Thoughts on the “Bond Bubble”, Equity Sentiment & Doctor Copper
Bond market ticks down finally after momentum run, bubble talk is nonsense
The Treasury bond market finally ticked down on Friday with the 30-year bond dropping 3 points to now yield 3.69%. While I would not be a buyer of T-bonds at these levels all the bubble talk seems silly. While I would be the first to argue that these bonds are overvalued and they discount far too much economic malaise going forward at current prices, I do not see the bubble argument given the typical use of the term and what it refers to historically.
There’s two great pieces out by Elliot Turner and Vince Farrell explaining the misuse of the term bubble. Recently, we’ve seen bubbles in the dot-coms where the Nasdaq collapsed from over 5,000 to less than 1,000 in 3 years, the oil bubble where prices collapsed from $147 to $33 in 6 months and the housing bubble where prices are still falling down 40-50% in some the key bubble areas.
Unless you’re actually a believer that the US government is going to lose control and hyper-inflation is going to overwhelm us, the worst that happens in the bond market is investors lock-in a paltry return for the next 30 years. Many of the hyper-inflationists forget what open market operations are and how they work. The FOMC has more than doubled the Fed’s balance sheet from $870 pre-crisis to $2.2 trillion by purchasing MBS and Treasuries. But, the debt is not retired, it is still on the balance sheet. This means the Fed has $2.2 trillion in assets it can sell back to the market to remove liquidity if inflation were to creep up on us giving it substantial inflation-fighting mechanisms to employ far before hyperinflation takes hold. How about we worry about deflation until we actually see some price inflation?
The bubble argument really only works out if there is a global loss of confidence in the US’s ability to repay its debt and we completely default through hyperinflation. Forecasting this event is an extremely premature conclusion when you consider the Japanese situation where debt-to-GDP has risen to 200% (versus ours with high-end estimates at 90%) in a far less dynamic and innovative economy, yet rates on the 30-year bond are a measly 1.7%. So much for bond vigilantes in Japan.
I do recognize the argument that if you’re investing in T-bonds as a way to guarantee capital then a relatively wild swing in prices could be very discomforting and inflict a good deal of pain to holders. But say bonds drop 10% or so, that is far from a so-called bubble in asset prices given its normal use in our lexicon.
Cramer’s call for Obama to shape discourse is right
I rarely weigh in on political matters but Cramer has recently been critical of President Obama for his lack of leadership in the current climate and I agree. Cramer is onto something here and Obama should heed his call. The Federal Reserve has long understood the power of language and uses language within the policy statements to influence market perceptions. Obama can do the same thing!
Everyday, one after another CNBC guest comes on to highlight the climate of uncertainty for US businesses largely blaming the White House and Congress for causing it while forgetting the current state of the recovery. We are in the first hiccup in what has been, and will be, a very long recovery. The political argument is convoluted and there may be some merit to it but I’d refer to Occam’s razor on this one: it’s probably much more likely that hiring is slow because the economy has just gone through the most devastating meltdown in 80 years and businesses are hesitant to jump back in. As an aside, I think the ‘flash crash’ was a damaging event psychologically for the average investor and has yet to be adequately addressed publicly.
Does Obama really not understand the power he holds over markets? The stress tests in the US and Europe were a joke in many respects with a contrived grading system and a manufactured outcome. But, you know what, they worked! Investors granted the leap of faith that was required and created a self-fulfilling prophecy of stability by investing in banking institutions, re-capitalizing them and buoying the entire financial system in short order.
Obama has to understand that he can shape the discourse. He could easily reassure the public that their 401(k)s are an excellent mechanism for generating long-term returns despite the struggles we’re experiencing, explain that safeguards have been enacted to prevent another flash crash and take a victory lap for the General Motors takeover and planned IPO. Even if I disagreed with the GM takeover in principle I still think it’s very important to highlight the fact that the government is not interested in owning the company and plans to exit as soon as possible returning the re-capitalized company to private equity holders.
Recent selling feels like March 2009
While markets are 3.4% lower than when I wrote that I believed the long-term rally was back on, I am sticking with my argument despite the volatility we have seen. August has been a dismal month taking back about 2/3rds of July’s gains but the selling this month feels like the despondency stage of the market emotion cycle.
I was telling a collegue that it feels a lot like the March 2009 bottom where traders just lose interest because it’s just a dribble lower day after day. It’s not nearly of the same magnitude but there are similarities I have recognized in my own outlook. Also, while I am not a big sentiment indicator guy, this one fits my thesis so I’ll use it (solid consistent application, right?). Bespoke has a chart showing bullish sentiment at its lowest level since the March 2009 bottom. That would clearly figure given that this is the deepest pull-in since the rally began from that bottom but it’s interesting nonetheless.
Doctor Copper says ‘what are you worrying about?’
Copper is often a great indicator of forthcoming demand and has recently led equity market moves. Copper mounted a strong reversal on Wednesday through the closely watched $3.20 level and then powered higher on Thursday and Friday to re-challenge previous highs of the recent move off the June lows. Copper’s move coupled with my feel for sentiment compelled me to dip my toe in SPY on Friday picking up about 1/5th of what I intend to scale up to should this rally find legs.
Below is a chart since the March 2009 bottom highlighting the moves in the S&P 500 represented by SPY and copper represented by JJC. Copper has either led by putting in a bottom earlier or the bottoms have exactly coincided. Surely this does not mean that we cannot go lower in both but copper has had a nice move higher lately that the market has yet to follow.
Links to some great posts making the rounds:
Interview with Justin Fox (The Myth of the Rational Market) ~ Wall Street Cheat Sheet
History of US Interest Rates: 1790-Present ~ The Big Picture
How (not) to Build a Market Indicator: The Hindenburg Omen ~ A Dash of Insight
M&A: Top or Bottom? ~ Investing Caffeine
Bonus: Great cartoon about living in New York titled “Miracle of Miracles”!
Brandon R. Rowley
“Chance favors the prepared mind.”
*DISCLOSURE: Long SPY.