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 2.99%, the ten years 2.59%, and the five years only 2.40%. The ten-year was threatening its all-time low yield of 1.33% only three years ago, a return as rare as a dodo bird, last seen in the 19th century.
What’s more, yields across the entire fixed income spectrum have been plumbing new lows. Corporate bonds (LQD) have been fetching only 3.72%, tax-free municipal bonds (MUB) 2.19%, and junk (JNK) a pittance at 5.57%.
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? Or that the State of Illinois at 3.1%? I think not.
It is a global trend.
German bunds are now paying holders 0.05%, and JGBs are at an eye-popping -0.05%. The worst quality southern European paper has delivered the biggest rallies this year.
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 last year when ten-year yields peaked at 3.25%. 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 were down in 2018. 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 nosedive, 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 2.59% rate.
This is the lesson I learned from servicing generations of Rothschilds, Du Ponts, Rockefellers, and Gettys. 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 use to mean much before 1980, back when the wealthy only owned less than 10% of the bond market, except to financial historians and private wealth specialists, of which I am one. Now they own a whopping 25%, and their behavior affects everyone.
Who has been 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, 3, and 4, now owns 13.63% of our $22 trillion debt.
An assortment of other government entities possesses 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. Ever. 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 have broken through the bottom of the past year’s trading 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 2012, 1.33% low, or lower.
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 than 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, of zero for 10-year Treasuries?
If so, bonds are a steal here at 2.59%. 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. You can count on that if the current president wins a second term.
Why Are They So Low?
https://www.madhedgefundtrader.com/wp-content/uploads/2019/04/US-debt-owners.png600897Mad Hedge Fund Traderhttps://www.madhedgefundtrader.com/wp-content/uploads/2019/05/cropped-mad-hedge-logo-transparent-192x192_f9578834168ba24df3eb53916a12c882.pngMad Hedge Fund Trader2019-04-24 02:07:262019-04-24 01:29:21Why Are Bond Yields So Low?
I believe that the global economy is setting up for a new Golden Age reminiscent of the one the United States enjoyed during the 1950s and which I still remember fondly.
This is not some pie in the sky prediction.
It simply assumes a continuation of existing trends in demographics, technology, politics, and economics. The implications for your investment portfolio will be huge.
What I call “intergenerational arbitrage” will be the principal impetus. The main reason that we are now enduring two “lost decades” of economic growth is that 80 million baby boomers are retiring to be followed by only 65 million “Gen Xer’s”.
When the majority of the population is in retirement mode, it means that there are fewer buyers of real estate, home appliances, and “RISK ON” assets like equities, and more buyers of assisted living facilities, health care, and “RISK OFF” assets like bonds.
The net result of this is slower economic growth, higher budget deficits, a weak currency, and registered investment advisors who have distilled their practices down to only municipal bond sales.
Fast forward six years when the reverse happens and the baby boomers are out of the economy, worried about whether their diapers get changed on time or if their favorite flavor of Ensure is in stock at the nursing home.
That is when you have 65 million Gen Xer’s being chased by 85 million of the “millennial” generation trying to buy their assets.
By then we will not have built new homes in appreciable numbers for 20 years and a severe scarcity of housing hits. Residential real estate prices will soar. Labor shortages will force wage hikes.
The middle-class standard of living will reverse a then 40-year decline. Annual GDP growth will return from the current subdued 2% rate to near the torrid 4% seen during the 1990s.
The stock market rockets in this scenario.
Share prices may rise very gradually for the rest of the teens as long as tepid 2-3% growth persists.
A 5% annual gain takes the Dow to 26,000 by 2020.
After that, we could see the same fourfold return we saw during the Clinton administration, taking the Dow to 100,000 by 2030.
If I’m wrong, it will hit 200,000 instead.
Emerging stock markets (EEM) with much higher growth rates do far better.
This is not just a demographic story. The next 20 years should bring a fundamental restructuring of our energy infrastructure as well.
The 100-year supply of natural gas (UNG) we have recently discovered through the new “fracking” technology will finally make it to end users, replacing coal (KOL) and oil (USO).
Fracking applied to oilfields is also unlocking vast new supplies.
Since 1995, the US Geological Survey estimate of recoverable reserves has ballooned from 150 million barrels to 8 billion. OPEC’s share of global reserves is collapsing.
This is all happening while automobile efficiencies are rapidly improving and the use of public transportation soars.
Mileage for the average US car has jumped from 23 to 24.7 miles per gallon in the last couple of years, and the administration is targeting 50 mpg by 2025. Total gasoline consumption is now at a five-year low.
Alternative energy technologies will also contribute in an important way in states like California, accounting for 30% of total electric power generation by 2020.
I now have an all-electric garage with a Nissan Leaf (NSANY) for local errands and a Tesla Model S-1 (TSLA) for longer trips allowing me to disappear from the gasoline market completely. Millions will follow.
