Why the “Bond King” Has Never Been More Bearish
The bond “super bubble” is coming to an end.
For the last three decades, U.S. bond prices have been in a steady uptrend. This epic bond bull market survived three recessions, the dot-com crash, and the 2008–2009 financial crisis.
Because of this, bonds have become very popular with investors. You can see why in the chart below, which shows the Dow Jones Equal Weight U.S. Corporate Bond Index since 1997. This index tracks the performance of U.S. corporate bonds.
As you can see, a $100,000 investment in corporate bonds 20 years ago would now be worth more than $360,000. What’s more, corporate bonds did relatively well during the violent stock selloffs that occurred in 2000–2002 and 2007–2009.
Many investors have gotten used to making safe and steady returns in bonds.
But it looks like those days are over…
• Over the last few months, bond yields have skyrocketed…
A bond’s yield rises when its price falls.
The yield on the U.S. 10-year Treasury has jumped from a record low of 1.37% in July to 2.23% today. We’ve seen similar spikes in two-years all the way up to 30-years.
The same thing is happening overseas. Yields on French, Italian, and British government bonds have all hit multi-month highs over the last few days.
This is a huge deal. Just four months ago, MarketWatch reported that global interest rates reached the lowest level in 5,000 years.
• Still, you might not be worried about this if you don’t own any bonds…
But you must understand that the bond market is a cornerstone of the global financial system.
If it unwinds, it’s going to impact everything from stocks to the economy at large. We’ll explain what could happen in a minute.
But first, let's look at what some of the world’s smartest investors have to say about this.
• Ray Dalio thinks bond prices have peaked…
You've probably heard of Dalio. He manages more tan $150 billion at Bridgewater Associates, the world’s largest hedge fund.
Yesterday, Dalio explained why he thinks the bond market’s topped out:
[W]e think that there's a significant likelihood that we have made the 30-year top in bond prices. We probably have made both the secular low in inflation and the secular low in bond yields relative to inflation.
In the investing world, secular means long-term. In other words, Dalio’s saying bond yields and inflation rates have bottomed.
Now, we know higher bond yields are bad for bond prices. But rising inflation is also bad for bonds.
Inflation measures how fast prices for everyday goods and services rise. The higher the inflation rate, the faster everyday prices rise.
High inflation is obviously bad for the average person. It means the money in their wallet doesn’t go as far. It’s also bad for people who own bonds. That’s because inflation eats away at a bond’s future payments.
• If Dalio’s call sounds familiar, it’s because we’ve been saying the same thing for weeks…
On October 19, we told you that bondholders could take heavy losses if inflation keeps rising.
More recently, we've shown you plenty of reasons why inflation is likely headed higher.
This is clearly bad news for bonds. Unfortunately, many people are still on the wrong side of this trade. Dalio wrote yesterday:
When reversals of major moves (like a 30-year bull market) happen, there are many market participants who have skewed their positions (often not knowingly) to be stung and shaken out of them by the move, making the move self-reinforcing until they are shaken out.
• Jeffrey Gundlach also thinks the 30-year bull market in bonds is over…
Like Dalio, Gundlach is a world-class investor. He runs DoubleLine Capital, an investment firm that oversees more than $100 billion. He’s also one of the world’s leading bond investors.
He’s known on Wall Street as the “Bond King.”
According to Barron’s, Gundlach turned bearish on bonds months ago:
Gundlach says, he turned “maximum negative” on bonds on July 6, two days before the 10-year Treasury yield hit a multidecade closing low of 1.366%. He predicted shortly thereafter that the 10-year yield would top 2% by year end.
Gundlach’s prediction was spot-on. Remember, the U.S. 10-year currently yields 2.23%.
Since the election, Gundlach’s become even more bearish. Barron’s reported over the weekend:
Trump’s pro-business agenda is inherently “unfriendly” to bonds, Gundlach says, as it could to lead to stronger economic growth and renewed inflation. Gundlach expects President-elect Trump to “amp up the deficit” to pay for infrastructure projects and other programs. That could produce an inflation rate of 3% and nominal growth of 4% to 6% in gross domestic product. “If nominal GDP pushes toward 4%, 5%, or even 6%, there is no way you are going to get bond yields to stay below 2%,” he says.
