Investors around the world have been confused, befuddled and surprised by the persistent, ultra low level of long term interest rates in the United States.
At today?s close, the 30 year Treasury bond yielded a parsimonious 2.01%, the ten year, 2.62%, and the five year only 1.51%. The ten-year was threatening its all time low yield of 1.37% only two weeks ago, a return as rare as a dodo bird, last seen in August, 2012.
What?s more, yields across the entire fixed income spectrum have been plumbing new lows. Corporate bonds (LQD) have been fetching only 3.29%, tax-free municipal bonds (MUB) 2.89%, and junk (JNK) a pittance at 5.96%.
Spreads over Treasuries are approaching new all time lows. The spread for junk over of ten year Treasuries is now below an amazing 3.00%, a heady number not seen since the 2007 bubble top. ?Covenant light? in borrower terms is making a big comeback.
Are investors being rewarded for taking on the debt of companies that are on the edge of bankruptcy, a tiny 3.3% premium? I think not.
It is a global trend.
German bunds are now paying holders 0.35%, and JGB?s are at an eye popping 0.30%. The worst quality southern European paper has delivered the biggest rallies this year. Portuguese government paper is paying only 2.40%, and is rapidly closing in on US government yields.
Yikes!
These numbers indicate that there is a massive global capital glut. There is too much money chasing too few low risk investments everywhere. Has the world suddenly become risk averse? Is inflation gone forever? Will deflation become a permanent aspect of our investing lives? Does the reach for yield know no bounds?
It wasn?t supposed to be like this.
Almost to a man, hedge fund managers everywhere were unloading debt instruments in January. They were looking for a year of rising interest rates (TLT), accelerating stock prices (QQQ), falling commodities (DBA), and dying emerging markets (EEM). Surging capital inflows were supposed to prompt the dollar (UUP) to take off like a rocket.
It all ended up being almost a perfect mirror image portfolio of what actually transpired since then. As a result, almost all mutual funds are down so far in 2014. Many hedge fund managers are tearing their hair out, suffering their worst year in recent memory.
What is wrong with this picture?
Interest rates like these are hinting that the global economy is about to endure a serious nose dive, possibly even re-entering recession territory?or it isn?t.
To understand why not, we have to delve into deep structural issues, which are changing the nature of the debt markets beyond all recognition. This is not your father?s bond market.
I?ll start with what I call the ?1% effect.?
Rich people are different than you and I. Once they finally make their billions, they quickly evolve from being risk takers into wealth preservers. They don?t invest in start-ups, take fliers on stock tips, invest in the flavor of the day, or create jobs. In fact, many abandon shares completely, retreating to the safety of coupon clipping.
The problem for the rest of us is that this capital stagnates. It goes into the bond market where it stays forever. These people never sell, thus avoiding capital gains taxes and capturing a future step up in the cost basis whenever a spouse dies. Only the interest payments are taxable and that at a lowly 20% rate.
This is the lesson I learned from servicing generations of Rothschild?s, Du Ponts, Rockefellers, and Getty. Extremely wealthy families stay that way by becoming extremely conservative investors. Those that don?t, you?ve never heard of, because they all eventually went broke.
This didn?t used to mean much before 1980, back when the wealthy only owned 10% of the bond market, except to financial historians and private wealth specialists, of which I am one. Now they own a whopping 23%, and their behavior affects everyone.
Who has bee the largest buyer of Treasury bonds for the last 30 years? Foreign central banks and other governmental entities, which count them among their country?s foreign exchange reserves. They own 36% of our national debt, with China in the lead at 8% (the Bush tax cut that was borrowed), and Japan close behind with 7% (the Reagan tax cut that was borrowed). These days they purchase about 50% of every Treasury auction.
They never sell either, unless there is some kind of foreign exchange or balance of payments crisis, which is rare. If anything, these holdings are still growing.
Who else has been soaking up bonds, deaf to repeated cries that prices are about to plunge? The Federal Reserve, which thanks to QE1, 2, and 3, now owns 22% of our $17 trillion debt. Both the former Federal Reserve governor Ben Bernanke, and the present one, Janet Yellen, have made clear they have no plans to sell these bonds. They will run them to maturity instead, minimizing the market impact.
An assortment of other government entities possess a further 29% of US government bonds, first and foremost the Social Security Administration, with a 16% holding. And they ain?t selling either, baby.
So what you have here is the overwhelming majority of Treasury bond owners with no intention to sell. Only hedge funds have been selling this year, and they have already done so, in spades.
Which sets up a frightening possibility for them, now that we are at the very bottom of the past year?s range in yields. What happens if bond yields fall further? It will set off the mother of all short covering squeezes and could take ten-year yield down to match the 2012, 2.38% low.
Fasten your seat belts, batten the hatches, and down the Dramamine!
There are a few other reasons why rates will stay at subterranean levels for some time. If hyper accelerating technology keeps cutting costs for the rest of the century, deflation basically never goes away (click here?for ?Peeking into the Future with Ray Kurzweil?).
Hyper accelerating corporate profits will also create a global cash glut, further levitating bond prices. Companies are becoming so profitable they are throwing off more cash then they can reasonably use or pay out.
This is why these gigantic corporate cash hoards are piling up in Europe in tax free jurisdictions, now over $2 trillion. Is the US heading for Japanese style yields, or 0.39% for 10 year Treasuries?
If so, bonds are a steal here at 2.55%. If we really do enter a period of long term -2% a year deflation, that means the purchasing power of a dollar increases by 35% every decade in real terms.
The threat of a second Cold War is keeping the flight to safety bid alive, and keeping the bull market for bonds percolating. This could put a floor under bond prices for another decade, and Vladimir Putin?s current presidential run could last all the way under 2014.
All of this is why I?m out of the bond market for now, and will remain so for a while.
https://www.madhedgefundtrader.com/wp-content/uploads/2014/05/Orangutan.jpg346382Mad Hedge Fund Traderhttps://madhedgefundtrader.com/wp-content/uploads/2019/05/cropped-mad-hedge-logo-transparent-192x192_f9578834168ba24df3eb53916a12c882.pngMad Hedge Fund Trader2015-02-16 01:05:282015-02-16 01:05:28Why Are Bond Yields So Low?
Here are the long-winded, feeble bunch of excuses I promised you.
