Tag Archives: bonds

Most of the way there.

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The bounce has been faster and more comprehensive than I expected. I was thinking that we would top around these levels, but by summer or fall, not early May. I have continued to scale into distant-expiry SPY and QQQQ puts, favoring ITM and ATM, and have now deployed about 1/3 of the money I am willing to allocate to shorts. I also have a smidgen of shorter-term positions in certain ridiculously high-flying restaurant and other consumer stocks.

The bond sell-off and commodities rally indicate that inflation fears now have the upper hand, as most people still believe deflation will be a short-lived phenomenon. The aforementioned movements are setting up nicely for long and short replays, respectively.

Notwithstanding a long-overdue correction, I suspect that stocks have further to run, and am no longer such a skeptic of certain Elliott wavers’ target of S&P 1050. Bullishness is now at 80%, up from 2% in March, but judging from attitudes on TV, there is still a great deal of skepticism to be overcome before we can call a top. That said, the speed and evenness of the advance leads me to expect much more choppiness for the remainder.

Shorting precious metals has been frustrating, and I suspect that we are repeating the pattern of last spring, when we had to work our way through several months of chop after receding from manic levels (1030 gold that time, vs 1007 in February).

It is important to keep in mind the real situation, not just the current market mood (though you can’t trade on fundamentals alone). We can’t work off the greatest credit bubble in history in 18 months and just a 57% loss in the stock market. The real (private, productive) economy is not going to stop shedding jobs, let alone add them, for years, and people are so indebted that they cannot be enticed to reflate the asset bubble or return to previous levels of wasteful spending. It will take a generation to work through our debt and lifestyle delusions.

It bears repeating that today’s official headline unemployment number (8.9%) cannot be compared to numbers from before the 1990s, when the Clinton administration changed the reporting methodology to exclude large segments of unemployed. A more useful measure for historical comparisons is U-6 unemployment, which now stands at 15.8% for April. Today on Bloomberg I heard Christina Romer say that things were nothing like the Great Depression, as she compared apples to oranges. In reality, we are at solidly depressionary levels already.

Also bear in mind that stock valuations remain at bubble levels. This is easy to see when you remember that stocks have no intrinsic value other than marked to market book value and heavily discounted future earnings. The major indexes’ trailing PE’s on net earnings will be under 10 by the time this is over. We still need to work off the bubble that was blown in the 1990s, which didn’t finish deflating in 2003 because of the easing of credit. Every kind of credit is tightening now, unless of course you are a bank holding company.

Dollar to turn back up?

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December’s themes have been ‘quantitative easing,’ the ‘bond bubble,’ and the resumption of the dollar crisis. It seems as though reaching the $9 trillion bailout figure and ZIRP (Zero Interest Rate Policy) triggered some more recognition of Bernanke’s plan to destroy the currency. This helped to spur a rally in Euros, Swiss Francs and gold, all of which were oversold thanks to the general unwinding of the inflation/anti-dollar trade this fall.

The long bond is severely overbought at near 2.5% (though it can come back after a correction, this being a strong deflation). It is essentially all risk and no reward. Buyers at this price assume huge interest rate risks, but the fall in the dollar this month eliminated a fair chunk of currency risk in US bonds. If bonds sell off, as they should simply because the market is so bullish, I expect the dollar to regain much of its lost ground, thereby maintaining a kind of balance.

I have had some mild trepidation in seeing the Swiss Franc come back to 95 cents from 81 last month (I figured 90 would be all), but a quick check of Yahoo’s currency page reveals that the market still treats this venerable script much the same as the EU’s shaky upstart (3-month chart. CHF in blue, EUR in red):

Source: Yahoo! Finance. Click for sharper view.

The Franc of course is a far superior currency and lately strong against the Euro, but there has been no phase change since last summer, when I first got bullish on the dollar and realized that despite fundamentals, the Franc was due for a fall. The Euro is just as fundamentally junky as the dollar, since the ECB will surely come to ZIRP as well, and the Eurozone is under tremendous political strain. Plus, most people still think it is better than the dollar, and all things being equal it is usually preferable to be contrary.

