Jeff Gundlach Explains Biflation

Thursday, April 26th, 2012

Appropos Bernanke’s ~~razor’s-edge tight-rope-walk~~ fence-sitting as the not-too-cold-not-too-hot economy reduces the Fed’s ability to do anything, Jeff Gundlach of Double Line provided a succinct explanation of the the ‘uncomfortable position’ the ~~place-of-confusion~~ Fed finds itself in. Simplifying the dilemma to: the Fed cannot raise rates as the dramatic implications for the huge debt load (and implictly the interest expense saving the budget deficit) of the US Government are untenable while at the same time inflation (in the things we need – not just want) is rising notably. However the new bond-king notes rather sarcastically, that the Fed can show that there is only modest inflation thanks to housing and wage growth (and herelies ‘the biflation’). The old-school-Fed’s efforts at pre-emptive strikes against inflation is simply not going to happen, he states, citing an “intentional attempt to suppress national income – an attempt to stop nominal GDP growing too much – simply won’t be tolerated until inflation moves into the 4-5% category“.

Tags: Budget Deficit, Confusion, Debt Load, Dilemma, Dramatic Implications, Emptive Strikes, Fence, GDP, Gundlach, inflation, Interest Expense, New Bond, Nominal Gdp, Old School, Razor, Rope Walk, Succinct Explanation, Tight Rope, Uncomfortable Position, Us Government
Posted in Markets | Comments Off

Ten-Year Treasury Yield Breaks Above 200-DMA

Thursday, March 15th, 2012

by Bespoke Investment Group

Following a pretty sizable move in interest rates, the yield on the 10-Year US Treasury (2.22%) is now above its 200-day moving average for the first time since last July. Granted, 2.22% is still low by historical standards, but it still doesn’t negate the fact that the US government has seen its borrowing costs increase by 12% in a week. When your borrowing amounts are measured in trillions, every little basis point counts. For every trillion the government borrows, a one basis point increase in interest rates translates to an extra $100,000,000 in annual borrowing costs.

Tags: Basis Point Increase, Bespoke Investment Group, Dma, interest rates, Moving Average, Nbsp, Trillion, Trillions, Us Government, Us Treasury
Posted in Markets | Comments Off

The Bull Market in Stocks Looks Set to Continue – For Now

Wednesday, February 29th, 2012

Guest contribution by Dominic Frisby, MoneyWeek

There are, as I see it from the vantage point of my South London hide-out, two huge financial forces at work in the global economy.

We have the natural forces of deflation. Debt being paid down, credit tightening, houses being put in order – the inevitable deleveraging after a period of excess.

And we have the artificial forces of inflation. Systematic currency devaluation – the printing of money to buy bonds and supress interest rates in an attempt to re-inflate asset prices and stimulate growth.

The secret of success as far as trading equity and bond markets is concerned has been to correctly identify which force is dominant. In other words, to figure out whether or not we’re in an inflationary or deflationary cycle.

But how can you tell? And which are we in now?

Which way will the market head next?

Although things have slowed over this past week, we do still seem to be in an inflationary phase as far as stock markets are concerned. But are markets topping out before the next inevitable phase of deflation? Or is this a gentle slowing before the next bout of price rises? How does one know?

I suggested a simple method of technical analysis last week that takes the thinking out of the decision-making process – thinking can be a dangerous thing after all.

Nevertheless, we all do it at least some of the time. And I’ve been thinking hard this week about other ways to identify whether we’re in an inflationary or deflationary phase. And I may have come up with something.

Just as gold is a key holding of any hard-core inflationist, so government bonds make up a large portion of any hard-core deflationist’s portfolio. The US government bond market is the biggest market in the world. It can reveal a great deal about where money is flowing.

In the chart below you can see US government bond prices (in black), and the S&P 500 (in green), between 1981 and 2001.

As you can see, US government bonds, which had a rotten time of it during the inflationary 1970s, have been in a bull market since late 1981. And broadly speaking, for much of the time, they traded in the same direction as equities. When the S&P 500 rose, so did 30-year government bonds. When bonds fell, equities were either flat or they eventually fell too.

This was the case until mid-1998. Then they decoupled. Equities fell with the Asian crisis, while government bonds rose. When equities recovered, bonds fell. In other words, during equity routs, investors have flooded to the perceived safety of government bonds and bond prices have risen. When investors get greedy again and decide equities are OK, they move their money from bonds back into the stock market.

Here we see bonds and stocks from 1998 onwards. US bonds fell as equities rose into 2000. Then the bond market rallied to 2003, as equities fell in the dotcom bust. During the mega-run in equities between 2003 and 2007, US bonds traded in a range while equities surged ahead. Then bonds had a huge rally with the 2008 stock-market bust, fell with the subsequent rally from 2009, and then rallied with the bear market in stocks of 2011.

