Tuesday, August 31, 2010

Wall Streets Bond Obsession Continues!

Stocks remained on ignore again today as money continued to soar into bonds.  I have a feeling you are going to hear this line a lot from me in the oncoming months after I caught this piece:

Bonds Bubble Inflating Faster than Dotcom:

"Analysis from one Wall Street strategist shows that the pace of money flowing into bonds is faster at this stage than the infamous dotcom bubble of the late 1990s. And that's not necessarily bad news for those Treasury investors.

Almost two years into the bond flight, about $550 billion has poured into U.S. bond mutual funds and exchange-traded funds, according to BNYConvergEx Group Chief Market Strategist Nicholas Colas. Using inflation-adjusted figures, investors had put $499 billion at this same stage of the Internet bubble. Colas selected December 1996, the month of Alan Greenspan's "irrational exuberance" speech, as the estimated start of the bubble in equities. For bonds, he uses the collapse of Bear Stearns in March 2008."

Quick Take:

The article then explains that the tech bubble still had a lot of legs before it blew up:

""We all know bubbles can last longer than anyone thinks possible, and the money flows give us a sense just how much more cash may be waiting in the wings," said Colas, in a note to clients today. "In total, U.S. equity stock funds logged some $840 billion in new capital from Greenie's warning to the peak of the NASDAQ, and over $1 trillion before money actually stopped flowing into stocks. So that $550 billion in new bond fund money may have some more company soon, if the 1990s period is any guide."

My Take:

That last line is the money quote.  I have been discussing the idea of shorting treasuries after this move.  After finishing this article I am starting to think maybe my shorts should be focused on stocks instead.

The numbers above tell you that this move into bonds is basically only half over if you compare the bond bubble to the tech bubble back in the late '90's.

If history repeats itself then stocks are in a great deal of trouble here.   Before I get into that lets talk a little bit about bonds:

Owning bonds in a lot of ways is just like owning a stock.

Investors tend at times focus too much on bond yields versus the actual return on thebonds if  the demand for them rises.  TLT(which is a great barometer of how bonds are doing) has soared recently as money piles into the bond market:


Take Continued:

If you bought TLT when this bond bubble really started rolling in March at 87 you have made a killer return of about 25% in a span of 6 months.

If you go back a little further you can also see how this move may still have some legs:


As you can see we are still far below the highs of 123 that were seen when the stock market collapsed back in 2008.  This means that the money flows are likely to continue into bonds as Wall St sees so much more room on the upside.

What's startling to note here is the volumes in which money is now flying into bonds versus 2008.  As you can clearly see, the flight into bonds today is blowing away the volumes that we saw back in 2008 when it appeared the whole banking system was about to collapse.

This my friends is hard evidence that this flight into bonds has morphed into a speculative bubble versus a fear trade.

I mean think about it: If this was a fear trade then how could the volumes be so much higher then they were back in 2008 when it appeared the financial system might collapse?

The Bottom Line

We all know that Wall St has always been about making money.   Where they made it never mattered.  They will flock to anything that can turn a nice profit especially in an economy that's as bad as this one is.

Wall St is also famous for walking away when a game is over as they look for the a new bubble to blow.  It appears that stocks have become "passe" as the big money rolls into bonds.

When the Fed dropped rates to zero I figured Wall St would eventually  find a way to exploit it.  Ironically, you never would have guessed it would have been in bonds because rates were at zero.

I say this because zero rates made bonds very vulnerable to dropping in value because the consensus view during usual times would be that the Fed would only hold rates this low for a short period of time.  They would then raise rates as the economy recovered which would then push the values of the bonds down.

Wall St quickly realized after the stimulus was over that the Fed could not raise rates because the economy was basically screwed beyond belief.  

Once they came to this conclusion the trade was easy.  You have to hand it to Wall St:  They will always find a way to exploit various vulnerabilities in the economy. 

It doesn't matter if the economy is good or bad.  150$ oil anyone?

So now that we see the new game you need to ask yourself how can you profit from it?

The way I see it you could still pile into bonds.  Japan's 10 year bond dropped to 1% during their meltdown.  Why couldn't the same thing happen here?  If it does the bond trade will still work.

Another way to play it is to short the stock market.  It's clearly obvious by looking at the volume of money flying into bonds that Wall St has decided to pump the bond market versus the stock market.

Strange isn't it?  We are so used to it being the other way around.  This is not the first time this has happened.  I had an old banker friend tell me the stories about how Wall St basically bailed on the stock market in the 1970's when the stock market flat lined at DOW 1000 for a decade.

The traders all bolted to the credit markets because all of the money was being made in bonds because their yields were outperforming the returns in stocks. 

Ironically, the move into bonds this go around is for the exact opposite reason:  The move has been triggered by higher bond prices/falling yields versus lower bond prices/higher yields.

It doesn't matter to Wall St as long as the game is profitable. 

I think the stock market over the coming years is in deep trouble.  Stocks are now facing even more headwinds as Wall St flips into bonds. 

Facing a collapsing economy was bad enough.  Now they have to fight the good fight without the support of many of their old friends from the street!

The reality here is stocks now face a double edged sword when more weak economic data is released: 

On the one side investors will sell stocks because earnings will fall which will hurt values. 

On the other side economic weakness will likely push Wall St into selling more stocks and piling even more into bonds because the game will look increasingly profitable as the economy continues to fall off a cliff.

This will be a brutal 1-2 punch for stocks.  You can be sure that it will eventually put them on the canvass.

IMO, it's time to start focusing on the short side in the stock market moving forward as the bond bubble blows. 

Let me also say that the bond bubble isn't any different from any other Ponzi scheme.

This one will burst too and I am afraid it will be the last one when it's all said and done because there will be no economy to fall back on. 

For the near future however, the bond game still has plenty of tailwinds as the economy continues to worsen.

Disclosure:  No new positions at the time of publication.












6 comments:

Anonymous said...

http://www.propublica.org/article/banks-self-dealing-super-charged-financial-crisis

;)

Jeff said...

Nice read Anon

Wall St sure loves feeding frenzies don't they?

Bonds are today's version of CDO's in 2005!

Imagine how ugly this one is going to be when it eventually unwinds.

This bubble will end up being the largest of them all.

Anonymous said...

Meanwhile, in other news, Case Shiller reported that home prices rose...again. In DC the value is 185.77 up 7.2% YOY and up a full 12% since the March 09 bottom.

If you recall, Jeff promised us that by the end of May 2012, 21 months from now, DC housing prices will have CRASHED 30% and be down at 125.0 (or worse). By contrast, I insisted we would stay at 155 or above.

I am optimistic that prices will trend down soon, once again, driving him into a frenzy of emotion driven angst about how house prices in DC are far too high and due for an "imminent and severe crash of biblical proportions. Still, over the long term, I think its obvious who is right about this one.

21 months and counting. Tic, tic, tic...

Jeff said...

Hehe

We'll see. June still included the tax credit.

July's number was flat dismal. Feeling just fine with the call.

Anonymous said...

hello permabears, bull market is back! yeaahh

Jeff said...

lol

Up down up down. I'm getting dizzy!