Sunday Edition: Bonds Are The World’s Most Important Financial Market - Where Are They Headed Next?

February 5, 2017

Sunday Edition: Bonds Are The World’s Most Important Financial Market – Where Are They Headed Next?

Source: Bloomberg.

A few months back I wrote about how I believed the July high of 177’11 in the 30-year bond would ultimately mark the long-term top and beginning of a new bear market.

I still believe that high will hold and be referenced by future generations as the top to one of the longest bond bull markets in history.

But what do I know? I was only eight years old the last time bonds had the kind of inflexion point I believe is happening now. So I felt it might be beneficial to get the opinion of traders or analysts who actually traded through and had to navigate the runaway inflation of the ‘70s and the corresponding peak in interest rates and bottom in bonds.

The five opinions I will be sharing come from a recent Bloomberg Article written on January 27, 2017.

Our first bond trader is Gary Shilling. He was the first chief economist at Merrill Lynch Pierce Fenner & Smith in 1979 and he accurately predicted the end of the bond bear market back in 1981 and is still bullish on bonds today. He said the following:

“Back then, of all the economists on Wall Street, there were maybe 20 of us, and that was it.  In 1981, I said we’re entering a bond rally of our lifetime… I started to get involved in long bonds on a repo basis, very highly leveraged. Initially yields went back up; I was losing money. I was driving around town and I was saying my ‘God Shilling, you’re supposed to be smarter! You got this wrong!’ Luckily I hung on…

“…I’ve been hearing ‘inflation is back’ forever. There were people saying in 2010, 2011, 2012, 2013, 2014, 2015 that bonds are going to hell, and the world is just fine. My target is still 1 percent on the 10-year Treasuries, and 2 percent on 30-year Treasuries.”

Mike Harkins co-founded the asset management firm Levy, Harkins & Co. in 1979, and today is bearish on bonds and believes the world “couldn’t possibly be more wrongly positioned” for a secular shift in U.S. government bonds. Here’s what he had to say:

“…At 4 p.m. on Thursday afternoon, people raced to find out the money supply statistics and tore them apart for meaning. Now, it seems like no one even knows where to find money-supply data. Back in the late 1970s and early 1980s, when a bond went down by 15 percent but had an interest rate in double-digits, you had such a wonderful protection. That period was crazy. But this period is crazier. As a bond investor, you are now effectively taking equity-like risk but with no return… This world now is the exact opposite of the world in the 1970s: you can’t make money. You can only lose. You are priced as if the possibility of inflation is zero, while back in the bear market, the market psychology was that inflation would never end.”

Lacy Hunt was a former Dallas Fed and is now the economist at Hoisington Investment Management Co., based in Austin, Texas. He believes the post-election rout in U.S. government bonds is setting the stage for a rally and is bullish on bonds:

“I’m still long bonds, especially the long-end. The trend to inflation is still downward. When debt is at high levels and increasingly counterproductive, the most important lesson of economic history is that the velocity of money falls.”

Phil Roth started his career in 1966, and was the former chief technical market analyst at Morgan Stanley and an expert on the stock market cycle versus its bond counterpart. He’s currently bearish on bonds and shared this in the Bloomberg article:

“It’s certainly much harder to analyse markets because they are so globalized. But ultimately, I think interest rates are driven by growth and inflation expectations. We are not going to correct the bond bull run overnight. There will be years when the market does well, and years when the market does badly.”

And finally, William Fleckenstein, a hedge fund manager who started his career in 1979 as a broker and investment manager across various asset classes, is also a bond bear:

“When Volcker hiked rates by 200 basis points in late 1978, no one believed in him. The price of gold even eventually doubled. Psychology today is the opposite. Markets believe these idiots so much that even when they blow asset bubbles and those bubbles burst and then they do the exact same thing — keeping rates too loose — people still think it’s going to work. They have created a monumental duration-risk bubble… I suspect the 35-year-old bond market bull run ended in the summer… Big inflexion points in bond markets happen every 30 or 40 years. I think this inflexion point is happening now, and it’s a big deal.”

Based on the expert opinion of five “in-the-trenches” bond traders, it appears we have a mixed bag, with three bond bears and two bond bulls. In my opinion, I think they’ve all got it right. Here’s what I mean:

Lacy Hunt believes the post-election sell off in bonds has set the stage for a significant rally. I couldn’t agree more and shared that view in my post a few months back. I think the rally could easily last the next 12 to 15 months, making bonds one of the better performing assets in the short term, before starting the next leg down in the bear market.

And while I don’t share Gary Shilling’s opinion of a 1% target on the 10-year and a 2% target on the 30-year, I do believe we could see the 10-year fall back to 1.7% and the 30-year drop to 2.4%.

My father, who was a river guide for a number of years, used to always say “that’s close enough for river work” when something met an acceptable degree of accuracy. I think Gary Shilling might have to accept the 1.33% low on the 10-year and 2.10% low on the 30-year as “close enough for river work.”

But even if his targets of 1% and 2% are hit, then what? The way I see it, it would be nothing more than a retest, with a slightly higher high than the July high in bonds before the final top was in place, and the major inflexion point that happens every 30 to 40 years in bonds would begin, if it hasn’t already.

So should you invest in bonds for the next 12 months? Should you sell your bond holdings and wait for much lower prices down the road?

If you are a nimble swing trader you might take a long position in bonds using the TLT (20 year bond ETF), currently trading at $119 and look for a bounce back to $130 – $133. You can see my swing trade setup on the chart below.

Source: Trading View. Annotations: Author’s own.

If you have a more long-term orientation, then selling any exposure to bonds on the coming technical rally would be a good idea, if you haven’t already sold out.

But the best plan of action over the next 3 to 10 years, is to forget about bonds and expose your portfolio to undervalued fast-growing emerging market companies with a subscription to Sven’s Global Growth Stocks. These companies are certain to provide much higher returns than bonds or US stocks.

The official launch of Global Growth Stocks is coming up in just a few weeks. Click here to add your name to the list to receive updates on the release of this exciting new newsletter.


Shane Rawlings
Founder, Investiv