December's and January's are always slow. Lot of time is spent with family and friends, which leaves less time for blogging. You have probably noticed that it has been overdue for awhile now, but I've finally updated the "Important Charts" section of the blog. While the page contains a lot of different indicators for a variety of asset classes I follow, a cupel that have grabbed my attention in recent months are connected to the US Treasury Bond market. Consider these two charts:
Are government bond yields finally starting to move upward?
The other side of the bond market that measures inflation expectations via TIP vs Treasury spread, also known as break evens, disagrees. We seem to be overheating and could be signalling a top for majority of risk assets including S&P 500.
Do you think bond yields have finally bottomed, after a long 31 year secular bull market?
Please post your comments as to why you think or do not think so. I look forward to good debate and in the meantime, make sure you look at the rest of the charts at "Important Charts" section of the blog. Use the charts freely, as long as you source the blog. Enjoy!
p.s. Later on in the week I will continue with the Part IV update for 2013, focusing on Commodities.
I think bonds will consolidate in this area and won't rise until a war which set rates higher (this was the post 30s depression cause) or a Lehman event x10 to create the blow off top in bonds. The US and global economy remain far to weak to support higher interest rates and will choose war or Lheman bubble blowing.
ReplyDeleteI think the save haven bonds will go down, and the PIIGS bonds will go up, at least for the next 6 month. But its not easy to predict, whats going on in Euroland.
ReplyDeleteBen
This chart presents German and US 10 Year Bond Yield vs. the Japanese. German and US is reversed 10 years and if they will follow the same pattern as the Japanese Bond Yield then we still have the final parabolic move to come some time in the horizon.
ReplyDeletehttp://www.agrocura.dk/NR/rdonlyres/81417DF5-367A-40BB-BEF5-9864933AAFA4/0/RenterJapanGermanUSA.jpg
Why do the bond yields "have to" rise? People have forecasted this for 20 years for the JGB's... Yields are stilk down.
ReplyDeleteIt's not easy to clearly and exhaustively answer your question,since doing so would involve delving deeply into the Time Preference Theory of Interest,to determine how interest rates are set in a free market and more generally into Austrian economic theory,to determine how capital is formed and how the current fiat-money/fractional reserve banking system hampers and distorts this process.If you are really interested in finding out the answer for yourself,I suggest that you read "The Theory of Money and Credit" and "Human Action" by Mises and "Man,Economy and State with Power and Market" by Rothbard:let me know in a couple of years time how it went ;)!
DeleteThe short answer is that the US and Japan are not comparable since money supply growth in Japan(and this includes uncovered money substitutes)has been muted for years,whilst in the US it has "enjoyed"(to the detriment of all of its citizen)robust growth,at a rate at least comparable to that of the '70s.
The honest answer to your question is "I don't know"...There are too many conflicting forces at play right now to be able to clearly determine the likely direction of bond yields:I feel I have no edge.If I were to guess I would say that they have not yet topped,but this is based mostly on a hunch.
ReplyDeleteI am bearish on bonds because of the sheer size of US debt and deficit(not only in % terms but in absolute terms as well:it's not easy to find so many "natural" buyers)which could increase even further if we again see ballooning expenses coupled with collapsing receipts as in 2008/2009;money printing and debt monetization;the already huge and ever-growing worldwide debt pile that needs financing and rollover;the fact that in the end it's all a confidence game and hence bond prices are resting on precarious foundations.
I am bullish because the public is not so bullish;reservation demand for money might play a positive role during a crisis;the pool of highly-rated eligible collateral keeps on shrinking;the rest of the world is not in a rosy situation and it's likely that a renewed crisis will first hit Australia and/or Canada and Europe/UK,since the US still enjoys dominant status and that's where money goes to hide(it will stop someday,but it's nigh impossible to tell when).
I guess we'll find out during the next bear market:should yields fail to decrease substantially it'd be a huge warning sign.
http://www.ritholtz.com/blog/2012/11/shocking-news-bond-bearishness/
ReplyDeleteI'm sure I'm not the only one who Googled the above and came across this link.
