Sunday, August 22, 2010


The great debate this week in finance/economics land centered around the topic of the US Treasury Bond Market. Is it a bubble? The narrative has been excruciatingly painful. The WSJ had this drivel piece this week.

The Great American Bond Bubble

Now, we all must consider the source of this article, Jeremy Siegel. This is the same author who alerted everyone in the early to mid 90's that equities should be bought hand over fist for the long term. Heck! He even wrote a book on the subject.

The whole idea is that over the long run say 20-30 years stocks are better than bonds and have to be bought on any and all pullbacks. Valuations don't matter as much as owning great stocks run by great managers. His blind premise is that if you just buy and hold stocks during an extended period, you will always make money. This was exactly what parasitic Wall Street financial firms as well as mutual fund companies wanted to hear. They pounded this message into the brains of every American in their advertising campaigns, literature and propaganda. The problem is it was all a huge lie. Valuations do matter and guess what? The only great stocks are the ones you buy that go up. "Great" CEO's are often conflicted by their own personal gain via stock options that they will resort to cooking the books by managing and massaging earnings.

Roger Lowenstein has a better book.

One will have a better opinion of GE's Jack Welch after reading this account of Wall Street excess.

Back to the Bond bubble talk. Its all talk. What is happening at the moment is a tectonic shift in American investing. Many Americans have simply had it with equities that have done nothing for 12 years. I am not saying that equities are done forever, but the current equity market structure leaves a lot to be desired. High Frequency trading is some 70% of all trading on the NYSE and most are still clueless to actually what happened on the Flash Crash Day.

Most are looking at where bond yields were and where are they now and just saying its a bubble. Most of these charlatans are just stock promoters and Wall Street hacks. Most are saying that bonds are in a 30 year bull market. This is true and some sort of shakeout will happen over the next few weeks as loose longs will sell and cause yields to rise, but this is temporary because at the end of the day most everyday Americans have lost respect, patience, and most of all trust in the equity markets. The bond bears point out to the fact that Treasuries are trading like .COMS back in 1999-2000. This is absurd. There was nothing backing lousy Internet stocks, most didn't have revenue, Treasuries are backed by the full faith of the US Government, the USA will never default. NEVER! If in the 1 in a quadrillion chance the USA does default, owning anything is a problem, its the least of our worries. Long term Treasuries only weaken if inflation gets to be a problem, deflation is the current theme as economic growth will stay weak. Treasury yields are very low and will get even lower if trend line CPI reaches even -1% to -2%. Many traders and investors are fighting the deflation trend, they simply believe that expanding the money supply will stoke inflation. Many traders are still in fact short treasuries like they were in Japan the last 20 years. The BOJ actually has had an easier time in JGB Bond auctions because there is so much demand on the buy side from all of the traders who are short JGB's. But the bigger trend is that most young Japanese citizens and almost all of the Japanese elderly are simply buying JGB's instead of equities because they are worried about their futures. This is fast becoming the trend in the US as well, as many are growing smarter by the day. Many Americans (Surprise) have lost money being invested in equities. They want the safety of Treasury Bonds no matter how low the yields are. They know that eventually the bond will mature at full face value. The even bigger trend here are the outflows from equity funds into bond funds, for example, from January 2008 through June 2010, outflows from equity funds totalled $233B while bond funds have seen a massive $559B of inflows. This makes selling bonds by the US very easy and compelling. This is not a fly by night rush into bonds. Its a major shift by Americans. Also, its a profitable shift. Treasury bonds have generated a total return of 13% over that time frame versus -21% for equities. In fact, both the absolute and risk adjusted return on Treasury bonds have been spectacularly superior to equities for the last 10 years. Americans have become very smart out of survival.

The NY Times has this.
Small Investors Flee Stock Market Even As Companies Recover.

Bottom line is this. Who cares where yields are! If you buy Treasuries today for what ever maturity you will get your money back at maturity. Can you honestly say that with stocks? 

At the moment 10Y Treasuries are yielding some 2.7%. If deflation runs say 1.5%, your total return is 4.2% in real terms. Can anyone say they can get 4.2% risk free return in a deflationary no growth environment in stocks? Not even Madoff can promise you that. This is the reason why everyone is invested in 10Y JGB's.

Bonds are like equities in the sense they get overbought and oversold. Bonds currently are overbought, and they will trade off as weak owners get rung out of the market, but just look at the demographics changes that are happening in the USA. Look at the continued outflows from equity funds into bond funds. Liquidity runs markets, its the fuel that stokes the fire. Equities are running out of fuel and bonds are gaining it.  

I am sure there will be more Treasuries are a bubble talk over the next few months and even years. Each time yields and equity prices will be lower. There is a huge graveyard of traders and investors who shorted JGB's all through out the last twenty years in Japan. They should have shorted the Nikkei and went used the proceeds to buy JGB's. Silly little fools they were. 

It will be no different here.

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