I have broken every rule in my trading book hanging on to my position in the (TBT) for the past four months. I ignored my own stop losses. I listened to the morons on TV saying interest rates were about to spike up. I took the pile of charts that were telling me there was no bottom in sight, and deliberately lost them behind the radiator.
I even listened to the Fed signaling me with an emergency flare gun that they would raise rates in June.
As a result, I have been punished. Not too severely though, for I did follow one cardinal rule: I kept the position small. I did not double, triple and quadruple up, as many in the hedge fund industry have done.
As a result, I am merely suffering a thrashing in the woodshed, the kind my grandfather used to give me when he caught me shooting out the lights with my .22 rifle on our ranch in Indio, California. This is not a beheading, nor even a water boarding, and not a scintilla of an existential threat.
Still, a $14, 25% loss on a single position is no laughing matter. It?s about as welcome as a slap in the face with a wet mackerel. This is all proof that after 45 years in this business, I can still make the mistakes of a first year intern that was only hired for her good looks, shapely figure and loose morals.
If you told me that US GDP growth was 5%, unemployment was at a ten year low at 5.6%, and energy prices had just halved, I would have pegged the ten-year Treasury bond yield at 6.0%. The US economy created 2.9 million jobs in 2014, the most since 1999. Full employment is now almost a gimme.
Yet here we are at 2.00%.
You might as well take your traditional economic books and throw them in the trash. Apologies to John Maynard Keynes, John Kenneth Galbraith, and Paul Samuelson. It is yet another indication that this market has an insatiable need to teach an old dog new tricks.
After turning a blind eye to the writing on the wall, it?s time for me to read it out to you loud and clear.
The collapse of the German bond market is the big deal here. With the European economy in free fall, and doubts remaining about the ability of quantitative easing to work there under any circumstances, investors are assuming the future demand for money on the beleaguered continent will be zero.
German 10 year bond yields at 0.45% and still falling make 10 year US Treasuries at 2.00% appear the bargain of the century. Governments and hedge funds alike can buy US paper, sell short European paper against it, hedge out the currency risk, and lock in a risk free 1.55% a year for ten years. Sounds like a deal to me.
Multiply this by trillions of dollars and you can see what the problem is.
The other big deal here is the price of oil. I will reiterate my belief that if Texas tea stays down at the $40 handle, it is worth not just a 10% gain in stocks, but a double. The flipside is that interest rates stay far lower for longer than anyone expects, even including the Fed.
People just don?t understand how far reaching the impact of oil prices is. This heralds an entire new leg in the deflation story, one that could continue for years. It completely rules out any chance of a hike in interest rates this year. It is also fantastic news for the US bond market, and terrible for the (TBT).
If you want to add a third strike against continuing with a short bond position, look no further than the string US dollar. Investors around the world are pouring money into the greenback for a host of reasons. What do they do with the dollars when they get here? Buy bonds.
For more depth on why I totally missed the boat on bonds, please click here for ?10 Reasons Why I Am Wrong on Bonds?.
There are also opportunistic issues to consider here.
With implied volatilities on options sky high here, I can slap on almost any other options position and make back my 2.5% loss on the (TBT) in a couple of weeks. So there is no point in tying up 10% of my portfolio in a position that is dying a death of a thousand cuts.
Also, If you have been short the Euro (FXE), (EUO) and the Japanese yen (FXY), (YCS) after the past seven months, as I begged you to do, you have already more than made back the money.
https://www.madhedgefundtrader.com/wp-content/uploads/2014/09/John-Thomas5-e1410989501597.jpg400266Mad Hedge Fund Traderhttps://madhedgefundtrader.com/wp-content/uploads/2019/05/cropped-mad-hedge-logo-transparent-192x192_f9578834168ba24df3eb53916a12c882.pngMad Hedge Fund Trader2015-01-12 01:04:492015-01-12 01:04:49Throwing in the Towel on the Bond Market
I am once again writing this report from a first class sleeping cabin on Amtrak?s California Zephyr. By day, I have two comfortable seats facing each other next to a broad window. At night, they fold into bunk beds, a single and a double. There is a shower, but only Houdini could get in and out of it.
We are now pulling away from Chicago?s Union Station, leaving its hurried commuters, buskers, panhandlers, and majestic great halls behind. I am headed for Emeryville, California, just across the bay from San Francisco. That gives me only 56 hours to complete this report.
I tip my porter, Raymond, $100 in advance to make sure everything goes well during the long adventure, and to keep me up to date with the onboard gossip. The rolling and pitching of the car is causing my fingers to dance all over the keyboard. Spellchecker can catch most of the mistakes, but not all of them. Thank goodness for small algorithms.
As both broadband and cell phone coverage are unavailable along most of the route, I have to rely on frenzied searches during stops at major stations along the way to chase down data points.
You know those cool maps in the Verizon stores that show the vast coverage of their cell phone networks? They are complete BS. Who knew that 95% of America is off the grid? That explains a lot about our politics today. I have posted many of my better photos from the trip below, although there is only so much you can do from a moving train and an iPhone.
After making the rounds with strategists, portfolio managers, and hedge fund traders, I can confirm that 2014 was one of the toughest to trade for careers lasting 30, 40, or 50 years. Yet again, the stay at home index players have defeated the best and the brightest.
With the Dow gaining a modest 8% in 2014, and S&P 500 up a more virile 14.2%, this was a year of endless frustration. Volatility fell to the floor, staying at a monotonous 12% for seven boring consecutive months. Most hedge funds lagged the index by miles.
My Trade Alert Service, hauled in an astounding 30.3% profit, at the high was up 42.7%, and has become the talk of the hedge fund industry. That was double the S&P 500 index gain.
If you think I spend too much time absorbing conspiracy theories from the Internet, let me give you a list of the challenges I see financial markets facing in the coming year:
The Ten Highlights of 2015
1) Stocks will finish 2015 higher, almost certainly more than the previous year, somewhere in the 10-15% range. Cheap energy, ultra low interest rates, and 3-4% GDP growth, will expand multiples. It?s Goldilocks with a turbocharger.
2) Performance this year will be back-end loaded into the fourth quarter, as it was in 2014. The path forward became so clear, that some of 2015?s performance was pulled forward into November, 2014.
3) The Treasury bond market will modestly grind down, anticipating the inevitable rate rise from the Federal Reserve.
4) The yen will lose another 10%-20% against the dollar.
5) The Euro will fall another 10%, doing its best to hit parity with the greenback, with the assistance of beleaguered continental governments.