Personally, I don't have an answer because I don't know enough about the bond market to be honest.
Mitch
I fully agree with Rothbardian.
ReplyDeleteAnd I would also like to add that I would like to see sentiment turn before going bearish on bonds. The majority has been bearish bonds for one or two decades as many has pointed out. This is really not the scenario one would see before a change of trend.
So a final deflationary crises would be a good trigger. But that would of course also be very negative for risky assets.
But I have noted that despite the latest QEs the yields are trending upwards. And that can in itself, paradoxically, trigger the deflationary scenario, since longer-term financing becomes expensive.
macrot, Ben & Mitch - thank your for your views.
ReplyDeleteNiels - great charts as always. To get German and US bonds to move into extreme territory like in the chart you presented, we would have to see some kind of meltdown in global economy, earnings and financial credit markets freeze yet again. Maybe not as bad as Lehman type of an outcome, but something that would be known as an aftershock. Similar occurrence was seen in 1929/32 followed by 1937/38.
The Rothbardian Investor - I always find your answers of very interesting to read. My view is also that I do not know weather or not yields have bottomed from a secular point of view. Chris Kimble, who runs a great technical analysis website, sent me this chart yesterday. It shows that we are about to bottom in yields, but just like during late 1940s, this "process" could take months and quarters yet. So far, the selling of bonds does not look that dramatic. As you said yourself, the real test will come once the equity bear market starts. Will bond yields go down yet again or have they already peaked.
Johan - I also seem to think that we are overdue for a deflationary scenario. The chart above shows that inflation expectations are peaking as consensus trade is risk on trade and inflation asset trade. As we know, majority of the time, majority of the investors are wrong. I believe it is only a matter of time until we see majority surprises again and it could happen sometime in 2013/14!
Break even chart looks very interesting. It seems that S&P peaks as every time we see an approach towards 2.5% inflation target.
ReplyDeleteI don't think the Fed will allow to raise rates, since this would cripple the housing market. US debt is at 84 trillion. A rise in rates would kill the economy.
ReplyDelete"But we have an improving economy!" Sure: because it is improving and has been in a bull market for years, now already 25% are plundering their 401ks to pay the monthly bills. After a great recovery todayit are 12% MORE than 2008.
What i see in the comments sections everywhere:
Everyone has bought the central banks "inflation is no threat" theme.
Everyone is head over heels into stocks.
And nobody own miners.
Then i love them.
The Fed has signaled that they'll keep rates inverse to unemployment, so the direction points to a gradual uptick in rates as unemployment drops (on paper, anyways). That said, a correction could just as easily shift equities back to treasuries and lower yields.
ReplyDeleteOn the other hand, if the correction is a result of a US default (temporary or not), it's hard to predict what would happen. You could argue that even with a temporary default, the US still leads the world in GDP by a long shot and is still the safest debtor nation. On the other hand, a default could cause a genuine shake-up and/or down-grade that forces pension funds and other risk-managed funds to flee out of treasuries and into alternative "safe" assets. Not sure what would be considered safe in that scenario, except perhaps the Yen, Franc, PMs, commodities and it sounds very contrary, but possibly even corporate bonds.
That said, if I had to pick, I would say treasury yields can still go lower, especially if a correction happens for any reason (including default). I think most retail, pension managers and other vanilla investors know what it's like to be burned now and will simply exit into cash, which will eventually be rotated into treasuries. I think the institutions will seek yield elsewhere but it's hard to see anything other than US treasuries that can absorb a large exit.
Thanks for the chart Tiho!I agree that we are close to a major turning point,but it's going to be very tricky!After all during the last one none other than Stanley Druckenmiller blew up his firm!
ReplyDeleteI suspect that a safer bet would be to sell bonds of already troubled or soon-to-be-troubled countries like Spain/Italy and France.Italian BTPs have been on a tear recently and French bonds are very close to their all-time highs and have shown safe-haven behaviour:I think that selling the former as they approach the 115/118 area and waiting for the latter to show their hand as the next crisis strikes and sell them when they give signs of exhaustion will prove to be profitable moves.