In a way, this is good news. After all, what American wouldn’t want the economy to grow faster?
• Unfortunately, Trump’s pro-growth policies could come at a steep price…
For one, inflation could take off. We could also see more deficit spending, more debt, and more currency debasement.
Plus, problems in the bond market could spill over into other assets, like stocks. Dalio wrote yesterday:
The question will be when will this move short-circuit itself—i.e., when will the rise in nominal (and, more importantly, real) bond yields and risk premiums start hurting other asset prices.
Gundlach is also worried about the side effects of rising yields. Barron’s reported:
“[T]he structure of the U.S. economy and the pricing of the stock market are predicated on 1.5% Treasury yields and zero short-term interest rates.” Rising rates would hurt the U.S. housing market and possibly dent corporate stock-buyback programs. Buybacks helped boost share prices in recent years and were funded, in many cases, with borrowed money.
A buyback is when a company buys its own shares off the marketplace.
Since the financial crisis, Corporate America has borrowed enormous sums of money to pay for buybacks. As we’ve explained many times, buybacks are a big reason stocks have kept rising even though earnings have been falling.
If rates keep rising, it will become much more expensive for companies to borrow money…and that could kill the buyback craze. In short, the stock market could lose one of its biggest sources of demand.
• To be clear, we aren’t saying higher rates will kill the buyback craze overnight…
But it’s something we’re going to keep a very close eye on. It’s also something to think about before diving headfirst back into stocks.
Chart of the Day
Dividend-paying stocks are getting crushed…
Today’s chart shows the performance of telecom stocks, real estate stocks, and utility stocks over the past month. All three of these sectors are known for paying steady, often generous dividends.
When bond yields are low or falling, many investors like to own these stocks. When yields are high or likely to rise, investors don’t like these stocks as much. That’s because it's easier for them to earn decent income in other assets, like bonds.
Over the past month, telecom stocks are down 7.5%. Real estate stocks are down 4.2%. Utilities have fallen 4%. According to MarketWatch, these are the three worst-performing sectors in the S&P 500 over that stretch.
If rates keep climbing, these stocks should continue to lag the market. Keep this in mind if you own stocks in these sectors, or any stock that you bought mainly for its dividend.
Egypt as a Regional Non-Power
Domestic political and economic problems have constrained the country's influence over other Arab states.
Turkey’s Erdogan threatens to let 3m refugees into Europe
Turkish president responds angrily to parliament vote to suspend membership talks
by: Laura Pitel in Ankara and Arthur Beesley in Brussels
Turkey’s president Recep Tayyip Erdogan warned Brussels on Friday he would allow 3m refugees to cross over to Europe unless the EU softened its criticism of Ankara.
Mr Erdogan, who has previously warned that he could put refugees “on buses” to Europe, hit out angrily in response to the non-binding vote.
The EU struck a crucial but controversial immigration deal with Turkey in March after hundreds of thousands of people crossed illegally from Turkey to Greece last year.
In exchange for a series of promises, including accelerated membership talks and steps towards visa-free travel for Turkish citizens to the EU’s Schengen zone, Turkey agreed to crack down on smugglers and to accept migrants and refugees returned from Greece.
The agreement and other measures have dramatically reduced the numbers crossing the Mediterranean, but it has been complicated by growing anti-EU sentiment in Turkey and fears of increasing authoritarianism that have only deepened since July’s aborted coup attempt.
Mr Erdogan’s remarks met a chilly response in Brussels, where officials insist Europe is upholding its side of the migrant deal.
“Rhetorical threats are absolutely unhelpful and should not be the standard tone between partners,” said a senior EU official. “This will not help Turkey’s credibility in the eyes of European citizens. Europe will not be blackmailed.”
The Turkish president has also threatened repeatedly to respond to popular demand to bring back the death penalty, a move the EU has warned would instantly put an end to Turkey’s longstanding accession bid.
The vote by the European Parliament reflects growing frustration and hostility on both sides of the Turkey-EU partnership but is non-binding. Only European governments have the power to put a formal end to Turkey’s accession talks.