Now let’s layer gold on here (GLD in green):

Source: Yahoo! Finance. Click for sharper view.

So gold still trades like a currency, albeit a volatile one.

Now let’s layer on the long bond (TLT as proxy):

Source: Yahoo! Finance. Click for sharper view.

So that’s what I’m working with. All three asset classes look overbought to me: bonds, gold and the Euro/CHF, and I suspect that their rallies are related and associated in traders’ minds with recent Fed and Treasury actions.

Could a sell-off here coincide with a surprise resumption of the equity crash, now that the widely-expected (even here) bear market rally (something akin to the 45 percent move from Nov ’29 to April ’30) has yet to materialize with any real strength?

October and November unwound a lot of old bull market positions, but not all of them. The equity culture is still alive, and since it’s never the thing you fear that gets you, perhaps despite Mr. B and the Bailouts, the dollar is not done with its comeback.

Bailouts will cost jobs and cause good businesses to go bankrupt.

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Bottom line: Bailouts will waste our savings and remaining credit, and exacerbate the flight of capital and talent from the US.

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I was extremely surprised on Monday when the House rejected the first version of the Crime of ’08, but I remain certain that an essentially identical bill will become law. When it does, maybe as early as the end of this week, any ensuing rally (and there is no guarantee that a rally will occur) will last a few weeks at most and lead to a very powerful decline as the reality of the depression sinks in this winter. (Obama’s inauguration should be another huge disappointment, just more false hope to be sold.)

The bailout will cost the economy jobs because it is a transfer of savings from intelligent, prudent hands that are likely to deploy it productively to those that create nothing but distortions in the marketplace. The financial scamsters have balance sheets in such horrible shape that it could take up to $5 trillion to recapitalize them, so it is a certainty that this $700 billion is just a first installment to keep the lights on, but not enough to enable them to start taking risks again.

You can lead an investor to credit, but you can’t make him borrow.

On the demand side of the credit equation, the citizenry is fed up with debt. People are saddled with enough of it already, and with their homes and investments falling in price, they feel compelled to save, not borrow. Anyone willing to take a consumer loan right now is the most reckless sort of borrower and should learn to live on earnings alone. Smart car shoppers pay cash, and smart house shoppers are biding their time. It is a bad policy to finance consumption anyway, including home purchases. What’s wrong with renting and saving up?

Many companies have a need for short-term funding, but this is just to put out fires, not to invest in productive capacity. Interest rates on those loans should be high in order to justify the risk of supporting businesses that might be dependent on a bubble economy and therefore deserve to fail. The short-term commercial money market got way out of hand in recent years and contributed to a lot of wasteful expansion, so it is healthy for it to contract.

Today’s ISM numbers are just a taste of what is to come. The industrial sector will need to scale down massively because it expanded too much during the boom. Responsible executives are in no mood to borrow and build. It won’t do any good to offer them even extremely low interest rates because if they invest right now it will be hard for them to generate a positive return.

Companies will start to invest again when the contraction runs its course, when assets and labor are attractively priced and executives perceive a resuscitation in demand. There is nothing the government can do to speed along this process but get out of the way and let the reorganization take place.

Beanie Baby economy.

Think of the economy as a large corporate conglomerate with lines of business in a dozen sectors from Beanie Babies to soybean milling. The company has a line of credit at its disposal, in case it wants to take advantage of opportunities.

The Beanie Baby line was generating great profits until two years ago, but last year kids moved on to Hello Kitty, and the company has had to take some big write-downs on unsold inventory. During the mania, the head of the Beanie Baby division was the highest paid employee outside the executive suite, and the adjustment has been very hard on him. He won’t accept that Beanie Babies were just a fad, but insists that the continuity of this line of business is absolutely critical to the future of the company, and he is clamoring for more funding to make up for the losses on inventory and keep the factory running.