To reciprocate,I will show you this chart,which you may already know(and for which credit goes to the always excellent www.acting-man.com): http://research.stlouisfed.org/fredgraph.png?g=eDk
It shows the ratio between industrial production of business equipment(higher order goods)and industrial production of non-durable consumer goods(lower order goods):it represents the fact that inflationary policies engender an imbalance in the production structure,by drawing more resources towards higher order stages of production that appear falsely profitable thanks to the abundance of money/credit.
All the spikes have to be painfully corrected,as they are both unsustainable and contrary to consumer wants.These corrective processes are usually accompanied by nasty bear markets,particularly when they happen in the context of a secular bear market,which is nothing more than a secular readjustment of these and other imbalances,all caused by the fiat-money/fractional reserve lending system.
Note how the rate of ascent has accelerated markedly since the beginning of the 1990s,as the inflationary effort of the FED intensified.Note also how all recent corrections have been artificially stopped by means of even more inflation,to the point where the imbalances are now greater than they were at the last peak,and greater than any other peak previously reached.
I suspect we are close to a major top(related stock market tops usually occur either concomitantly or slightly before).The only other alternative,given its quasi-vertical rate of ascent,would probably be what Mises termed the crack-up boom(or the as he originally termed it "die Katastrophenhausse",literally "catastrophic rally/disastrous bull market"),in which case gold and silver will serve you very well.
I definitely agree with your view. If I didn't think bear market was upon us, I would haven't have engaged into shorting certain sectors of the overbought US stock market. However, my view back in August of last year still seems to early, mainly more to do with time than with price. However certain sectors have overshot on the upside like Dow Transports, to my disliking.
DeleteNonetheless, S&P 500 still stands around high 1400s as it did in September of last year during elections. I do see a bear market coming which is mostly linked to my view of the economy and the business cycle. The chart you discussed there is very interesting and obviously just another reason to expect a slowdown in investment, capex, profits, margins, etc etc. Also, not all is well with the stock market despite new highs, as leaders like Apple are also failing to rally higher despite "all the money printing and stimulus".
Now, there could be a surprise outcome, as you yourself stated. In this scenario, also known as inflationary boom, everything would go up including risk currencies, equities, commodities, etc etc. However, if stocks do go up from here, I think Precious Metals and in particular Silver would go into a parabolic rally to mimic 1980. Since majority of my NAV is in PMs, if we see a crack up boom, I'll make a lot more money in Silver relative to losses in shorting stocks.
The view here is that I am long assets in secular bull market that have recent corrected and offer value, while engaging into short selling assets in secular bear market which are near the high end range of their sideways multi-year pattern. In coming quarters and years, buy the end of 2013 and into 2014, it will be interesting to see how things play out.
Yes,I think you're positioned in a very prudent and potentially very profitable way.I think at this point,with all the truly important data&measures continuing to deteriorate,it's mostly a matter of patience and "sitting tight" whilst maybe suffering for a few percentage points more,until the crowd abandons its delusional views.
DeleteHi Rothbardian Investor,
DeleteThank you for this truly very interesting chart. It actually also interests me from a philosophical/sociological perspective, we live in times that are extremely obsessed with the future, failing to live in the present, we are obsessed with health and longevity, afraid of flobal warming and a future apocalypse. And this thus shows in interest rates and investment patterns: our times invest too much into the future ( higher order goods, real estate) and not enough in the present tnon-durable goods). This, I believe, was the austrian school explanation of the 1929 crash and the Great Depression. It would be interesting to see how this relates to Kondratieff cycles.
Thanks Belsha!The Austrian school explains all these depressionary/recessionary phenomena,whether cyclical or secular,as the inevitable result of illusory booms brought about by credit expansion:the ensuing malinvestments have to be liquidated,as they are unsustainable.It's important to note,however,that praxeology is a value-free analysis:the objective of the Austrian school is not to tell us whether the current level of saving or investment or interest rates is either too high or too low,but rather whether it is the result of a natural market process(and thus reflects the actual consumers wants/preferences)or whether it is brought about by artificial means.In fact,they would(correctly)argue that,as long as it's natural,there isn't a too high or too low level of saving/investments/interest rates:it all depends on the indisputable wants of the consumers.The unsustainability of the booms are not a result of too high or too low levels,but rather of artificial levels that encourage the undertaking of apparently profitable enterprises which are in reality unsustainable(like the endless building of skyscrapers in Dubai).
