shows.
“Looking back to 1962, ten-year yields in “real terms” — adjusted for core CPI — are not shockingly low. As you can see, in the 1970s, the real yield went sharply negative because reported inflation ate up the entire yield and then some.”
The media has also been quick to show us the “massive” inflow into bonds in the past year or so implying that there is overexposure. They also are implying that this is irrational behavior.
The reality is that U.S. investors don’t have nearly the exposure to bonds as they do stocks or real estate. According to recent data from David Rosenberg, the American household has about 6% of their assets in bonds compared to 27% in real estate and 27% in stocks. The real exposure to the U.S household is in real estate and stocks. Combined, it represents over 50% of their assets.
On the other note, “The rationality of the message runs completely against the grain of how bubbles typically work. Consider two bubbles of recent vintage, the dot-com bubble and the housing bubble. In both cases, the message sent at the height of these bubbles was NOT rational. It was flat-out nutty. In the case of the dot com bubble, we were supposed to believe that fly-by-night companies with huge burn rates and zero earnings, founded by college kids and touted by sock puppets, were supposed to be worth triple-digit multiples on their way to dominating the world. In the case of the housing bubble, we were supposed to believe that home prices would never fall… that 50-year mortgages were the new thing” says the Taipan Publishing Group.
I think Felix Zuluf articulated the rational message of the bond market quite well in his latest commentary. “When an economy shows the weakest recovery on record despite one of the biggest monetary and fiscal stimuli on record, something is definitely different from previous cycles. In our view, it is debt deleveraging. So far, the US consumer and financial institutions have undertaken steps and decreased leverage to some degree but we are nowhere near the end of this process. At the very best, it will take another 2 years but most likely longer until that process is complete. In the meantime, household income growth or the lack thereof will become the decisive factor. At present, it does not look very encouraging as it is stagnant in most countries or anemic at best. Moreover, in the US, housing is an important balance sheet item for the average household and those prices continue to erode.”
As I said, I am not buying long bonds here but I can understand the message. I do think for safety reasons a position in short maturities still makes sense. Perhaps it’s a good time to tighten up maturities. I would also sell any long term bond funds as the return of principal does not exist there, and the fees will eventually eat up the low income distribution.
Everyone should be raising interest rates, they are too low worldwide,” Jim Rogers said in a phone interview from Singapore. “If the world economy gets better, that’s good for commodities demand. If the world economy does not get better, stocks are going to lose a lot as governments will print more money.”
So, perhaps interest rates are too low and a bond market top is in sight, who knows. Personally I agree with Jim Rogers that we are better advised to be long commodities and hard assets as opposed to paper assets such as stocks and bonds. On the other hand to have a position at the short end of the yield curve as a safe haven for future investment still makes sense.
I am sure of one thing. It always pays to maintain an “anything can happen” posture. It is only good planning to stay flexible and realize that several outcomes are possible. The most important thing is that our risk management strategy allows for the fact that we can be wrong yet live to fight another day.
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Charles Maley www.viewpointsofacommoditytrader.com Charles has been in the financial arena since 1980. Charles is a Partner of Angus Jackson Partners, Inc. where he is currently building a track record trading the concepts that has taken thirty years to learn. He uses multiple trading systems to trade over 65 markets with multiple risk management strategies. More importantly he manages the programs in the “Real World”, adjusting for the surprises of inevitable change and random events. Charles keeps a Blog on the concepts, observations, and intuitions that can help all traders become better traders.
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