6) Oil stays in a $50-$80 range, showering the economy with hundreds of billions of dollars worth of de facto tax cuts.
7) Gold finally bottoms at $1,000 after one more final flush, then rallies (My jeweler was right, again).
8) Commodities finally bottom out, thanks to new found strength in the global economy, and begin a modest recovery.
9) Residential real estate has made its big recovery, and will grind up slowly from here.
10) After a tumultuous 2014, international political surprises disappear, the primary instigators of trouble becalmed by collapsed oil revenues.
The Thumbnail Portfolio
Equities - Long. A rising but low volatility year takes the S&P 500 up to 2,350. This year we really will get another 10% correction. Technology, biotech, energy, solar, and financials lead.
Bonds - Short. Down for the entire year with long periods of stagnation.
Foreign Currencies - Short. The US dollar maintains its bull trend, especially against the Yen and the Euro.
Commodities - Long. A China recovery takes them up eventually.
Precious Metals - Stand aside. We get the final capitulation selloff, then a rally.
Agriculture - Long. Up, because we can?t keep getting perfect weather forever.
Real estate - Long. Multifamily up, commercial up, single family homes sideways to up small.
1) The Economy - Fortress America
This year, it?s all about oil, whether it stays low, shoots back up, or falls lower. The global crude market is so big, so diverse, and subject to so many variables, that it is essentially unpredictable.
No one has an edge, not the major producers, consumers, or the myriad middlemen. For proof, look at how the crash hit so many ?experts? out of the blue.
This means that most economic forecasts for the coming year are on the low side, as they tend to be insular and only examine their own back yard, with most predictions still carrying a 2% handle.
I think the US will come in at the 3%-4% range, and the global recovery spawns a cross leveraged, hockey stick effect to the upside. This will be the best performance in a decade. Most company earnings forecasts are low as well.
There is one big positive that we can count on in the New Year. Corporate earnings will probably come in at $130 a share for the S&P 500, a gain of 10% over the previous year. During the last five years, we have seen the most dramatic increase in earnings in history, taking them to all-time highs.
This is set to continue. Furthermore, this growth will be front end loaded into Q1. The ?tell? was the blistering 5% growth rate we saw in Q3, 2014.
Cost cutting through layoffs is reaching an end, as there is no one left to fire. That leaves hyper accelerating technology and dramatically lower energy costs the remaining sources of margin increases, which will continue their inexorable improvements. Think of more machines and software replacing people.
You know all of those hundreds of billions raised from technology IPO?s in 2014. Most of that is getting plowed right back into new start ups, accelerating the rate of technology improvements even further, and the productivity gains that come with it.
You can count on demographics to be a major drag on this economy for the rest of the decade. Big spenders, those in the 46-50 age group, don?t return in large numbers until 2022.
But this negative will be offset by a plethora of positives, like technology, global expansion, and the lingering effects of Ben Bernanke?s massive five year quantitative easing. A time to pay the piper for all of this largess will come. But it could be a decade off.
I believe that the US has entered a period of long-term structural unemployment similar to what Germany saw in the 1990?s. Yes, we may grind down to 5%, but no lower than that. Keep close tabs on the weekly jobless claims that come out at 8:30 AM Eastern every Thursday for a good read as to whether the financial markets will head in a ?RISK ON? or ?RISK OFF? direction.
Most of the disaster scenarios predicted for the economy this year were based on the one off black swans that never amounted to anything, like the Ebola virus, ISIS, and the Ukraine.
With the economy going gangbusters, and corporate earnings reaching $130 a share, those with a traditional ?buy and hold? approach to the stock market will do alright, provided they are willing to sleep through some gut churning volatility. A Costco sized bottle of Jack Daniels and some tranquillizers might help too.
Earnings multiples will increase as well, as much as 10%, from the current 17X to 18.5X, thanks to a prolonged zero interest rate regime from the Fed, a massive tax cut in the form of cheap oil, unemployment at a ten year low, and a paucity of attractive alternative investments.
This is not an outrageous expectation, given the 10-22 earnings multiple range that we have enjoyed during the last 30 years. If anything, it is amazing how low multiples are, given the strong tailwinds the economy is enjoying.
The market currently trades around fair value, and no market in history ever peaked out here. An overshoot to the upside, often a big one, is mandatory. After all, my friend, Janet Yellen, is paying you to buy stock with cheap money, so why not?
This is how the S&P 500 will claw its way up to 2,350 by yearend, a gain of about 12.2% from here. Throw in dividends, and you should pick up 14.2% on your stock investments in 2015.
This does not represent a new view for me. It is simply a continuation of the strategy I outlined again in October, 2014 (click here for ?Why US Stocks Are Dirt Cheap?).
Technology will be the top-performing sector once again this year. They will be joined by consumer cyclicals (XLV), industrials (XLI), and financials (XLF).
The new members in the ?Stocks of the Month Club? will come from newly discounted and now high yielding stocks in the energy sector (XLE).
There is also a rare opportunity to buy solar stocks on the cheap after they have been unfairly dragged down by cheap oil like Solar City (SCTY) and the solar basket ETF (TAN). Revenues are rocketing and costs are falling.
After spending a year in the penalty box, look for small cap stocks to outperform. These are the biggest beneficiaries of cheap energy and low interest rates, and also have minimal exposure to the weak European and Asian markets.
Share prices will deliver anything but a straight-line move. We finally got our 10% correction in 2014, after a three-year hiatus. Expect a couple more in 2015. The higher prices rise, the more common these will become.
We will start with a grinding, protesting rally that takes us up to new highs, as the market climbs the proverbial wall of worry. Then we will suffer a heart stopping summer selloff, followed by another aggressive yearend rally.
Cheap money creates a huge incentive for companies to buy back their own stock. They divert money from their $3 trillion cash hoard, which earns nothing, retire shares paying dividends of 3% or more, and boost earnings per share without creating any new business. Call it financial engineering, but the market loves it.
Companies are also retiring stock through takeovers, some $2 trillion worth last year. Expect more of this to continue in the New Year, with a major focus on energy. Certainly, every hedge fund and activist investor out there is undergoing a crash course on oil fundamentals. After a 13-year bull market in energy, the industry is ripe for a cleanout.
This is happening in the face of both an individual and institutional base that is woefully underweight equities.
The net net of all of this is to create a systemic shortage of US equities. That makes possible simultaneous rising prices and earnings multiples that have taken us to investor heaven.