As you can see, US government bonds, which had a rotten time of it during the inflationary 1970s, have been in a bull market since late 1981. And broadly speaking, for much of the time, they traded in the same direction as equities. When the S&P 500 rose, so did 30-year government bonds. When bonds fell, equities were either flat or they eventually fell too.

This was the case until mid-1998. Then they decoupled. Equities fell with the Asian crisis, while government bonds rose. When equities recovered, bonds fell. In other words, during equity routs, investors have flooded to the perceived safety of government bonds and bond prices have risen. When investors get greedy again and decide equities are OK, they move their money from bonds back into the stock market.

Here we see bonds and stocks from 1998 onwards. US bonds fell as equities rose into 2000. Then the bond market rallied to 2003, as equities fell in the dotcom bust. During the mega-run in equities between 2003 and 2007, US bonds traded in a range while equities surged ahead. Then bonds had a huge rally with the 2008 stock-market bust, fell with the subsequent rally from 2009, and then rallied with the bear market in stocks of 2011.

The bond market is signalling that we’re back in inflation mode

But here’s the thing. Since the October 2011 low, the stock market has rallied some 30%. But the bond market has not suffered the corresponding falls you might have expected. It is trading damn near its all-time highs.

There are all sorts of possible reasons for this: money fleeing Europe, or the relative strength of the US dollar, for example – you could come up with any number of things.

But here’s what I’ve noticed. Below is the same chart as the one above, except in this case, I’ve popped in a red arrow to mark each time the US bond market (black line) has moved to the top of its range.

Now look at what’s happened to the S&P 500 (green line) in the subsequent few months. Can you see? Highs in the bond market have frequently anticipated rallies in the stock market. It even worked to a limited extent in the deleveraging fiasco of 2008.

Why am I mentioning this now? I don’t know how much lower interest rates can go – or how much higher US government bond prices can get. However, I wouldn’t have thought that yields can go much lower than this. If they do, and the bond market breaks above say 145, then I’m wrong and we’re probably into another deflationary phase. But for now we are certainly at the upper end of their range. I suggest that equities are not a sell until bonds move to the lower end.

Yes, I know that it goes against the grain to buy into anything after it’s just had a 30% move up. I know valuations are getting a little rich, particularly in tech stocks. I know that sentiment is a little too bullish. I can find a hundred reasons why equities are set to crash. And it may be that bonds and equities have re-coupled again after their 13-year divorce and, just as the Asian crisis separated them, the European crisis has re-united them. The jury is still out on that one.

But for now the bond market is telling me that the inflation trade – or that risk – is back on. That means that cash is not the place to be, but assets – be it gold, equities or commodities – are. I’m still looking for a correction in equities, by the way, but I don’t think it’ll be the big kahuna and so pullbacks could be a buying opportunity. If the bond market heads back to the lower end of its range – in the low 120s – well, that’ll be your cue to start heading back into the deflation bunker.

And just before I go: I’m heading out to Canada next week for the PDAC, which is the biggest mining conference in the world. All the great and the good – not to mention the dastardly and the incompetent – of the digging and drilling world will be there. I’ll let you know what I learn when I get back.

Tags: Asset Prices, Bond Markets, Bond Prices, Currency Devaluation, Dangerous Thing, Dominic, Forces At Work, Frisby, Global Economy, Government Bond Market, Government Bonds, Hard Core, Large Portion, Moneyweek, Natural Forces, Secret Of Success, South London, Stock Markets, Us Government, Vantage Point
Posted in Markets | Comments Off

Biderman Beyond Baffled by B.O.’s Budget

Thursday, February 16th, 2012

In his best Lewis Black impression, TrimTabs CEO Charles Biderman succinctly destroys the ‘growth’ myth behind Obama’s budget plan as nothing but a handout and money-printing exercise in futility and drain-circling. Based on the $3.8tn budget plan, the TrimTabs truth-seeker notes that current government tax revenues are about $2.4tn, and growing at no more than $100bn each year, making the math surprisingly simple – we spend around $300bn per month and receive only $200bn with the missing $100bn to pay for the US government’s largesse (income shortfall) coming from – ‘printing money’. The spin is, of course, that revenues will somehow magically start to grow faster than spending and shrink the budget deficit. With take home pay at $6.3tn for everyone who pays taxes, up $300-400bn from the 2009 low, but still well below the $7.1tn rate from early 2008; Biderman’s consternation at the self-hypnosis that a $200bn tax increase in an economy where take-home pay has been growing by only $100bn per year will somehow create anything other than slow-growth at best (or more likely contraction) is palpable. This slow- or no-growth will mean less tax revenue and more spending on safety-nets and thus the Sausalito-savant factually points out that most people do not realize that government spending is simply giving people money whether they do anything useful with it or not and still the governments of the US, Japan, and Europe want us to believe that our economies will grow faster if we keep taking more money from the workers and give that money to the government.