Of course, any CEO worth his stock options knows not to throw good money after bad, and a good executive would probably liquidate the whole Beanie Baby operation and maybe find another use for those employees.

What we have here, though, is a former Beanie Baby division head as CEO, and a board of directors that itself got caught up in the craze and won’t let go of the hope that it can be resuscitated through a capital infusion and a good ad campaign. They decide to drain the company’s accounts and draw down its line of credit so that their favorite employees can keep their jobs and the factory can restock on Beanie Baby materials.

Month after month, the company makes the division’s hefty payroll, and even issues bonds to keep going, but despite their best efforts at advertising, the public just won’t buy more Beanie Babies, even at huge discounts. They have been burned by Beanie Babies and aren’t about to get caught up in that nonsense again.

Thank you for your contribution.

The soybean division, on the other hand, is generating solid profits on account of increased demand for protein in Asia, and they make a presentation requesting funding for a line of tofu. The expected returns look great, and equipment can be bought very cheaply because of the recession. The CEO explains that he is sorry, but the company’s cash and credit have tapped out to keep the essential Beanie Baby division going. All of the soybean profits are to be channeled there as well, and he appreciates the contribution.

The ambitious managers in the soybean division get fed up with this ridiculous and nepotistic company, and decide that their talents would be better rewarded in Hong Kong. Investors eventually make the same decision regarding their capital, and the company’s bonds and shares plunge. The exectutives now see which way the wind is blowing and start embezzling funds, and eventually the heap of the company ends up in bankruptcy court.

See ya! Bonds head for higher ground as stocks sink.

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S&P 500 in red, iShares Lehman 20+ year Treasury bond (TLT) in blue:

Source: Yahoo! Finance

Let’s look at the longer term view. It is remarkable how strong the old inverse relationship remains. Lower yields are NOT, repeat, NOT bullish for stocks! They are extremely bearish right now:

Source: Yahoo! Finance

The only explanation for this behavior that makes sense is deflation. There is no safe place for cash right now other than stacks of $100 bills or Treasury debt. I have been saying for some time now that even though the long bond will surely be defaulted on (probably through inflation), it is a great speculation. I think this will be a rally for the history books, as the sell-off in risk assets reaches the panic stage. We haven’t seen anything yet.

A long, cold winter ahead

Decades from now, I bet we’ll refer to the way things were before this decade and after, because the Great Crash of the late 2000s will change the face of the planet. Life will feel much different, more like winter, Kondratieff winter. I don’t buy into all aspects of K-wave theory (Elliott Waves are more my speed), but I am beginning to feel why he called deflationary depressions winter. Everything slows down (monetary velocity not least), and there is a retrenchment. We huddle together with those we trust and cling tightly to essentials. The profligacy of warmer, faster times is gone, and we keep it simple and safe.

We’ll look back at all of the obvious mistakes we made, and wonder how we could have been so reckless. And by the time we who are young are old, our grandkids will joke about what tightwads we are, since we lived through the Depression, as if one of those could ever happen again.

Resolving a difference of opinion: Treasuries rally as stocks tank

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Mama said there’d be days like this (30-year Treasury yields in blue, S&P 500 in red):

Click for sharper image. Source: Yahoo! Finance

Today’s action showed much a higher standard deviation move for Treasuries than stocks, and it may be a sign of things to come, as there has been a very strong correlation of Treasury yields with stock prices (inverse correlation of bond and stock prices) for the past couple of years:

Click for sharper image. Source: Yahoo! Finance

Note the divergence for the last month or so. Bond traders haven’t been feeling the same relief as stock market participants since July’s mini-panic. I’ve heard it said that the bond market has a Wharton MBA and the stock market has a masters from a South Florida community college. My money says the stock market chokes and comes down with bond yields right through the July and March lows in a long series of moves like today’s.

Are bonds a safe haven?