Amtrak needs to fill every seat in the dining car, so you never know who you will get paired with.
There was the Vietnam vet Phantom jet pilot who now refused to fly because he was treated so badly at airports. A young couple desperate to get out of Omaha could only afford seats as far as Salt Lake City, sitting up all night. I paid for their breakfast.
A retired British couple was circumnavigating the entire US in a month on a ?See America Pass.? Mennonites returning home by train because their religion forbade airplanes.
If you told me that US GDP growth was 5%, unemployment was at a ten year low at 5.8%, and energy prices had just halved, I would have pegged the ten-year Treasury bond yield at 6.0%. Yet here we are at 2.10%.
Virtually every hedge fund manager and institutional investor got bonds wrong last year, expecting rates to rise. I was among them, but that is no excuse. At least I have good company.
You might as well take your traditional economic books and throw them in the trash. Apologies to John Maynard Keynes, John Kenneth Galbraith, and Paul Samuelson.
The reasons for the debacle are myriad, but global deflation is the big one. With ten year German bunds yielding a paltry 50 basis points, and Japanese bonds paying a paltry 30 basis points, US Treasuries are looking like a bargain.
To this, you can add the greater institutional bond holding requirements of Dodd-Frank, a balancing US budget deficit, a virile US dollar, the commodity price collapse, and an enormous embedded preference for investors to keep buying whatever worked yesterday.
For more depth on the perennial strength of bonds, please click here for ?Ten Reasons Why I?m Wrong on Bonds?.
Bond investors today get an unbelievable bad deal. If they hang on to the longer maturities, they will get back only 80 cents worth of purchasing power at maturity for every dollar they invest.
But institutions and individuals will grudgingly lock in these appalling returns because they believe that the potential losses in any other asset class will be worse. The problem is that driving eighty miles per hour while only looking in the rear view mirror can be hazardous to your financial health.
While much of the current political debate centers around excessive government borrowing, the markets are telling us the exact opposite. A 2%, ten-year yield is proof to me that there is a Treasury bond shortage, and that the government is not borrowing too much money, but not enough.
There is another factor supporting bonds that no one is looking at. The concentration of wealth with the 1% has a side effect of pouring money into bonds and keeping it there. Their goal is asset protection and nothing else.
These people never sell for tax reasons, so the money stays there for generations. It is not recycled into the rest of the economy, as conservative economists insist. As this class controls the bulk of investable assets, this forestalls any real bond market crash, possibly for decades.
So what will 2015 bring us? I think that the erroneous forecast of higher yields I made last year will finally occur this year, and we will start to chip away at the bond market bubble?s granite edifice. I am not looking for a free fall in price and a spike up in rates, just a move to a new higher trading range.
The high and low for ten year paper for the past nine months has been 1.86% to 3.05%. We could ratchet back up to the top end of that range, but not much higher than that. This would enable the inverse Treasury bond bear ETF (TBT) to reverse its dismal 2014 performance, taking it from $46 back up to $76.
You might have to wait for your grandchildren to start trading before we see a return of 12% Treasuries, last seen in the early eighties. I probably won?t live that long.
Reaching for yield will continue to be a popular strategy among many investors, which is typical at market tops. That focuses buying on junk bonds (JNK) and (HYG), REITS (HCP), and master limited partnerships (KMP), (LINE).
There is also emerging market sovereign debt to consider (PCY). At least there, you have the tailwinds of long term strong economies, little outstanding debt, appreciating currencies, and higher interest rates than those found at home. This asset class was hammered last year, so we are now facing a rare entry point. However, keep in mind, that if you reach too far, your fingers get chopped off.
There is a good case for sticking with munis. No matter what anyone says, taxes are going up, and when they do, this will increase tax free muni values. So if you hate paying taxes, go ahead and buy this exempt paper, but only with the expectation of holding it to maturity. Liquidity could get pretty thin along the way, and mark to markets could be shocking. Be sure to consult with a local financial advisor to max out the state, county, and city tax benefits.
There are only three things you need to know about trading foreign currencies in 2015: the dollar, the dollar, and the dollar. The decade long bull market in the greenback continues.
The chip shot here is still to play the Japanese yen from the short side. Japan?s Ministry of Finance is now, far and away, the most ambitious central bank hell bent on crushing the yen to rescue its dying economy.
The problems in the Land of the Rising Sun are almost too numerous to count: the world?s highest debt to GDP ratio, a horrific demographic problem, flagging export competitiveness against neighboring China and South Korea, and the world?s lowest developed country economic growth rate.
The dramatic sell off we saw in the Japanese currency since December, 2012 is the beginning of what I believe will be a multi decade, move down. Look for ?125 to the dollar sometime in 2015, and ?150 further down the road. I have many friends in Japan looking for and overshoot to ?200. Take every 3% pullback in the greenback as a gift to sell again.
With the US having the world?s strongest major economy, its central bank is, therefore, most likely to raise interest rates first. That translates into a strong dollar, as interest rate differentials are far and away the biggest decider of the direction in currencies. So the dollar will remain strong against the Australian and Canadian dollars as well.
The Euro looks almost as bad. While European Central Bank president, Mario Draghi, has talked a lot about monetary easing, he now appears on the verge of taking decisive action.
Recurring financial crisis on the continent is forcing him into a massive round of Fed style quantitative easing through the buying of bonds issued by countless European entities. The eventual goal is to push the Euro down to parity with the buck and beyond.
For a sleeper, use the next plunge in emerging markets to buy the Chinese Yuan ETF (CYB) for your back book, but don?t expect more than single digit returns. The Middle Kingdom will move heaven and earth in order to keep its appreciation modest to maintain their crucial export competitiveness.
There isn?t a strategist out there not giving thanks for not loading up on commodities in 2014, the preeminent investment disaster of 2015. Those who did are now looking for jobs on Craig?s List.
2014 was the year that overwhelming supply met flagging demand, both in Europe and Asia. Blame China, the big swing factor in the global commodity.
The Middle Kingdom is currently changing drivers of its economy, from foreign exports to domestic consumption. This will be a multi decade process, and they have $4 trillion in reserves to finance it.
It will still demand prodigious amounts of imported commodities, especially, oil, copper, iron ore, and coal, all of which we sell. But not as much as in the past. The derivative equity plays here, Freeport McMoRan (FCX) and Companhia Vale do Rio Doce (VALE), have all taken an absolute pasting.