Tags: Budget Deficit, Budget Plan, Consternation, Contraction, Exercise In Futility, government spending, Government Tax, Growth Myth, Largesse, Money Printing, Printing Money, Safety Nets, Sausalito, Savant, Self Hypnosis, Shortfall, Tax Revenues, Truth Seeker, Us Government, Who Pays Taxes
Posted in Markets | Comments Off

What to Watch for in Early 2012 (Koesterich)

Wednesday, January 4th, 2012

It may be a new year, but there’s still a lot of unfinished economic business from 2011.

As 2012 gets underway, investors should pay close attention to two particular unresolved economic issues: High Italian bond yields and the ongoing drama of the payroll tax holiday.

These two pieces of unfinished business are likely to dominate headlines and influence markets during the first few months of this year. They both also could send the global economy back into a recession if they’re not solved adequately. What needs to happen for these issues to be resolved? Here’s a quick look at some signs investors should watch for.

High Italian bond yields. While Spanish bond yields have retreated back toward 5%, Italian bond yields remain stubbornly close to 7%. Investors should watch the upcoming Italian auctions for evidence of investor demand, which would help push down yields. In order to avoid a global recession, Italy, and other Southern European countries, must be able to continue to fund their deficits at reasonable interest rates.

The ongoing drama of the payroll tax holiday. In December, the US government extended both the US payroll tax holiday and unemployment benefits for only two months as part of a last-minute compromise. In coming weeks, Congress must extend both of these programs for the rest of the year or risk a potential slowdown in consumption and the overall US economy.

As for my economic expectations for 2012 in general, stay tuned. I’ll be detailing my broader outlook in a post later this week.

Tags: Bond Yields, Compromise, Congress, Consumption, Economic Business, Economic Expectations, Economic Issues, Global Economy, Global Recession, interest rates, Investor Demand, New Year, Payroll Tax, Slowdown, Southern European Countries, Tax Holiday, Two Pieces, Unemployment Benefits, Unfinished Business, Us Government
Posted in Markets | Comments Off

Corporate Bonds: Figuring out a Fair Price (Koesterich)

Monday, November 14th, 2011

Last week we argued that corporate bonds look reasonably priced and appear cheap relative to Treasuries. Now, I want to address the logical follow-up question: How do you know what a fair price is for corporate bonds?

One way to think about corporate bond valuations is to consider the spread. Investors in corporate bonds are assuming credit risk – the risk that the issuer won’t repay the principal or make good on an interest payment. Investors are arguably not subject to that risk with a Treasury bond (for all its troubles, the US government has never defaulted).

As investors are taking on marginally more risk, they should be compensated in the form of a higher return. The spread between the interest on a corporate bond and a Treasury obligation of a similar duration is one way to assess how much investors are being compensated for taking on additional risk.

In general, when the economy is stronger, spreads tend to contract as investors are less worried about companies defaulting. Conversely, when the economy is weaker investors should receive a higher return to compensate for the risk of increased defaults (as you would expect, defaults rise in recessions).

So when it comes to evaluating how wide the spread should be, start with your view on the economy. By comparing your view of the economy to current spreads, you can get at some rough measure of “fair value.”

Today, spreads are wide relative to their historic average – but they also appear wide given the state of the economy.

The spread between an index of Baa corporate bonds and the 10-year US Treasury note is approximately 3.30%, nearly twice the historical average. In other words, investors are sufficiently worried about the state of the economy that they are demanding twice the premium relative to Treasuries they normally receive (another interpretation is that Treasury yields are artificially low because the Fed is buying up a good chunk of existing supply).

But when we compare the current level of spreads to a measure of leading economic indicators (see the chart below), spreads also look too big. Based on this analysis, spreads should be about 1% tighter than they currently are, meaning that either Treasury yields should rise or corporate bond yields should fall.

Either way, corporate bonds look better than Treasury bonds.

Source: Bloomberg

Tags: Chunk, Corporate Bond, Corporate Bonds, Credit Risk, Duration, Economy, Interest Payment, Investors, Obligation, Recessions, Rough Measure, Treasuries, Treasury Bond, Treasury Note, Treasury Yields, Us Government, Us Treasury, Valuations, Wh
Posted in Markets | Comments Off

Corporate Bonds: Figuring out a Fair Price (Koesterich)

Tuesday, November 8th, 2011

by Russ Koesterich, Chief Investment Strategist, iShares