Is Rosie Right on Bonds?
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July 15th, 2009 by Prieur du Plessis, Investment Postcards from Cape Town
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The paragraphs below are excerpts from a recent report by David Rosenberg, chief economist and strategist of Gluskin Sheff & Associates.
“The consensus says that the era of the secular decline in government bond yields has come to an end because of the very low yields and the massive reflation efforts from governments everywhere. The consensus is that inflation is going to have to show up somewhere at some point. That may well be true, but despite huge policy initiatives, long-term bond yields did not hit their bottom in the US until late 1941 at below 2% and this was a good 12 years after the initial shock.
“Nobody built more bridges or paved more river beds than the LDP did in the 1990s in Japan, and despite a doubling in the government debt-to-GDP ratio and multiple credit downgrades, the yield on the 10-year JGB did not hit their lows at less than 1% until 2003 - again, this was 13 years after the initial shock. To be sure, there were selloffs and spasms along the way, but it took years for fiscal and monetary policy to finally break the downtrend in bond yields.
“To be sure, this has been a brutal year for US Treasuries, with the yield on the 10-year note nearly doubling this year at the June 10 peak of 3.98% (though the Treasury market has generated a +2% return so far in July - the first positive showing since March). From our lens, it cannot be said that the secular bull market in bonds is over until the 10-year breaks above 5.26% because then and only then will we be able to say that for the first time in this 28-year secular bull phase, the prior interim high was ‘taken out’. Look at the time series below and you will see that ever since bond yields peaked during the inflation bubble of 1981 they kept on hitting lower and lower ‘highs’ during the eight cyclical selloffs, and they continuously made lower ‘lows’ during the intermittent eight cyclical rallies. That is how a secular bull market is ultimately defined:
October 26, 1981 (High): 15.60%
October 13, 1982 (Low): 10.39%
June 25, 1982 (H): 14.76%
May 4, 1983 (L): 10.12%
August 8, 1983(H): 12.20%
April 6, 1986 (L): 6.98%
March 20. 1989 (H): 9.53%
October 15, 1993 (L): 5.19%
November 7, 1994 (H): 8.05%
October 5, 1998 (L): 4.16%
January 20, 2000 (H): 6.79%
June 13, 2003 (L): 3.13%
June 12, 2007 (H): 5.26%
December 8, 2008 (L) 2.08%
June 10, 2009 (H): 3.98%
Today: 3.26%.
“Keep in mind that over half the time, bond yields hit their fundamental lows in the June-December period; and we also know that Treasuries have rallied in 15 of the last 20 third quarters. So the seasonals, if nothing else, are quite positive for the fixed-income market during this time of year.”
Will Rosie be on the money? I am not so sure. The graph below shows the historical relationship between the US GDP-weighted Purchasing Managers Index (PMI) and the yield on 10-year Treasuries. Should the PMI show further improvement and break above 50 (indicating expansion), long bond yields may not have much downside potential. In any event, I am not sure who wants to sink money into a 10-year T-Note with a 4% coupon that is losing 6-8% a year as a result of dollar depreciation.
Source: Plexus Asset Management (based on data from I-Net Bridge).
Dr. Prieur du Plessis is an investment professional with 26 years' experience in investment research and portfolio management. More than 1,200 of his articles on investment-related topics have been published in various regular newspaper, journal and Internet columns, including his blog, Investment Postcards from Cape Town. He has also published a book, Financial Basics: Investment. Prieur is Chairman and principal shareholder of South African-based Plexus Asset Management, which he founded in 1995. The group conducts investment management, investment consulting, private equity and real estate activities in South Africa and a number of foreign countries. He also serves as Honorary Consul of Slovenia for South Africa, actively developing economic, cultural and scientific relations between Slovenia and South Africa. Prieur is 54 years old and live with his wife, television producer and presenter Isabel Verwey, and two children in Cape Town, South Africa. His leisure activities include long-distance running, traveling, reading, motor-cycling and scripophily. Read more from the author/contributor here.
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Tags: Bear Market, Bond Yields, Chief Executive Officer, David Franklin, Debt Program, Dollar Terms, Economic Data, Eric Sprott, Government Debt, Income Securities, Instalment, Lows, Market Commentary, Money Manager, Money Printing, Mortgage Backed Securities, Ponzi Scheme, Printing Program, Sprott Asset Management, Sprott HedgePosted in Markets |
December 31st, 2009 at 3:10 pm
Unfortunately, the debt is a real incredible pyramid. The greater fool buys it long for record low returns, both present and probably terminal, from the US market maker, for now.
January 1st, 2010 at 8:51 am
Mark,
Thanks for your note. After reading this, it seems so obvious doesn’t it, that at some point, there has to be a return to risk aversion away from risk assets for the demand for U.S. t-bonds to take off, just as the government requires it. It is the central bankers who dangle the carrots, and the market which pursues them. We are just pawns in a chess game. Pay no attention to the man behind the curtain, who pulls the levers and runs the machine, and just do what you’re expected to do - react…
The question remains, will the U.S. government be able to pull it off. Will they be able to rollover $7-trillion over the next 2 years? Will the commercial real estate market be able to rollover $750-billion in mortgages?
Pierre Daillie
January 4th, 2010 at 1:36 pm
The US debt will roll over, however at what price (interest rate). The US desperately needs low single digit rates. With a budget (tax base) of under $3 trillion, a trillion $ budget deficit already and a huge trade deficit, they cannot afford anything higher. Economist talk about US GDP of $15 trillion and country debt at ~100% of that is nonsense; you can\’t tax 100% of GDP. Either the US interest or currency bubble will burst, or both. Currency erosion is the invisible wealth destroyer, globally, yet much more politically paletable in the US than the alternative.
Where to find a few trillion fast, for free? China probably has better opportunities at home, or in Asia.
January 10th, 2010 at 1:01 am
What if Japan resumes its support of US treasuries, reinstating the Plaza Accord it abandoned in March 2004? The complete withdrawal of the yen carry trade in 2008 brought Japan to the brink of economic collapse, as deflation caused by the increasingly expensive yen was cratering domestic consumption, and killiing exports.
Japan is heavily long its own currency as a result the total destruction of its previous carry trade 2007-8, to the tune of trillions. The yen is expensive and could use a lashing. Within its toolbox, outside of printing free-to-carry money, Japan can buy US treasuries in order to devalue the yen. Japan, and China can in tandem play an instrumental role in aiding America to recover so that American consumers can resume their consumption of Toyotas and Sonys from both.
And, if as a result of intervention, prices in Japan start to rise again, then the Japanese consumer will have motivation to go out and shop to their pent up heart’s demand.
The world and the U.S. need balance, and it is indeed in China’s and Japan’s best interest, to insure the idea that America is too big to fail - all else is just a lot of rhetoric and hype.