While Austria has called for a halt to the process, Germany, France and most other EU states support continued engagement. They see Turkey, the world’s largest host of refugees, as a difficult but vital partner for tackling the migration crisis and maintaining the cohesion and stability of the bloc.
Ankara is also an important security partner in the battle against Isis, intercepting foreign jihadist fighters seeking to reach Syria or Iraq from its territory.
Some analysts have questioned whether Mr Erdogan would follow through on his ultimatum to open up the borders, given that the Turkish authorities have imposed travel restrictions on large numbers of Turkish citizens.
Several alleged leaders of the July coup attempt are reportedly on the run, while many other people have been subjected to travel restrictions since the coup, as the government has sacked 125,000 people from the military, police and the public sector.
Gold: What's Next?
By: Axel Merk
Since 1971, the price of gold has had a zero correlation to the S&P 500 index based on our analysis (-0.016 based on daily returns, to be precise). From that point of view, gold may be a long-term diversifier. That said, there are times when the correlation is positive; others when it is negative:
Staying on the theme of gold as a potential diversifier, the price of gold has had a positive return in each bear market in equities since 1971, with the notable exception of what I might call the Volcker-induced bear market when interest rates were rose substantially:
While investors may appreciate diversification, they may appreciate positive returns even more. We have had a notable selloff in bonds since the election; and, as one can see from above, the price of gold has, of late, been correlated to those of bonds. So what is going on?
- Infrastructure spending. We believe a) Trump will get at least some infrastructure spending done, and b) that it will be inflationary. Trump is a deal maker, so he may well promise some Senator their favorite bridge to nowhere if he will let him build his wall. This is a simplified way of saying that in Washington, it should be possible to spend money by making promises across the aisle, even if budget conscious Republicans object. In an environment where unemployment is already low, we believe this will induce wage inflation. Last time we checked, the government is usually not the most efficient in allocating resources, i.e. a fiscal spending program may foremost increase the deficit. Incidentally, we observe that currencies of countries where inflation ticks up often rise versus peers; while that may sound counter-intuitive, the reason is that investors assume central banks will counter inflationary pressures with higher interest rates. As such, if one believes the Fed will be "ahead of the curve", i.e. hike interest rates before inflation picks up, that would be a negative for gold. If, however, investors believe that the Fed will fall further "behind the curve," we believe there's a good chance gold will do well, even as nominal rates move higher.
- Even if Congress doesn't pass legislation a President Trump proposes, he should have substantial influence on how agencies are run, suggesting that he should be able to execute on his promise to reduce the regulatory burden on business. If history is any guide, the pendulum is unlikely to swing quite as much as hoped for (or feared - depending on where one stands on this debate); however, on the margin, this should be a positive for investments. One of the reasons the long-term bonds have yielded so little is because businesses have preferred to purchase financial assets (e.g., share buybacks) rather than invest in real business. As such, to the extent that the selloff in the bond market reflects that businesses would now rather invest in new ventures (rather than the prospect of higher inflation), we believe it is negative for the price of gold.
We have not seen Trump propose any serious fix to what may be the soaring cost of entitlements.
That is, even before additional fiscal spending proposed by President-elect Trump, deficits may balloon in a few years.
What we haven't mentioned is the potential impact of a trade war. At this stage, the market appears to suggest that Trump might back off from his anti-trade rhetoric. The reason we think so is because we think the dollar is vulnerable in a trade war; that's because we need foreigners to finance U.S. deficits; the U.K. is the latest example of a country that relies on financing from abroad to have seen its currency suffer when trade barriers have risen (a vote for "Brexit" suggests the introduction of trade barriers). The dollar might not decline versus the Mexican peso or other emerging market currencies, but it may well decline versus major currencies and gold.
So what will happen to the price of gold?
We expect to see a battle of the various forces discussed above. For now, the market may be pricing in stronger real growth through less regulation, with a Fed able to raise interest rates as the economy strengthens. In many ways, we have seen this movie before, with the market anticipating a rate hike due to improving fundamentals.
