Quotable
From February 2010:
“Shorting Treasuries is a ‘no brainer…every single human being should have that trade.’”
Nassim Taleb
LOL…hoisted on the horns of a Black Swan petard were you Mr. Taleb?
Commentary & Analysis
Guru Follies
The newsletter crowd, to which I plead guilty, loves to tell you scary stories that often seem to be missing an important element—facts. Let’s take a short stroll down memory lane and review the latest stories from the gurus.
1. Always a favorite, the US dollar is going to get killed. This one is back on the front burner thanks to QE3. Of course, the fact that the dollar didn’t get killed by QE1 or QE2 seems not to matter. It is QE3 that will surely do the dirty deed this time. The newsletter gurus seem to lose sight of one very important axiom of price, it is this: If supply increases, but demand for the increased supply increases even more, price doesn’t collapse; it tends to rise (cateris paribus). The demand for dollar liquidity in a world where the European banking system is desperately deleveraging and many in the private world are doing the same likely means the world reserve currency remains supported.
2. Inflation will soar. This is one of my favorites, as the newsletter crowd remains stark-raving loony over this one despite the facts. After all, this inflation call is simple…more money means more inflation. Slam dunk! But we haven’t seen inflation as defined by the newsletter crowd. We have seen some commodity prices surge on investment liquidity and supply problems, granted. As I have shared with you many times before, if money doesn’t make it into the real economy to be used by real people to bid up the prices of real goods, it isn’t inflation in the normal sense we think of when we say “inflation.” But if we say there has been a massive inflation in financial assets; that would make sense. That’s because much of the money the Fed has created has leaked into financial assets. We can say there has been asset inflation driven by the financial economy. We can say that overall there has been a decline in the purchasing power of global fiat currencies as we view the price of gold. But this is different and more easily deflated.
3. There is a massive bond bubble out there just waiting to pop. I believe we are on our third fear-mongering bond bubble theme since QE started…it could be more, I really have lost track of this favorite scare story. And of course with QE3 fresh in the minds of newsletter buyers, this bubble story is hot again. The flimsy logic behind a bond bubble is the idea that money has moved into bonds irrationally, for some speculative gains and all these investors just don’t understand that hyper-inflation is just around the corner. And if you hold US bonds, you are really in trouble because QE3 is the straw that has broken the greenback’s back and that will add to the pain for bonds. Let us consider some real reasons why bonds are loved and why they could remain loved for a very long time: a. Global demographics – As people get older their portfolio tends to shift toward what they perceive is less volatile and more safe investments such as fixed income.
b. Secular change in consumption patterns – The credit crunch really was a sea change I think. Massive personal balance sheet overleverage, coupled with the decline in the biggest personal asset—real estate—seems to have triggered a sea change in both real consumption and attitude toward future consumption. This means more savings. More savings tends to mean more money in fixed income net…net.
i. The knock-on effect of a change in global consumption/increased savings is the catalyst for rebalancing the current account deficit nations with the current account surplus nations. It is especially bad news for those with export-dominated growth models who will take the brunt of the adjustment domestically…and we know who you are: China, Germany, and Japan…
c. Massive global debt levels equals below capacity future growth. Below capacity future growth will tend to push down the expected return from growth assets—stocks—relative to fixed income. And slower growth is usually accompanied by lower future inflation expectations. And lower future inflation expectations are usually discounted into the current yield for fixed income. Thus, bonds will tend to remain supported.
d. Risk bid. If I am right that the Eurozone crisis is far from over, and that China will likely experience either a hard landing or lead to a major negative growth surprise, the idea of a major risk bid of global money running for safe haven is still a high probability. And safe haven money flows into…you guessed it…fixed income.
e. Historical parallels. This from Hoisington Research, a fixed income investment management firm based in Houston who has been more right on bonds and interest rates for the last five years than anyone I have seen….
“Long-term Treasury bond yields are an excellent barometer of economic activity. If business conditions are better than normal and improving, exerting upward pressure on inflation, long-term interest rates will be high and rising. In contrary situations, long yields are likely to be low and falling. Also, if debt is elevated relative to GDP, and a rising portion of this debt is utilized for either counterproductive or unproductive investments, then long-term Treasury bond yields should be depressed since an environment of poor aggregate demand would exist. Importantly, both low long rates and the stagnant economic growth are symptoms of the excessive indebtedness and/or low quality debt usage.”
We know that debt levels in the industrialized world are in the ozone and still rising. Now take a look at what yields did historically during three similar crisis periods—Japan 1989, United States 1873, and United States 1929–when debt levels were much lower globally than they are now.
Back to Hoisington:
“In the aftermath of all these debt-induced panics, long-term Treasury bond yields declined, respectively, from 3.5%, 3.6% and 5.5 % to the extremely low levels of 2% or less in all three cases (Chart above). The average low in interest rates in these cases occurred almost fourteen years after their respective panic years with an average of 2% (Table below). The dispersion around the average was small, with the time after the panic year ranging between twelve years and sixteen years. The low in bond yields was between 1.6% and 2.1%, on an average yearly basis. Amazingly, twenty years after each of these panic years, long-term yields were still very depressed, with the average yield of just 2.5%. Thus, all these episodes, including Japan’s, produced highly similar and long lasting interest rate patterns. The two U.S. situations occurred in far different times with vastly different structures than exist in today’s economy. One episode occurred under the Fed’s guidance and the other before the Fed was created. Sadly, there is no evidence that suggests controlling excessive indebtedness worked better with, than without, the Fed. The relevant point to take from this analysis is that U.S. economic conditions beginning in 2008 were caused by the same conditions that existed in these above mentioned panic years. Therefore, history suggests that over-indebtedness and its resultant slowing of economic activity supports the proposition that a prolonged move to very depressed levels of long-term government yields is probable.”
Now, you may want to sell this bond market here based on the view it is a bubble. But before you do, let me share an anecdote. I remember it vividly. The recently deceased renowned global strategist, Barton Biggs, who spent most of his years toiling away at Morgan Stanley and was a rock-star when global strategists played those roles, made a bond bubble call back in the mid-1990’s. He said that shorting the Japanese government bond market was the “trade of a lifetime.” Well, maybe. Unfortunately Mr. Biggs didn’t live long enough to see that trade work out.
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Thank you.
Jack Crooks
Black Swan
www.blackswantrading.com