The food commodities were certainly the asset class to forget about in 2014, as perfect weather conditions and over planting produced record crops for the second year in a row, demolishing prices. The associated equity plays took the swan dive with them.
However, the ags are still a tremendous long term Malthusian play. The harsh reality here is that the world is making people faster than the food to feed them, the global population jumping from 7 billion to 9 billion by 2050.
Half of that increase comes in countries unable to feed themselves today, largely in the Middle East. The idea here is to use any substantial weakness, as we are seeing now, to build long positions that will double again if global warming returns in the summer, or if the Chinese get hungry.
The easy entry points here are with the corn (CORN), wheat (WEAT), and soybeans (SOYB) ETF?s. You can also play through (MOO) and (DBA), and the stocks Mosaic (MOS), Monsanto (MON), Potash (POT), and Agrium (AGU).
The grain ETF (JJG) is another handy fund. Though an unconventional commodity play, the impending shortage of water will make the energy crisis look like a cakewalk. You can participate in this most liquid of assets with the ETF?s (PHO) and (FIW).
Yikes! What a disaster! Energy in 2014 suffered price drops of biblical proportions. Oil lost the $30 risk premium it has enjoyed for the last ten years. Natural gas got hammered. Coal disappeared down a black hole.
Energy prices did this in the face of an American economy that is absolutely rampaging, its largest consumer. Our train has moved over to a siding to permit a freight train to pass, as it has priority on the Amtrak system. Three Burlington Northern engines are heaving to pull over 100 black, brand new tank cars, each carrying 30,000 gallons of oil from the fracking fields in North Dakota.
There is another tank car train right behind it. No wonder Warren Buffett tap dances to work every day, as he owns the road. US Steel (X) also does the two-step, since they provide immense amounts of steel to build these massive cars.
The US energy boom sparked by fracking will be the biggest factor altering the American economic landscape for the next two decades. It will flip us from a net energy importer to an exporter within two years, allowing a faster than expected reduction in military spending in the Middle East.
Cheaper energy will bestow new found competitiveness on US companies that will enable them to claw back millions of jobs from China in dozens of industries. This will end our structural unemployment faster than demographic realities would otherwise permit.
We have a major new factor this year in considering the price of energy. Peace in the Middle East, especially with Iran, always threatened to chop $30 off the price of Texas tea. But it was a pie-in-the-sky hope. Now there are active negotiations underway in Geneva for Iran to curtail or end its nuclear program. This could be one of the black swans of 2015, and would be hugely positive for risk assets everywhere.
Enjoy cheap oil while it lasts because it won?t last forever. American rig counts are already falling off a cliff and will eventually engineer a price recovery.
Add the energies of oil (DIG), Cheniere Energy (LNG), the energy sector ETF (XLE), Conoco Phillips (COP), and Occidental Petroleum (OXY). Skip natural gas (UNG) price plays and only go after volume plays, because the discovery of a new 100-year supply from ?fracking? and horizontal drilling in shale formations is going to overhang this subsector for a very long time.
It is a basic law of economics that cheaper prices bring greater demand and growing volumes, which have to be transported. However, major reforms are required in Washington before use of this molecule goes mainstream.
These could be your big trades of 2015, but expect to endure some pain first.
The train has added extra engines at Denver, so now we may begin the long laboring climb up the Eastern slope of the Rocky Mountains.
On a steep curve, we pass along an antiquated freight train of hopper cars filled with large boulders. The porter tells me this train is welded to the tracks to create a windbreak. Once, a gust howled out of the pass so swiftly that it blew a train over on to its side.
In the snow filled canyons we sight a family of three moose, a huge herd of elk, and another group of wild mustangs. The engineer informs us that a rare bald eagle is flying along the left side of the train. It?s a good omen for the coming year. We also see countless abandoned gold mines and the broken down wooden trestles leading to them, so it is timely here to speak about precious metals.
As long as the world is clamoring for paper assets like stocks and bonds, gold is just another shiny rock. After all, who needs an insurance policy if you are going to live forever?
We have already broken $1,200 once, and a test of $1,000 seems in the cards before a turnaround ensues. There are more hedge fund redemptions and stop losses to go. The bear case has the barbarous relic plunging all the way down to $700.
But the long-term bull case is still there. Someday, we are going to have to pay the piper for the $4.5 trillion expansion in the Fed?s balance sheet over the past five years, and inflation will return. Gold is not dead; it is just resting. I believe that the monetary expansion arguments to buy gold prompted by massive quantitative easing are still valid.
If you forgot to buy gold at $35, $300, or $800, another entry point is setting up for those who, so far, have missed the gravy train. The precious metals have to work off a severely, decade old overbought condition before we make substantial new highs. Remember, this is the asset class that takes the escalator up and the elevator down, and sometimes the window.
If the institutional world devotes just 5% of their assets to a weighting in gold, and an emerging market central bank bidding war for gold reserves continues, it has to fly to at least $2,300, the inflation adjusted all-time high, or more.
This is why emerging market central banks step in as large buyers every time we probe lower prices. For me, that pegs the range for 2015 at $1,000-$1,400. ETF players can look at the 1X (GLD) or the 2X leveraged gold (DGP).
I would also be using the next bout of weakness to pick up the high beta, more volatile precious metal, silver (SLV), which I think could hit $50 once more, and eventually $100.
What will be the metals to own in 2015? Palladium (PALL) and platinum (PPLT), which have their own auto related long term fundamentals working on their behalf, would be something to consider on a dip. With US auto production at 17 million units a year and climbing, up from a 9 million low in 2009, any inventory problems will easily get sorted out.
Would You Believe This is a Blue State?
8) Real Estate (ITB)
The majestic snow covered Rocky Mountains are behind me. There is now a paucity of scenery, with the endless ocean of sagebrush and salt flats of Northern Nevada outside my window, so there is nothing else to do but write. My apologies to readers in Wells, Elko, Battle Mountain, and Winnemucca, Nevada.
It is a route long traversed by roving banks of Indians, itinerant fur traders, the Pony Express, my own immigrant forebears in wagon trains, the transcontinental railroad, the Lincoln Highway, and finally US Interstate 80.
There is no doubt that there is a long-term recovery in real estate underway. We are probably 8 years into an 18-year run at the next peak in 2024.
