Thursday, September 9, 2010

Bondzilla Returns!

What an interesting day today.

There are lots of things to talk about so let's get right to it.  Let's start with the ugly 30 year treasury auction today.  Here was the recap from the link above:

"This week's government debt sale ended on a sour note, with investors unfriendly toward a sale of long bonds.

The $13 billion sale of 30-year bonds fetched a high yield of 3.82 percent, 0.042 percentage points above the "when issued" expectations. Bidders put up 2.73 times the amount bid, a measure known as the bid-to-cover ratio.

Foreign demand also was soft, with indirect bidders making up just 36 percent of total buyers."

Needless to say the bond market didn't like the news.  Notice the sharp spike in 30 year yields at 1:00 when the auction results were released:

My Take:

This afternoons bond sale was very disappointing considering the flight to safety we are currently seeing into bonds.  The fact that only about a third of the auction was bought by foreigners is also pretty disturbing.

When you really think about it:  Should we really be surprised at these results? 

I mean investors are scared to death right now.  The idea of holding a bond that doesn't mature for 30 years must sound daunting when we can't even predict how the economy will look 6 months from now.

Foreigners have to be concerned about our ability to keep rates this low as our deficits continue to soar.    There is also the risk of inflation that could be triggered if we saw the dollar collapse or a devaluation of the currency by the Fed.

I think there is another developing threat to the bond market that is starting to get a lot of press.  This is the emergence of corporate debt.  Take a close look at the video below:

My Take:

Buying corporate debt is beginning to look like a much better bet moving forward.

Think about it:

Why buy treasuries that pay nothing and expose you to the serious threats of the USA's deficits when you can invest in a corporate bond of a company that has a stronger balance sheet and pays a higher yield?

Sounds like a no brainer idea to me.  There are plenty of solid companies that will survive our depression.   I agree with the bond trader above:  If you are comfortable with the duration of the bond and the yield then go for it!

You can see why companies are swarming to the bond market with debt offerings.  They know they will likely never see today's perfect combination of strong demand for corporate debt and low borrowing costs ever again in their lifetime.

Market Volume

I wanted to end with a little piece on the market volumes and sentiment before I get to the bottom line.

Bob Pisani had another interesting statistic today on the trading volume in early September:

"In the first 5 trading days, September consolidated trading volume at the NYSE was down 31 percent compared to the same period last year. August volume was also 31 percent below the same period last year."

Quick Take:

Where are all of the bulls?  I thought this was recovery summer?

Basically the volume tells you that you can hear the crickets chirping on the trading floors of the stock market.  This doesn't bode well for equities. 

The video above that began with a hedge fund trader who called for the death of  "cult of equity had a good take on it:

Here is the link to the article that the CNBC referred to.

Some tidbits from the piece:

"The “cult of equity” is dead as dividend yields in most of the west have risen above bond yields, according to one of Europe’s leading equity fund managers.

Alister Hibbert, a fund manager in European equities at BlackRock, told the Financial Times in a video interview that the cult started when dividend yields fell below bond yields about 60 years ago.

“We have now moved decisively the other way ... and that seems to be in relatively normal market times. So I think the cult of equity is dead,” he said.

They suggest that many equity professionals are admitting defeat after a poor decade for share prices has seen investors move away from equities and into bonds.

The cult of equity is widely regarded as starting in the 1950s as institutional investors piled into shares, pushing the dividend yield below the bond yield."

Quick Take

This was actually a bit too bullish for me at the end.  I think he is right but way early.  Nonetheless, he does make a good point about the psychology of investors who have taken a beating in equities over the past 10+ years.

The Bottom Line

Keep an eye on this huge shift into corporate bonds.  This will not bode well for stocks or treasuries in my opinion. 

I say this because the massive flight into corporate bonds suggests that there are now three viable competitors for investors.

Corporate bonds have always been around. 

However,they were never really a real threat to government bonds because they were considered "risky" versus investing in a treasuries that were backed by the full faith and credit of the United States Government.

This investor sentiment has now changed because investors are now questioning the solvency of the US.  They are then questioning treasuries as a result.

It will be interesting to see how stocks and treasuries react to their new corporate competition.  

Remember, there is only so much money that can be spread around so both stocks and treasuries could suffer as money finds safer places to hide.

Disclosure:  No new positions taken at the time of publication.


getyourselfconnected said...

I stole your bottom line tag with full credit toniight!

Jeff said...

Thanks get!