The net result of all of this is lower energy prices for everyone.
It will also flip the US from a net importer to an exporter of energy with hugely positive implications for America’s balance of payments.
Eliminating our largest import and adding an important export is very dollar bullish for the long term.
That sets up a multiyear short for the world’s big energy-consuming currencies especially the Japanese yen (FXY) and the Euro (FXE). A strong greenback further reinforces the bull case for stocks.
Accelerating technology will bring another continuing positive. Of course, it’s great to have new toys to play with on the weekends, send out Facebook photos to the family, and edit your own home videos.
But at the enterprise level, this is enabling speedy improvements in productivity that are filtering down to every business in the US, lower costs everywhere.
This is why corporate earnings have been outperforming the economy as a whole by a large margin.
Profit margins are at an all-time high.
Living near booming Silicon Valley, I can tell you that there are thousands of new technologies and business models that you have never heard of under development.
When the winners emerge, they will have a big cross-leveraged effect on the economy.
New health care breakthroughs will make serious diseases a thing of the past which are also being spearheaded in the San Francisco Bay area.
This is because the Golden State thumbed its nose at the federal government ten years ago when the stem cell research ban was implemented.
It raised $3 billion through a bond issue to fund its own research even though it couldn’t afford it.
I tell my kids they will never be afflicted by my maladies. When they get cancer in 20 years, they will just go down to Wal-Mart and buy a bottle of cancer pills for $5, and it will be gone by Friday.
What is this worth to the global economy? Oh, about $2 trillion a year, or 4% of GDP. Who is overwhelmingly in the driver’s seat on these innovations? The USA.
There is a political element to the new Golden Age as well. Gridlock in Washington can’t last forever. Eventually, one side or another will prevail with a clear majority.
This will allow the government to push through needed long-term structural reforms, the solution of which everyone agrees on now, but nobody wants to be blamed for.
That means raising the retirement age from 66 to 70 where it belongs, and means-testing recipients. Billionaires don’t need the maximum $30,156 annual supplement. Nor do I.
The ending of our foreign wars and the elimination of extravagant unneeded weapons systems cuts defense spending from $800 billion a year to $400 billion, or back to the 2000 pre-9/11 level. Guess what happens when we cut defense spending? So does everyone else.
I can tell you from personal experience that staying friendly with someone is far cheaper than blowing them up.
A Pax Americana would ensue.
That means China will have to defend its own oil supply instead of relying on us to do it for them for free. That’s why they have recently bought a second used aircraft carrier. The Middle East is now their headache.
The national debt then comes under control, and we don’t end up like Greece.
The long-awaited Treasury bond (TLT) crash never happens.
Fed governor Janet Yellen has already told us as much by indicating that the Federal Reserve will soon start to unwind its massive $3.9 trillion in bond holdings.
What have bond prices done?
The reality is that the global economy is already spinning off profits faster than it can find places to invest them, so the money ends up in bonds instead.
Sure, this is all very long-term, over the horizon stuff. You can expect the financial markets to start discounting a few years hence, even though the main drivers won’t kick in for another decade.
But some individual industries and companies will start to discount this rosy scenario now.
Perhaps this is what the nonstop rally in stocks since 2009 has been trying to tell us.
Dow Average 1900-2015
Another American Golden Age is Coming
https://www.madhedgefundtrader.com/wp-content/uploads/2013/03/OPEC-Share-of-World-Crude-Oil-Reserves-2010.jpg253504Mad Hedge Fund Traderhttps://www.madhedgefundtrader.com/wp-content/uploads/2019/05/cropped-mad-hedge-logo-transparent-192x192_f9578834168ba24df3eb53916a12c882.pngMad Hedge Fund Trader2018-12-12 01:06:102018-12-11 18:17:45Standby for the Coming Golden Age of Investment
Last week saw the sharpest move up in stock prices in seven years. Why doesn’t it feel like it? Maybe it’s because we are all recovering losses instead of posting new profits. The mind has a funny way of working like that.
In fact, 2018 may go down as the year that EVERYTHING went down. Stocks (SPY), bonds (TLT), commodities (COPX), precious metals (GLD), foreign currencies (FXE), emerging markets (EEM), oil (USO), real estate (IYR), vintage cars, fine art, and even my neighbor’s beanie baby collection were all posting negative numbers as of a week ago.
In fact, Deutsche Bank tracks 100 global indexes and 88 of them were posting losses on the year. The normal average in any one year is 27. This is why hedge fund are having their worst year in history (except for this one). When your longs AND your shorts plunge in unison, there is nary a dime to be had. Even gold, the ultimate flight to safety asset has failed to perform.
Theoretically, this is supposed to be impossible. When stocks go down, bonds are supposed to go up and visa versa. So are emerging markets and all other hard assets.
This only happens in one set of circumstances and that is when global liquidity is shrinking. There is just not enough free cash around to support everything. So, the price of everything goes down.