But the big money has been made here over the past two years, with some red hot markets, like San Francisco, soaring. If you live within commuting distance of Apple (AAPL), Google (GOOG), or Facebook (FB) headquarters in California, you are looking at multiple offers, bidding wars, and prices at all time highs.
From here on, I expect a slow grind up well into the 2020?s. If you live in the rest of the country, we are talking about small, single digit gains. The consequence of pernicious deflation is that home prices appreciate at a glacial pace. At least, it has stopped going down, which has been great news for the financial industry.
There are only three numbers you need to know in the housing market: there are 80 million baby boomers, 65 million Generation Xer?s who follow them, and 85 million in the generation after that, the Millennials.
The boomers have been unloading dwellings to the Gen Xer?s since prices peaked in 2007. But there are not enough of the latter, and three decades of falling real incomes mean that they only earn a fraction of what their parents made.
If they have prospered, banks won?t lend to them. Brokers used to say that their market was all about ?location, location, location?. Now it is ?financing, financing, financing?. Banks have gone back to the old standard of only lending money to people who don?t need it.
Consider the coming changes that will affect this market. The home mortgage deduction is unlikely to survive any real attempt to balance the budget. And why should renters be subsidizing homeowners anyway? Nor is the government likely to spend billions keeping Fannie Mae and Freddie Mac alive, which now account for 95% of home mortgages.
That means the home loan market will be privatized, leading to mortgage rates higher than today. It is already bereft of government subsidies, so loans of this size are priced at premiums. This also means that the fixed rate 30-year loan will go the way of the dodo, as banks seek to offload duration risk to consumers. This happened long ago in the rest of the developed world.
There is a happy ending to this story. By 2022 the Millennials will start to kick in as the dominant buyers in the market. Some 85 million Millennials will be chasing the homes of only 65 Gen Xer?s, causing housing shortages and rising prices.
This will happen in the context of a labor shortfall and rising standards of living. Remember too, that by then, the US will not have built any new houses in large numbers in 15 years.
The best-case scenario for residential real estate is that it gradually moves up for another decade, unless you live in Cupertino or Mountain View. We won?t see sustainable double-digit gains in home prices until America returns to the Golden Age in the 2020?s, when it goes hyperbolic.
But expect to put up your first-born child as collateral, and bring your entire extended family in as cosigners if you want to get a bank loan.
That makes a home purchase now particularly attractive for the long term, to live in, and not to speculate with. This is especially true if you lock up today?s giveaway interest rates with a 30 year fixed rate loan. At 3.3% this is less than the long-term inflation rate.
You will boast about it to your grandchildren, as my grandparents once did to me.
Crossing the Bridge to Home Sweet Home
9) Postscript
We have pulled into the station at Truckee in the midst of a howling blizzard.
My loyal staff have made the 20 mile trek from my beachfront estate at Incline Village to welcome me to California with a couple of hot breakfast burritos and a chilled bottle of Dom Perignon Champagne, which has been resting in a nearby snowbank. I am thankfully spared from taking my last meal with Amtrak.
Well, that?s all for now. We?ve just passed the Pacific mothball fleet moored in the Sacramento River Delta and we?re crossing the Benicia Bridge. The pressure increase caused by an 8,200 foot descent from Donner Pass has crushed my water bottle. The Golden Gate Bridge and the soaring spire of the Transamerica Building are just around the next bend across San Francisco Bay.
A storm has blown through, leaving the air crystal clear and the bay as flat as glass. It is time for me to unplug my Macbook Pro and iPhone 6, pick up my various adapters, and pack up.
We arrive in Emeryville 45 minutes early. With any luck, I can squeeze in a ten mile night hike up Grizzly Peak and still get home in time to watch the season opener for Downton Abbey season five. I reach the ridge just in time to catch a spectacular pastel sunset over the Pacific Ocean. The omens are there. It is going to be another good year.
I?ll shoot you a Trade Alert whenever I see a window open on any of the trades above.
https://www.madhedgefundtrader.com/wp-content/uploads/2013/01/Zephyr.jpg342451Mad Hedge Fund Traderhttps://madhedgefundtrader.com/wp-content/uploads/2019/05/cropped-mad-hedge-logo-transparent-192x192_f9578834168ba24df3eb53916a12c882.pngMad Hedge Fund Trader2015-01-06 01:02:142015-01-06 01:02:142015 Annual Asset Class Review
This is a bet that the ten-year Treasury bonds, now trading at a 2.50% yield, don?t fall below 2.40% over the next 14 trading days. It has to make this move on top of an unbelievable decline in yields from 3.0% to 2.50% since September. And it has to do it quickly.
The Federal Reserve on Wednesday to consider whether they should raise rates, lower them, or leave them unchanged. Some traders are looking for hints of a taper that may arrive earlier than expected. I think there is zero chance of this. The futures markets for overnight money are trading at prices suggesting that this won?t occur until April or May of 2015! (No typo here). We could be setting up for a classic ?buy the rumor, sell the news? move here.
We are also blessed with a short calendar for the November 15 expiration, as November 1 falls on a Friday. This also takes us into the usual volatility sapping Thanksgiving holidays.
My standing view on bonds is that we will trade in a 2.40%-3.0% range for some time. Given that the ?Great Reallocation? trade may begin in earnest in 2014. We should take a run at the higher end of that range as we go into yearend.
Loss of 1.5% in fiscal drag from Washington next year could take US GDP growth up from a sluggish 2.0% to a more sporty 3.5%. This is not an environment where you want to own any kind of fixed income security.
You might also consider buying November call spreads on the double short Treasury bond ETF, the ProShares Ultra Short 20+ Treasury Fund (TBT), or just buying the (TBT) outright. Another run at the highs for the year from here is worth ten points.
While examining your own fixed income exposure, you might want to use the current strength in bonds to lighten up in other areas. Municipal bond prices (MUB) are now so high that the capital risk no longer justifies the tax savings. Get rid of them! The only successful muni bond strategy here is to die, and let your heirs sort out the wreckage. That way, your widow gets the step up in the cost basis.
Ditto for junk bonds (JNK), (HYG), which after the latest humongous rally, also see low yields no longer justifying the principal risk. The only bonds I like here are master limited partnerships (LINE), where double digit yields adequately pay you for your risk. I also like sovereign bonds (ELD), which will be supported by emerging market currencies appreciating against the US dollar.
https://www.madhedgefundtrader.com/wp-content/uploads/2013/10/The-End-is-Near-sign.jpg301420Mad Hedge Fund Traderhttps://madhedgefundtrader.com/wp-content/uploads/2019/05/cropped-mad-hedge-logo-transparent-192x192_f9578834168ba24df3eb53916a12c882.pngMad Hedge Fund Trader2013-10-29 01:04:552013-10-29 01:04:55The Run in Bonds is Over
Let?s face it, the carnage in the bond markets in May outdid the sack of Rome.
