Guest Post: Generation Alpha
Submitted by Yves Lamoureux, of Macquarie Private Wealth; You can catch Yves on Taking Stock on Bloomberg TV tomorrow at 5pm, and on the Closing Bell on Fox Business at 3 pm.
What most people believe today is that they can extrapolate trends and have great success at placing odds with certainty. Why is it then that most people fail to see that the long-term interest-rate trend is down and going lower?
I have maintained the view for months that prices for 30-year Treasuries are in a secular bull market. The point was also made that after a mismanagement of rates in the 1970s, bonds would seek equilibrium, i.e., find lower yields.
If all of my various angles on the subject were faces of a cube we would be looking at a hypercube.
In essence, the current adjustment upward in bond prices is the result of a lack of immunization. When offered a flu shot, do you decline because there is a chance you might not get the flu? It is the same with immunizing a portfolio. Managers have the obligation to cover the inflation basis and the deflation basis but are failing to do so, or in other words, the cost of the sole diversifier is going up.
When it comes to pure diversification, one of the only remaining asset classes that actually acts in opposition to all other assets are Treasuries. Let's be clear: my thesis does not include corporate bonds. In my view, corporates in the end will still act with the same positive correlation to stocks.
I have been in the deflation camp since 2007. The data I was looking for arrived early in 2008: I knew that I had to track differential rates of money velocities and my proprietary model clearly showed the way.
What distinguishes my view from most is that I too saw the giant increase in the money base, but I also examined its rate of destruction.
What would create deflation was the differential rate of money creation over the rate of money destruction. At a -2% to -4% annual change rate in money aggregates, this creates mild deflation, which is what I claim would be the warranted scenario.
I look at the fiscal and economic states of Japan and Germany and ask, Does anyone believe that these two countries are in much better shape than the US? I don't. The US yield curve has absolutely no reason to be as steep as it is. It would be normal to expect similar yield curves.
I therefore argue that 30-year Treasuries will eventually trade more in line with the 30-year of Japan at 1.79% and the 30-year of Germany at 3.42%. A combined yield of both would give us 2.60%.
The first half of 2010 has been great to us so far. Lots of doubts still abound, but the trend has remained clear since breaking the 4% yield.
As the market comes around to my way of thinking, I will be preparing my exit.
Who says that things come in straight lines? Think of a series of staircases as the inflation/deflation tug of war continues. I did warn of such an event making it a difficult environment for both bulls and bears. This is why I expressed my view in relative terms defined by the outperformance of bonds over stocks.
“I expect bonds to deliver better or equal real returns with fewer risks than stocks going forward. Negative risk premium is the new normal and new behavioural shifts strongly underpin that case.”
From Negative risk premium and Return
Assumptions, October 1st 2009
Yves Lamoureux , Investment Advisor , Macquarie Private Wealth Inc.
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