The reason most of you don’t recognize this is that last time this happened was in 1980 when most of you were still a gleam in your father’s eye.
If you don’t believe me check, out the chart below from the Federal Reserve Bank of St. Louis. It shows that after peaking in July 2014, the Adjusted Monetary Base has been going nowhere and recently started to decline precipitously.
This was exactly three months before the Federal Reserve ended the aggressive, expansionary monetary policy known as quantitative easing.
The rot started in commodities and spread to precious metals, agricultural prices, bonds, and real estate. In October, it spread to global equities as well. Beanie babies were the last to go.
Want some bad news? Shrinking global liquidity, which is now accelerating, is a major reason why I have been calling for a recession and bear market in 2019 all year.
They say imitation is the sincerest form of flattery. Perhaps that is why 2019 recession calls are lately multiplying like rabbits. Nothing like closing the barn door after the horses have bolted. I wish you told me this in September.
Disturbing economic data is everywhere if only people looked. The S&P Case-Shiller Home Price Index rate of price rise hit an 18-month low at 5.5%. With housing in free fall nationally further serious price declines are to come. With mortgage rates up a full point in a year and affordability at a decade low, who’s surprised?
General Motors (GM) closed 3 plants and laid off 15,000 workers, as trade wars wreak havoc on old-line industries. It looks like Millennials would rather ride their scooters than buy new cars.
Weekly Jobless Claims soared 10,000, to 234,000, a new five-month high. Not what stock owners want to hear. THE JOBS MIRACLE IS FADING!
October New Home Sales were a complete disaster, down a stunning 8.9% and off 12% YOY. These are the worst numbers since the 2009 housing crash. I told you not to buy homebuilders! They can’t give them away now!
Oil plunged again, off 20% in November alone. Is this punishment for Saudi Arabia chopping up a journalist or is the world headed into recession?
It seems we don’t have quiet weeks anymore. Normally, sedentary Jay Powell ripped it up with a few choice words at the New York Economic Club.
By saying that we are close to a neutral rate, the Fed Governor implied that there will be one more rate rise in December and then NO MORE. Happy president. But the historical neutral range is 3.5%-4.5%, meaning there is room for 2-6 X 25 basis point rate hikes to keep the bond vigilantes at pay. Such a card! Thread that needle!
Cyber Monday sales hit a new all-time high, up to $7.3 billion, with Amazon (AMZN) taking far and away the largest share. The stock is now up $300 from its November $1,400 low.
Salesforce, a Mad Hedge favorite, announced blockbuster earnings and was rewarded with a ballistic move upwards in the shorts. Fortunately, the Mad Hedge Technology Letter was long.
The Mad Hedge Alert Service managed to pull victory from the jaws of defeat in November with a last-minute comeback. Add October and November together and we limited out losses to 0.59% for the entire crash.
This was a period when NASDAQ fell a heart-stopping 17% and lead stocks fell as much as 60%. Most investors will take that all day long. I bet you will too. Down markets is when you define the quality of a trader, not up ones, when anyone can make a buck.
My year to date return recovered to +27.80%, boosting my trailing one-year return back up to 31.56%. November finished at a near-miraculous -1.83%. That second leg down in the NASDAQ really hurt and was a once in 18-year event. And this is against a Dow Average that is up a pitiful +2.9% so far in 2018.
My nine-year return recovered to +304.27. The average annualized return revived to +33.80.
The upcoming week is all about jobs reports, and on Friday with the big one.
Monday, December 3 at 10:00 EST, the November ISM Manufacturing Index is published. All hell will break loose at the opening as the market discounts the outcome of the Buenos Aires G-20 Summit.
On Tuesday, December 4, November Auto Vehicle Sales are released.
On Wednesday, December 5 at 8:15 AM EST, the November ADP Private Employment Report is out.
At 10:30 AM EST the Energy Information Administration announces oil inventory figures with its Petroleum Status Report.
Thursday, December 6 at 8:30 AM EST, we get the usual Weekly Jobless Claims. At 10:00 AM we learned the November ISM Nonmanufacturing Index.
On Friday, December 7, at 8:30 AM EST, the November Nonfarm Payroll Report is printed.
The Baker-Hughes Rig Count follows at 1:00 PM. At some point, we will get an announcement from the G-20 Summit of advanced industrial nations.
As for me, I’ll be driving my brand new Tesla Model X P100D which I picked up from the factory yesterday. I’ll be zooming up and down the hills and dales of the mountains around San Francisco this weekend.
I’ll also be putting to test the “ludicrous mode” to see if it really can go from zero to 60 in 2.9 seconds and give passengers motion sickness. I will go well equipped with air sickness bags which I lifted off of my latest Virgin Atlantic flight.
Talley Ho! Good luck and good trading.
John Thomas CEO & Publisher The Diary of a Mad Hedge Fund Trader
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Global Market Comments September 24, 2018 Fiat Lux
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