Not only did the Treasury bonds (TLT) get hit. The entire high yield space was slaughtered, including corporates (LQD), junk bonds (JNK), REITS (VNQ), master limited partnerships (KMP), municipal bonds (MUB), and high dividend equities. Anything that looked and smelled like a bond got dumped.
As American bonds get their clocks cleaned, so did virtually the entire fixed income space worldwide. Yields on ten-year Japanese government bonds nearly tripled from 0.37% to 0.95%. German bond yields skyrocketed, from 1.20% to 1.55%. Suddenly, a global capital shortage broke out all over like a bad rash.
So has the Great Reallocation out of bonds into stocks begun? Has the Great Bond Crash of 2013 only started? Or is there something more complex going on here?
Don?t worry, the bond market is not about to crash. All we are seeing is a move to a new trading range for the ten year, from 1.50%-2-10% to 1.90%-2.50%. This has been my forecast for the Treasury bond markets all year. High yielding instruments, like those in junk bonds and REITS, will see more dramatic price declines. There are several reasons why this is the case.
For a start, the economy is just too weak to support any further back up in rates. Much of corporate American has grown so used to free money that even a modest rise in rates would be cataclysmic. It was also drop the residential real estate recovery dead in its tracks. Watch the US government?s budget deficit soar, once again, if interest rates continue their assent.
A 2% GDP growth will never be a springboard for 4%, 5%, or 6% yields. In fact, the risk is that we slow down from here, forcing the Fed to come to the rescue with more accommodative swaths of quantitative easing.
Look at the inflation, that great destroyer of bonds. The last reported unadjusted YOY CPI by the Bureau of Labor Statistics came in at a gob smackingly low 1.1% in April (click here for the website).? Real deflation is anything but a major threat, and will not provide the rocket fuel for further bond selling. When you here of friends getting surprise 20% pay hikes, then you can expect a return in inflation. That has been happening in China for several years now. But so far, I have not heard the good news at home.
Check out who has been buying bonds for the last five years? More than half of the Treasury auctions have gone to foreign governments. First it was China, and more recently to European central banks. These people don?t sell. They just redirect new cash flows. You can count on them keeping the bonds they already have until maturity, even if it is 30 years out. They will never be the source of large scale selling.
Examine who has the highest fixed income weightings in the US. It is the fabled ?1%.? When I serviced some of the wealthiest old money families on behalf of Morgan Stanley during the 1980?s, I was struck by one thing. These were the most conservative people in the world. Protection of principal was their primary consideration. Interest income was almost an afterthought.
This is because the majority of wealthy investors inherited their money, and lived in constant fear they would lose what they have. This is because, as trust fund kids, they had no idea how to earn their own money and create new wealth. Once capital disappeared, it was gone for good. Get a job? Heaven forbid! This investor class also has no desire to get hit with the long-term capital gains such sales would generate. So don?t expect selling from them either.
So, at worst case, you might see another 20-25 basis point rise in Treasury yields to the top end of the new range. At that point, they will be a buy for a rally that might correspond to a stock market selloff and flight to safety bid for bonds which I expect this summer. This takes the ten-year back to a 1.90% yield.
This will be particularly crucial for those who have been trading leveraged short fixed income instruments like the (TBT). They saw a dramatic 12-point, 20% rally in May from bottom to top. Any further gains from here will be of the high risk, low return variety. Maybe, it?s time to sit down and smell the roses? Or take a long summer vacation, as I plan to.
https://www.madhedgefundtrader.com/wp-content/uploads/2013/06/Statue1.jpg448337Mad Hedge Fund Traderhttps://madhedgefundtrader.com/wp-content/uploads/2019/05/cropped-mad-hedge-logo-transparent-192x192_f9578834168ba24df3eb53916a12c882.pngMad Hedge Fund Trader2013-06-05 09:04:282013-06-05 09:04:28Welcome to the Sack of Rome
I received a flurry of inquires the other day when Ben Bernanke mentioned the word ?sterilization? in his recent congressional testimony. And he wasn?t giving advice to the country?s wayward teenaged girls, either.
Sterilization refers to a specific style of monetary policy. Sterilized policies seek to manipulate the money markets without changing the overall money supply. The Fed implemented just such a strategy in 2011 when they initiated their ?twist? policy. This involved buying 10, 20, and 30 Treasury bonds and selling short an equal amount of short-term Treasury bills.
The goal here was to force investors out of the safety of Treasury bonds and into riskier assets like stocks, commodities, and real estate. Given the market action since then, I?d say they succeeded wildly beyond their dreams.
Dollar for dollar there is no change in the Fed?s balance sheet when sterilized actions are undertaken, although there is a huge increase in the risk profile of their portfolio. A private institution would be insane to do this at this stage of the economic cycle, as the risk of capital loss is great. But governments are exempt from mark to market rules and can carry this paper at cost or par, whatever they want. That?s why we have a central bank.
The Fed is now running up against a unique problem. The twist program is so large that it is literally running out of short-term securities to sell. When this happens, they may well resort to 28-day repurchase agreements instead, which are essentially sales of short term paper out the back door. This is what Uncle Ben was attempting to explain to our congressional leaders, which I?m sure went straight over their heads.
The really interesting thing here is why Bernanke is suddenly interested in sterilization? These are the types of policies you pursue to head off inflation. With wages continuing to fall, it is difficult to see why this should be an issue.
Maybe he?s looking at the price of homes and the stock market instead, which have recently been going through the roof. Perhaps he?s looking several years down the road. The great challenge for the Federal Reserve from here will be unwinding their massive $3.5 trillion balance sheet it built up during the Great Recession, without triggering runaway price increases.
https://www.madhedgefundtrader.com/wp-content/uploads/2013/03/Pills.jpg258379Mad Hedge Fund Traderhttps://madhedgefundtrader.com/wp-content/uploads/2019/05/cropped-mad-hedge-logo-transparent-192x192_f9578834168ba24df3eb53916a12c882.pngMad Hedge Fund Trader2013-03-21 09:13:212013-03-21 09:13:21When Sterilization is Not a Form of Birth Control
Have I seen this movie before? Four years ago, analysts were predicting default rates as high as 17% for Junk bonds in the wake of the financial meltdown, taking yields on individual issues up to 25%.