The problem is that we have such a leveraged economy, that higher bond yields and the anticipation of higher rates may well cause risk premia to rise, i.e. volatility in the market to increase, possibly toppling over equity prices. The associated volatility may cause 'financial conditions to deteriorate' as the Fed likes to put it, causing them to back off from any hawkish plans. That is, the anticipation of higher real rates may fizzle out yet again, providing support for the price of gold.
And aside from higher rates being a source of market volatility, it may well be that Trump policies themselves, such as the introduction of trade barriers, may cause volatility to rise and gold to benefit.
In short, if investors believe the future is bright, with businesses increasing investments and with the Fed's magic wand doing wonders to keep inflationary pressures just right without causing too much of a stir, gold might not rise in value.
If however, investors believe that this tug of war between the different forces will ultimately get the Fed to be 'behind the curve,' i.e. inflationary pressures to increase; or if investors believe the stock market might experience another bear market, then gold may continue to be a worthy diversifier.
For those who believe that this will be a repeat of Reaganomics, we would like to caution that Reagan came into office when unemployment was much higher and with a most hawkish Federal Reserve Chair.
Finally, in addition to all of the above, the Fed continues to sit on a huge balance sheet; that balance sheet hasn't been a problem with lackluster growth; but we see major challenges ahead for both stocks and bonds if indeed we get significant growth out of the Trump policies. We shall dive into these risks more in a future analysis.
We don't have a crystal ball, but we believe in prudent risk management. As such, we encourage investors to assess the risks of certain scenarios unfolding. If we then add to that the fact that gold has a low correlation to bonds and equities, we believe investors may want to consider including gold in a prudent asset allocation.
Barack and Angela’s Tragic Romance
The American president and the German chancellor will share a legacy as long-term thinkers, advocates of openness — and, perhaps, as the last of their kind.
By Joerg Forbrig
On what is his last tour of Europe this week, and what is likely to be his last major tour abroad, outgoing U.S. President Barack Obama has reserved a full two days for Berlin. This unusually long visit to the German capital is not a coincidence. It is here that he first became a figure of global importance when, in July 2008, the then-candidate mesmerized a crowd of 200,000 Berliners. It is here that he developed his strongest rapport with any world leader: German Chancellor Angela Merkel. Most importantly, however, it is here that his foreign-policy legacy now has its strongest, if not last, line of defense.
That Obama would develop this level of political and personal intimacy with the country was hardly obvious eight years ago. In character alone, Obama and Merkel made for something of an odd couple.
The charismatic orator met understatement personified. The public intellectual outshined the reclusive scientist. His biography spans the globe; she hails from provincial East Germany. The one roused sky-high expectations; the other was eternally underestimated. And if Obama’s attention was drawn to the rising powers of Asia, Merkel was focused on keeping the Old Continent afloat. It seemed improbable back then that the two leaders would form any bond beyond the polite and profesional.
Joerg Forbrig is a senior transatlantic fellow with the German Marshall Fund of the United States in Berlin.
Les doy cordialmente la bienvenida a este Blog informativo con artículos, análisis y comentarios de publicaciones especializadas y especialmente seleccionadas, principalmente sobre temas económicos, financieros y políticos de actualidad, que esperamos y deseamos, sean de su máximo interés, utilidad y conveniencia.
Pensamos que solo comprendiendo cabalmente el presente, es que podemos proyectarnos acertadamente hacia el futuro.
Gonzalo Raffo de Lavalle
Las convicciones son mas peligrosos enemigos de la verdad que las mentiras.
Quien conoce su ignorancia revela la mas profunda sabiduría. Quien ignora su ignorancia vive en la mas profunda ilusión.
“There are decades when nothing happens and there are weeks when decades happen.”
Vladimir Ilyich Lenin
You only find out who is swimming naked when the tide goes out.
No soy alguien que sabe, sino alguien que busca.
Only Gold is money. Everything else is debt.
Las grandes almas tienen voluntades; las débiles tan solo deseos.
Quien no lo ha dado todo no ha dado nada.
History repeats itself, first as tragedy, second as farce.
We are travelers on a cosmic journey, stardust, swirling and dancing in the eddies and whirlpools of infinity. Life is eternal. We have stopped for a moment to encounter each other, to meet, to love, to share.This is a precious moment. It is a little parenthesis in eternity.
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