Thursday, December 27, 2012

Floyd Norris NYT: Bear Market In Bonds

Stock and Bond bull and bear markets start and end at extremes. The seasons come and go, nothing lasts forever. 

For whatever it is worth, Floyd Norris stated in his column tonight that the long term bull market in bonds is kaput.   

He stated in his column that a "new bear market almost certainly has begun" in bonds.  NYT 

Without question, bonds were at one extreme when the long term bond bull market started in 1982. The 30 year treasury bond was yielding 14% to 15.25% in 1981-82. It is now yielding less than 3%. That should cause any bond bull concern. 

The TIPs have gone into La La Land. As Norris points out, the treasury just auctioned a 4 year and 4 month TIP with a negative current yield of -1.496%. .pdf I have sold out of TIPs. 

The death phase of a stock or bond bull market is reflected both in price and enthusiasm with myriad arguments used to justify extreme prices. This time is different, but it is never really different. 

A stock market novice could have picked the end of the 1982-2000 stock bull market by simply looking at the Shiller PE Ratio.

The last two years of that bull move was fluff. From my viewpoint, the bull market ended in October 1997 and the rest was insanity. Item # 3 Dating the Start of the Current Long Term Secular Bear Market (May 2010 Post)

The yield on treasury securities is equally insane now.  Anyone buying at today's prices is virtually guaranteed a negative real rate of return before taxes. 

The Federal Reserve could easily lose control over the long rates sometime in 2013, notwithstanding a continuation of zero percent federal funds and massive purchases of treasury securities with newly created money which may actually add fuel to a steepening yield curve. The likelihood of that happening would increase with a continued recovery in U.S. home prices, plus an acceleration of new home construction and automobile sales. 

When the worm turns against bond owners, and it will turn, it will likely turn with a vengeance. 

When a long treasury is yielding 3%, the damage to a holder with a rise to 5% would be devastating. 

See generally:
Impact of Rising Rates Starting at Page 8:‎ .pdf

My current thinking is that the long term bull market in bonds will soon be over. I am not likely to own any bond fund by the end of 2014. I will continue to own individual bonds and floaters whose coupons rise with short term rates. I will probably shorten my weighted average maturity some of individual bonds. 

Depending on how 2013 develops, I may start to trim or even eliminate my modest CEF leveraged bond fund positions next year. 

I am just super cautious on bonds now. We may be fine for another year, maybe two, but I would not bet on it. I would keep a close eye on the yield spread between short and long term bonds. The Federal Reserve can keep control over the short term rates and start to lose its influence over the longer term rates even with QE4.  A widening spread would be just one signal. 

I also discuss this topic at Income Investing Message Board - Msg: 28628964, and in a subsequent post published today at the same site: Income Investing Message Board - Msg: 28630078

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