I thought a lot about the idea of a bond bubble over the weekend. The USA Today laid out both sides of the bond debate today in tightly wrapped clear and concise piece:
"The risk is that just as tech stock investors thought the good times would never end, current bond fund investors have a too pessimistic view of the future.
The anti-bubble crowd, including David Rosenberg of Gluskin Sheff and Julian Jessop of Capital Economics, argues that the massive shift into bonds is rational. They say that low yields make financial sense because inflation is virtually non-existent, the Federal Reserve has said short-term rates will remain near 0% for a long time, the economic recovery is losing steam, and risk assets such as stocks are performing erratically.
Those warning of trouble ahead point out that investors are leaving stock mutual funds and piling into bond funds, including funds that invest in Treasuries, in an extreme fashion. Since the start of 2008, bond funds have had $601 billion of cash inflows, vs. outflows of $240 billion for stock funds, the Investment Company Institute says."
The "bond bubble" debate dominated the blogosphere today. I also noticed that the inflationists and the deflationists were all over each other as Wall St tries and figure out what in the hell is going on in the capital markets. You can tell this flight to safety is freaking a lot of people out.
I have pretty much concluded that all options are on the table at this point. When I look at the market all I see is fear. I don't see fear of deflation. When I look at the flight into bonds I see petrified investors with no answers.
When I look at the anemic volumes I see investors that are so afraid they are paralyzed so they do nothing.
Conversation With a Wall Street Banker
When I spoke to my best source on Wall St this weekend I got a similar reaction. Here were some of his quotes:
"Jeff, money is scared right now"
"nothing looks safe"
We also talked about the Druckenmiller getting out of the game:
"This just shows you how tough things are out there"
"No one knows where to put money to work"
We also discussed shorting the bond market and on this point and he was hesitant. He didn't think getting out in front of this in either direction was a very good idea.
I must admit it was a strange discussion. It was not the normal banter that we usually have when we debate the markets. The one feeling that kept hitting me during this conversation was how quiet he was.
This is extremely rare because he is NEVER at a loss for words. He's also a person that I have a tremendous amount of respect for because of his experience.
The conversation was almost surreal for me: I mean here I am talking shop with a grizzled Wall St veteran who has 42 years of Wall St experience in stocks, bonds, and the securitization markets and he's speechless when it comes to having any conclusions about the market.
The way Wall St. is trading right now you can tell that he is not alone.
Here is the last point he made to me:
"I am glad I am not your age because this is going to be one hell of a mess to clean up"
Needless to say I didn't feel any better about our situation after we finished our talk.
The Bottom Line
I don't see any confidence in the market right now. The best of the best are petrified and are hiding in treasuries because they are unable to make sense of what is going on right now.
The deflation trade is on in bonds but it's not on in other areas that it should be if we were witnessing true deflation. If this were a true classic deflationary panic then answer these questions for me:
Why is gold holding firm at $1200 when the CPI is flat or declining?
Why are commodities soaring in such a deflationary environment?
Why is the Yen soaring against the dollar?
Why aren't stocks collapsing ?
None of this makes any sense. I can see why some of the big players are walking away from the game. I would be taking my billions and walking away too at this point.
The deflationists and the Inflationists are going to go ballistic battling each other over the coming weeks. I for one don't see either choice as an "all or nothing" scenario.
Trying to paint the markets with a broad brush and saying everything will drop or rise as a result of deflation or inflation is silly.
I for one believe that this deflationary panic into bonds is a temporary phenomenon. Inflation is the only way we will really get out of this in the long run. It will likely be through a currency devaluation(more on this on a later post).
Meanwhile, as we obsess over deflation, other parts of the world are currently battling inflation. Hat tip to Itulip. India is seeing serious inflation despite higher unemployment:
My only take on all of this is it's very easy to get confused when half the world is fearing deflation while the other half is experiencing the exact opposite. You can see why investors around the world are sitting on their hands.
One thing for now is for sure:
Investors are scared to death. What worries me about all of this fear is people tend to panic when they are fearful.
When people panic they often make VERY bad decisions. The fact that investors are avoiding stocks and staying in treasuries at zero yield tells me that there is very little confidence in the stock market.
If we see a panic it will likely be to the downside in stocks. The fact that stocks are not going up right now when bonds are yielding nothing tells you all you need to know when it comes to the appetite for equities.
If bonds start to drop I think you may start seeing money going underneath the mattress as confidence in all assets becomes lost. I wish I was kidding. I think its that bad folks.
I wish I had some strong advice as to what to do at this point. The only thing I can say right now is hedge yourself for deflation(dollars, bonds) and inflation(commodities/Metals) and just hope that this the whole banking system doesn't collapse.
Disclosure: No new positions at the time of publication.