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Yes and no. The bonds that were able to retain a AAA rating held their own through the Great Depression:

But holders of Baa debt took it on the chin:

What the above graphs don’t show is the downgrades that took place along the way. Many bonds rated AAA in 1929 became Bbb or worse by 1932, in which case holders showed a huge capital loss. Of course, the bottom was a fantastic buying opportunity for those who had any money. Only 1/2 a percent of bonds issued in the Depression defaulted (source), which attests to how strict lending standards became.

Just so you know what kind of environment we are talking about here, when you hear Great Depression, think 45% drop in GNP:

And a corresponding drop in personal consumption:

Long term treasuries were the best performers, as yields just continued along their already established downward trend, albeit with some volatility, and there were of course no downgrades:

That crazy, crazy bond market: a call for sub-3% long bonds

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All of a sudden, the bubbleheads seem to have caught on that the recession is worldwide and that this means lower demand for commodities. With the dollar rallying to boot, the (bad) idea of buying copper or oil as a dollar hedge is gone.

I predict that the dollar rally will strengthen the compression of Treasury yields at all ends of the curb, as the market perceives a lower currency risk. This is a sign of deflation: an increasing preference for cash. With the banking system on the verge of a collapse worse than the ’30s, people will have no choice but to buy Treasuries. These promises of an insolvent and unrepentant debtor are safer than cash in the bank (because its not really in the bank!).

This flight to safety will send short-term yields back under 1% (as they were in March), and traders will move out the yield curve to get ahead of the compression, driving long bonds to historic lows, likely well under 3%.

Talk about a conundrum.  The nation is already on the hook for $50+ trillion and is on track to run trillion dollar deficits to pay for wars, the Fannie and Freddie bailouts, baby boomers’ retirement and medical bills, growing unemployment payments, and the new New Deal that is being drawn up and fought over (Boone Pickens wants a piece). It is safe to say that the US will never have a balanced budget again and will default on its entitlement promises and outstanding loans within a generation.

In more than a few ways the coming depression is a gift for the government, not the least of which is the ability to keep the game going a bit longer by creating demand for its debt at ridiculously low rates. What choice do investors have to keep their money safe, when banks are broke, corporations are going broke, commodities are collapsing and real estate is toast, all over the world? (I would suggest gold, but even that should go still lower in this panic, as weaker hands are forced to sell anything with a bid).

But the 30-year T-bond under 3 percent? Preposterous, you say! Bond traders are the smartest, most wizened bunch out there. They don’t let just any bloke into that club. They know the long bond is all risk for no reward. But look at these startling illustrations of what the market has done at the past two turning points in the generation-long bond cycle: the 1940s and early 1980s:

Here first is a shot of yields as they made their last bottom, in the ’40s:

And here is CPI hitting double digits at the same time:

Next, yields topped out a quarter century ago like this:

Note how by 1982, CPI was 6% and dropping fast, but yields remained over 12%.  And how do you explain that second peak over 13% in 1984, when CPI had merely ticked up from under 3% to just over 4% ?

So it may seem crazy, but it is entirely possible (and given the banking crisis, likely) that long Treasury yields will fall to 60 year records in the face of horrible fundamentals. But once they get there, I expect them to turn up and keep going, as the government starts to default by Fed printing.

To all those who feel that the US debt just DESERVES to be shorted, I say wait. It will get more deserving.

Bullish on the biggest deadbeat’s debt

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I have come around 180 degrees from last summer, and I’m bullish on long bonds now. The trend is clear over the past 12 months. The yields are moving with stocks.  The old correlation still holds, despite the dropping dollar and recently soaring commodities. The final flameout for the dollar is coming, but not just yet.

Dropping US, UK and Swiss government bond yields signal deflation and depression. I think they are a great speculation, particularly the Swiss bonds, since the country and currency are strongest.

Whatever you do, I wouldn’t buy one of those inverse bond funds, except for an inverse junk bond fund (such as RYIHX). In Depression #1, Treasuries soared and corporates were decimated.  And clearly, municipals are burnt toast. Sucks to be a government that can’t print money (sorry, Panama).

How to play it? I like 2010 calls on TLT.