Liquidity in the market vaporized, and huge volumes of unsold paper overhung the market. To me, this was an engraved invitation to come in and buy the junk bond ETF (JNK) at $18. Since then, the despised ETF has risen to $41, and with the hefty interest income, the total return has been over 160%. What was the actual realized default rate? It came in at less than 0.50%.
Fast forward to two years ago (has it been that long?). Bank research analyst Meredith Whitney predicted that the dire straits of state and local finances will trigger a collapse of the municipal bond market that will resemble the ?Sack of Rome.? She believed that total defaults could reach $100 billion. This cataclysmic forecast caused the main muni bond ETF (MUB) to plunge from $102 to $93. Oops! That turned out to be one of the worst calls in the history of the financial markets. But the fees she earned making such a bold prediction landed her on Fortune?s list of the wealthiest women in America.
I didn?t buy it for a second. States are looking at debt to GDP ratios of 4%, compared to 100% for the federal government. They are miles away from the 130% of GDP that triggered distressed refinancing?s by Italy, Greece, Portugal, and Ireland.
The default risk of muni paper is being vastly exaggerated. I have looked into several California issues and found them at the absolute top of the seniority scale in the state's obligations. Teachers will starve, police and firemen will go on strike, and there will be rioting in the streets before a single interest payment to bond holders is missed.
How many municipal defaults have we actually seen in the last 20 years? There have only been a few that I know of. The nearby City of Vallejo, where policemen earn $140,000 a year, is one of the worst run organizations on the planet. Orange County got its knickers in a twist betting their entire treasury on a complex derivatives strategy that they clearly didn't understand, sold by, guess who, Goldman Sachs (GS). The Harrisburg, PA saga continues. To find municipal defaults in any real numbers you have to go back 80 years to the Great Depression. My guess is that we will certainly see a rise in muni bond defaults. But it will be from two to only a dozen, not the hundreds that Whitney is forecasting.
Let me preface my call here by saying that I don?t know much about the muni bond market. It has long been a boring, quiet backwater of the debt markets. At Morgan Stanley, this is where you sent the new recruits with the 'C' average from a second tier school who you had to hire because his dad was a major client. I have spent most of my life working with top hedge funds, offshore institutions, and foreign governments for whom the tax advantages of owning munis have no value.
However, I do know how to use a calculator. Decent quality muni bonds now carry 3% yields. If you buy bonds from your local issuer, you can duck the city, state, and federal tax due on equivalent grade corporate paper. That gives you a pre tax yield of 6%. While the market has gotten a little thin, prices from here are going to get huge support from these coupons.
Since the tax advantages of these arcane instruments are highly local, sometimes depending on what neighborhood you live in, I suggest talking to a financial adviser to obtain some tailor made recommendations. There is no trade for me here. I just get irritated when conflicted analysts give bad advice to my readers and laugh all the way to the bank. Thought you should know.
There are two additional tail winds that munis may benefit from in 2013. No matter what anyone says, your taxes are going up. Balancing the budget without major revenue increases is a mathematical impossibility. That will increase the value of the tax-free aspect of munis. A serious bout of ?RISK OFF? that sends the Treasury market to a new all-time high, as I expect this summer, will cause munis to rise even further.
Perhaps the best way to play this area is through the Invesco High Yield Muni A Fund (ACTHX), which boasts a positively Olympian 5.56% tax-free yield.
https://www.madhedgefundtrader.com/wp-content/uploads/2013/02/Sculpture.jpg337258Mad Hedge Fund Traderhttps://madhedgefundtrader.com/wp-content/uploads/2019/05/cropped-mad-hedge-logo-transparent-192x192_f9578834168ba24df3eb53916a12c882.pngMad Hedge Fund Trader2013-02-12 23:02:272013-02-12 23:02:27The Muni Bond Myth
Legal Disclaimer
There is a very high degree of risk involved in trading. Past results are not indicative of future returns. MadHedgeFundTrader.com and all individuals affiliated with this site assume no responsibilities for your trading and investment results. The indicators, strategies, columns, articles and all other features are for educational purposes only and should not be construed as investment advice. Information for futures trading observations are obtained from sources believed to be reliable, but we do not warrant its completeness or accuracy, or warrant any results from the use of the information. Your use of the trading observations is entirely at your own risk and it is your sole responsibility to evaluate the accuracy, completeness and usefulness of the information. You must assess the risk of any trade with your broker and make your own independent decisions regarding any securities mentioned herein. Affiliates of MadHedgeFundTrader.com may have a position or effect transactions in the securities described herein (or options thereon) and/or otherwise employ trading strategies that may be consistent or inconsistent with the provided strategies.
We may request cookies to be set on your device. We use cookies to let us know when you visit our websites, how you interact with us, to enrich your user experience, and to customize your relationship with our website.
Click on the different category headings to find out more. You can also change some of your preferences. Note that blocking some types of cookies may impact your experience on our websites and the services we are able to offer.
Essential Website Cookies
These cookies are strictly necessary to provide you with services available through our website and to use some of its features.
Because these cookies are strictly necessary to deliver the website, refuseing them will have impact how our site functions. You always can block or delete cookies by changing your browser settings and force blocking all cookies on this website. But this will always prompt you to accept/refuse cookies when revisiting our site.
We fully respect if you want to refuse cookies but to avoid asking you again and again kindly allow us to store a cookie for that. You are free to opt out any time or opt in for other cookies to get a better experience. If you refuse cookies we will remove all set cookies in our domain.
We provide you with a list of stored cookies on your computer in our domain so you can check what we stored. Due to security reasons we are not able to show or modify cookies from other domains. You can check these in your browser security settings.
Google Analytics Cookies
These cookies collect information that is used either in aggregate form to help us understand how our website is being used or how effective our marketing campaigns are, or to help us customize our website and application for you in order to enhance your experience.
If you do not want that we track your visist to our site you can disable tracking in your browser here:
Other external services
We also use different external services like Google Webfonts, Google Maps, and external Video providers. Since these providers may collect personal data like your IP address we allow you to block them here. Please be aware that this might heavily reduce the functionality and appearance of our site. Changes will take effect once you reload the page.
