Tuesday, June 22, 2010

Bond Bubble?

I found an interesting article on bonds today that was done by CNBC.  The network actually interviewed some bond traders for a change which was very refreshing. 

Kudos to CNBC for mixing things up! Let's hope this trend continues because I don't think I can handle much more of the usual bulltards they roll out every 10 minutes pumping equities.

Let's listen to the video(make sure you listen to the second half) first and then I will have some quotes and some comments around the bond bubble that I think is forming below:

My Take:

Ahhh....Isn't it nice to hear a credit analyst dicuss the economy versus an analyst from the Wizards of Wall St?  The crew in Chicago is so much more intelligent.

The most interesting part of this piece was his take on how it appears the USA is on it's own when it comes to sticking with the "throwing money out of helicopters" economic policy.

Japan and England have already announced severe austerity measures.  Germany and the PIIGS are also in agreement.  China has a surplus so they don't have this problem but they have been critical of the Fed's spending.

What I don't understand is why our politicians are so scared to join them.  What are they so afraid of?  Were there riots in the street's of England and Japan after their severe austerity measures were announced?  No.  Some anger perhaps but I think the people of both nations understand that this needs to be done for the good of their respective countries.

The reality here is it's the only policy that will work.  You can't keep throwing $1 trillion dollars at a bad economy thinking that you will get $1.5 trillion back.

I think the USA would be willing to accept austerity if it was the right thing to do for the long term sustainability of this nation. 

Just look at the Tea Party:  They are essentially running on an austerity platform and the voters have responded by rapidly making them a major player in many of the recent elections across the country. 

Lets face it:  The taxpayers were already molested by Wall St via the TARP legislation and the the people in this country did NOTHING in response.  If that won't make them turn off American Idol and riot in the streets then nothing will.

I say bring on austerity because it will give our children a future!

Bond Bubble?

I am starting to believe that the massive move into bonds might be overdone.  We saw another highly successful bond auction today. 

The bond traders in the article above have nailed it.  Let me share a few quotes with you from above:

"The trend toward long-dated bonds is not surprising to those who think the market for Treasury's has been overheated and led by investors who are ignoring inflationary signals.
The trend is "another indication of how bubblicious this market has become," says Michael Pento, chief strategist at Delta Global Advisors in Parsippany, N.J. Pento points out that by 2015 the US will be spending 30 to 50 percent of all revenue on debt service payments, a factor that will drive up interest rates and push people away from bonds.

"If you have 50 percent of all revenue going to interest payments, what do you have left?" he says. "You have exploding deficits, you have skyrocketing interest rates, people selling your currency—you have economic catastrophe."

"The amount of debt we're going to be seeing over the next decade is worrisome, the Fed's balance sheet is worrisome. Those are off into the future now," says Kim Rupert, managing director of global fixed income analysis at Action Economics in San Francisco. "At some point something's gotta give and rates are going to turn sky high. It's just a matter of when."

"With long-term US bonds you're really playing with fire," says Mike Larson, analyst at Weiss Research. "We're still borrowing and overspending and we don't really have a concrete plan to get that down."

"Nevertheless, Ferry says he's seen enough to know that trouble is ahead.

"Everyone wanted a piece of the inflationary theme when the Fed went to quantitative easing. They got killed. So now they're seeing the other side," he says. "That's indicative in our mind of a last-ditch, crazy fifth wave. This is what happens at the end of cycles. We're in that final stage."

The Bottom Line

I could not agree more with the bond traders that are quoted here.

If the USA decides to be a renegade and go it alone with deficit spening then I think bonds are going to sell off hard and yields will soar asa  result.

Remember, risk is relative and if the USA continues it's Ponzi spending at a time where everyone else is tightening their fiscal belts then our bonds will have to be repriced for risk.  The effect of this repricing of risk will be ugly for treasuries.

IMO a bond collapse seems inevitable after reading Pento's quote where he claimed that 30-50% of our GDP will go towards servicing our debt by 2015 if we don't cut our spending.

In fact, bonds should sell off no matter what we do from here.

If we keep spending rates will rise because our risk of default will rise relative to other countries who are in the process of cutting spending. 

If we stop spending(by choice or force) rates will rise because we will be suffering from severe austerity at a time where we must continue to service our massive debt load.

So are bonds a bubble?  My answer is yes.  The scary thing for me as an investor is I don't know where to put my money:

Equities?  Hahahahaha....P/E's are insane.  Someday I will be back but not now.

FDIC?  CD's and money market funds are an option.  At a minimum I believe that you should own both bonds and FDIC investment vehicles(underneath the guaranteed limits of course).

Short treasuries?  This is a nice hedge against your bond holdings.  You can do this in a variety of ways.  You can own the etf TBT which shorts longer term treasuries.  This is not a good long term hold because of the slippage that is seen in the ultra short etf's.  You can also buy PUT's on symbol TLT.   The risk here of course is they expire so I would go out as far as you can when you buy them.

Bond funds?   I really like this idea because they can manage risk for you.  My largest bond holding is PIMCO's PTTRX.  Bill Gross is the best bond guy in the world in my opinion.  He consistently beats 95% of his competitors year after year.

We are certainly in unprecedented times.  Could this be a time where we see a deflationary collapse with higher bond yields at the same time as a result of overwhelming deficits?  Every collapse has its own characteristics so perhaps this is how ours will be different.

Let's not forget about inflation here either.  There is still the risk that the Fed could print in a desperate attempt to get us out of this mess.  A dollar devaluation is also a serious risk to the inflation equation and it's something that I think we will see at some point.

Either way one thing is clear:   We are on the cusp of hitting some sort of economic reset.

What it looks like remains to be seen.  However, diversification is a must as an investor as we all prepare for it.

Disclosure:  No new holdings at the time of publication.  Own PTTRX in longer term accounts.  Owner of TBT in short term accounts.


Anonymous said...

2015? How long can the Fed keep interest rates low?

Jeff said...


Sometimes its not up to the Fed when it comes to interest rates.

The bond market can take interest rates higher by themselves by simply not buying treasuries.

The Fed then has to raise the yield on them in order to make them more attractive.

The Fed Funds rate is becomes irrelevant if real rates are significantly higher.