Stocks represent ownership in corporations that have assets and strive to make a profit, often paying out a portion of the profit in the form of dividends and retaining earnings to grow the business and increase the dividends in the future.
But the primary purpose of this comment is to suggest what things may look like when the Great Bull Market in Bonds, which began in 1981 with 30-year Treasury Bonds yielding 15.25%, finally comes to its glorious end.
For starters, I think it is safe to say that the bull market in bonds will end reasonably close to the point in time that inflation (or deflation) bottoms. This is because we have determined that by far the major economic factor that correlates consistently with the direction of market-determined interest rates, at least for long term Treasury Bonds, is CPI Inflation (headline and core).
The bond market, like politics, is an emotional issue and not well-liked in general by Wall Street because it has a negative correlation to the stock market most of the time. For a growth bull, the bond is the "enemy". The economic environment that most favours the long end of the bond market tends to be low or no growth and bonds have traditionally been an asset allocation decision that is bearish on the stock market.
As a result, fear mongering often takes the place of thoughtful and objective analysis when it comes to bond market commentary. One way or another, the long end of the bond market has continually been characterized as high risk for the last 30 years that it has been outperforming the S&P 500. That’s a little unfair – after all, it is the benchmark risk free asset for funding actuarial liability when taken to the extreme of a 0% Coupon Treasury Strip.
Let’s move on and make a sensible and objective effort at making a long-term forecast for core CPI Inflation. Based on our analysis, we could well see core inflation receding from around 1% now to near 0% in the next 12-to-24 months, which would imply an ultimate bottom in the long bond yield of 2.5% and 2% for the 10-year T-note. We should add that as long as the Fed funds rate remains at zero, reverting to a normal shaped Treasury curve would generate similar results for the long bond and 10-year note at the point at which the inevitable "bull flattener" reaches its climax. As we saw in Japan, this will take time, but yields at these projected levels will very likely come to fruition in coming years.
So what will be the cause of the next secular uptrend in inflation or hyperinflationary shock? It pays to look back at history. Prior to the inflation of the 1970s-early 1980s, periods of very high inflation were primarily associated with war. Increased credit demands to fund the war effort combined with the drop in productivity that goes along with blowing everything up is an inflationary stew.
Wars were typically followed by brief periods of deflation followed by stable prices until the next war. In the 1970s several factors other than war led to the brief bouts of hyperinflation and they are much debated. What is perhaps most important to recognize is that whether it is war, OPEC or rampaging Baby Boomers, history supports the notion that high inflation, at least at the core CPI level, tends to occur in brief bouts.
A quick look at the core CPI chart shows that for all but a brief period since WWII, inflation has been well below 5%. But it was the period from 1970 to 1980 that contained all readings above 5%. Coincidentally, this was the period in which the Baby Boomers were buying their first refrigerators to go along with a bungalow as they formed their households.
By 1983, core CPI was back down to 5% and never looked back, but the psychological damage was already done. Inflationary expectations were indelibly etched into the mindset of the Baby Boom cohort. So everyone positioned themselves for inflation by leveraging up their asset purchases. Inflationary expectations were the rationale for overconsumption and depleted savings rates.