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ReplyDeleteThe chart of brekeven index is questionable. Here a complete different chart of a 10 year brek even index from dow and credit swiss.
ReplyDeletehttp://www.djindexes.com/inflation/
(just click 10 year brek enen index.)
TIP/TLT ratio is not at extreme levels also. So, these vihicle show us there is many place to swell S&P using printing press.
Would not surprise me to see Apple back up near 600 bucks by next Friday's close.
ReplyDeleteWhat makes you say that Bob?
DeleteJust my gut feeling and anecdotal evidence.
DeleteI think ipads flew off the shelves in the last quarter.
I visited many PC shops in the run up to Christmas and there was tumble-weed blowing past the Windows laptop and PC stands. But you could not get near the Apple stands so crowded were they with people from children to people in their 70s wanting to try out the ipads.
I also think Apple will soon announce something in China - China will become the world's biggest smartphone market this year. If they do not get good sales in the Chinese market this year they will be left behind as other players increase their market-share. No, I am not thinking of Nokia.
So I think Apple will either announce a deal with China Mobile OR they will do what they just said they will not do - and that is make a cheaper iphone.
The phones that are flying off the shelves in China at the moment, and which are the main cause of mobile phone growth in China, are in the 140 USD to 250 USD price bracket. The current iphone sells for about 500 USD to 600 USD in China. It is simply too expensive for the market which is forecast to account for most of the massive smartphone growth in China going forward.
Simply, on price alone, Apple is doomed to fail in China despite huge growth ahead for smartphones in China. So either China Mobile agrees to heavily subsidise iphones, (Why? After all Apple needs China Mobile more than China Mobile needs Apple), or Apple brings out a cheaper smartphone and targets that sweet $140 to $250 price bracket.
Probably both will occur.
If either is announced on Wednesday then I expect Apple shares to soar as a result.
Good Points. I'll have to keep an eye on this one.
DeleteI'm new to the markets and am still learning so I'm curious of a few things.
In your opinion how much of this information has already been priced-into the market considering over the last 10 or so years apple has already gone up 81 times and technology has traditionally been one of the most competitively inviting sectors once there has been a successful domination of product advances which has resulted in an already profitable outcome ie near parabolic rise in stock prices and an outright sentiment mania?
http://www.cnbc.com/id/100382535
DeleteThank you for all comments. I will soon be putting up a Part 4 post regarding what to expect in 2013 and into the future, when it comes to commodities. I will be covering Copper, Oil, Gold, and even some Agricultural commodities. Stay tuned!
ReplyDeletep.s. I have also updated my trading diary on the side of the blog. No major changes and no new purchases. The major part of my fund remains long Silver, which is by far and away the largest position. Othe repositions remain opened as they are longer term bets. Quite a few small bets and hedges (totalling few % points of NAV) via options have expired and majority have resulted in losses, especially linked to Japanese Yen. That currency has really been smashed and bashed.
ReplyDeleteMr Abe has panicked the global investment community rather swiftly, promising that he will weaken the Yen dramatically. We have now had a crash in the Yen from 81/82 levels towards 90 level. It seems that investors have lost confidence in the Yen as a safe haven. Sentiment is super extreme and we have gone down sometime like 12 weeks in the row. Rebound is to be expected.
Hi Tiho:
ReplyDeleteI had also loss from Yen.
But much interesting is "when will the K-cycle winter end ...."
The sentiment of spring " Fear of return to depression , Fragile confidence ...."
Maybe what we need the the time of "depression" bottom....
Hi there! Were you able to fulfill all the settings of this blog on your own or you turned to professionals to receive help?
ReplyDelete