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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.
Generation Alpha
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.
The opinions contained in this report are those of the author and are not necessarily those of Macquarie Private Wealth Inc (MPW). Every effort has been made to ensure that the contents of this document have been compiled or derived from sources believed to be reliable and contains information and opinions which are accurate and complete. However, neither the author nor MPW makes any representation or warranty, expressed or implied, in respect thereof, or takes any responsibility for any errors or omissions which may be contained herein or accepts any liability whatsoever for any loss arising from any use of or reliance on this report or its contents. No entity within the Macquarie Group of companies is registered as a bank or an authorized foreign bank in Canada under the Bank Act, S.C. 1991, c. 46 and no entity within the Macquarie Group of companies is regulated in Canada as a financial institution, bank holding company or an insurance holding company. Macquarie Bank Limited ABN 46 008 583 542 (MBL) is a company incorporated in Australia and authorised under the Banking Act 1959 (Australia) to conduct banking business in Australia. MBL is not authorised to conduct business in Canada. No entity within the Macquarie Group of companies other than MBL is an authorised deposit-taking institution for the purposes of the Banking Act 1959 (Australia), and their obligations do not represent deposits or other liabilities of MBL. MBL does not guarantee or otherwise provide assurance in respect of the obligations of any other Macquarie Group company. Macquarie Private Wealth Inc is a member of CIPF and IIROC.
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Wow, this is exciting.
It's like the Black Swan v. Hendry and this dude is in
the Hendry camp. Less people on his side of the trade.
Rates low for some time to come? Probably right.
Well they'd love to inflate rates to fulfill Keynesianism cult religion, but since all economic models have been blown out of the water by never-imagined fiat printing and pumping they cant very well do that on the back of record unemployed and bankrupt. 0% is the new norm, well untill armageddon anyway where the last thought on anyones mind will be 'hmmm I wonder what a 30yr mortgage is goin for today' as they fry up some squirrel outside their lean-to.
Interesting, and apparently correct, thesis. Do you have an explanation for the explosion in gold since 2003?
The bet in gold was that the price would decline and interest rates rise and the dollar remain strong. Instead, gold prices rose, interest rates declined, and the Yen is the strongest currency.
But the insurers are profiting
http://www.bloomberg.com/news/2010-07-28/fallen-soldiers-families-denied-cash-payout-as-life-insurers-boost-profit.html
"The US yield curve has absolutely no reason to be as steep as it is."
Ummm... The current Plan isn't working and there is going to be no QE2 and states are going to start passing out IOUs to avoid default. That and a couple of other things...
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?
Paraphrasing: "I present this sweeping generalization. Why doesn't everyone agree with me?"
Kind of amusing, considering the next article at ZH quotes David Rosenberg as saying the 30 year bull market in bonds is over. Haven't seen two directly contradictory opinions right next to each other in a while.
That's a sweet return 15+% for 30 years.
Didn't Rosie say he thought the bond bull would end in the next few years? It seems to me that what the two of them are saying is not incompatible.
It all hinges on this guy's theory that money is actually being destroyed. Banks losing bets is not money being destroyed. That is banks losing money to someone else. Whether it be banks losing money on hedgefund CDS traders, or banks losing money to the public in the form of home loans they don't pay back. No where is money being destroyed. Home prices falling don't take money out of the system because the original home seller already banked that money. It only lowers consumer activity coming from the person stuck with the depreciating asset. When banks get refunded for their losses and keep those refunds on deposit at the Fed, that does not destroy money either.
Bank money is the dumb money and it always has been. They are chasing Treasuries by will or mandate. It does not matter. You don't want to be there. They will sell the bottom in Treasuries as hard as they are buying the top.
Wealth has been determined by bits of paper for far too long - 'money' is very much being destroyed if you determine money to include the broad supply including CREDIT.
Bits of paper have been going to paper heaven ever since 2007. I think you'll find the Fed are losing the reflation battle. And the harder they try , the deeper the debt deflation will bite. Gold isnt pointing towards inflation , its pointing towards a loss of confidence in policy and as a TRUE store of wealth it remains the ultimate source of money. Gold should be used as THE denominator in all risk asset valutions going forward. See how the Nikkei has done price in Gold since 1989. ZERO rates do nothing for anything.
Its really surprising we cant all see it for what it is. Be prepared for 100 year mortgages at super low rates like they have in Japan and a real estate market that goes nowhere forever.
We'll zombify until, like Japan, we run headfirst into the demographic wall... Unfortunately, there are no such things as perpetual motion and magic.
What does the bond market actually see?
Especially in sovereign debt. And how much of this market is not tied to central bank activity. Why is there some type of theoretical purity in sovereign debt instruments?
What is the foundation of this trust? and why do we not see trends based on vulnerabilities of fiat currency like USD. Where is the cause and effect? Where is the market?
What do we see? We see the US sovereign debt market act like a closed system subject to frozen FED rates. It is interesting when rates are 0.25% for a protracted period of time, the effects elapse. So other market drivers should be detected in the forefront. So, where are they?
But what of the risks in sovereign debt? There is no mention of this or how the risks should be exhibited. Why?
US sovereign debt behavior is very bazaar. It is if there is not risk of loss. When we know that the dollar is unprotected and current deficits will debase the currency.
The answer to me is that the behavior does not mirror the risks. The risks are not even mentioned.
So what is going on?
My feeling is that the system that was originally put into place to efficiently manage the auction of debt (FED and Primaries) has morphed to satisfy debt needs through QE leverage, with the big banks taking the middleman profit.
Is it the ultimate Ponzi? Perhaps not, but certainly a confidence game.
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So we say, Okay essentially they are monetizing the debt through a revolving door, between MBS debt and Treasuries money transfer through the bank reserve slush fund.
But is this the big plan? or a temporary extend plan? or what is it really? where is the happy outcome?
So as we move through this thought process we come back the the original question.
What does the bond market actually see?
Mark Beck
Because most people believe that it is foolish to lend money to someone (with no collateral) for a 30 year period at 4% interest. It has nothing to do with the trend, it is just common sense.
Greed trumps common sense in all universes. This will hold true in this bond market as well. It's really not about monetary security, is it? Not unless one is playing with one's own money. That's why my money is in my hands, not that of an "advisor" or "broker". I can hold all my assets in a physical form of some sort or another: house, car, chattels, fiat cash, gold, silver, business inventory. I have no need of a loan either, thank you very much.
Unfortunately, common sense is now about as common as common courtesy. When people get scared again (3...2...1...) they will flock to Treasuries for "Safety," just as they did in 2008. It's the only market large enough to absorb the huge amount of OPM under management, and if you're one of those managers you don't want to be the only one wandering away from the herd. Yes, at some point interest rates will rise and the herd will be seen to have been wrong yet again, but not until deflation has had its day.
This drop in the rate of returns for government paper to below the inflation rate is a Bernanke ploy to fuel the financials' stock market--the only sector for which he has concern. It means investors in government paper are actually losing value and are under pressure to leave that market segment for equities… destroying the savings of most Americans along the way.
“Falling interest rates have become a challenge to fund managers and pension schemes, forcing them to turn to equities to derive growth of capital gains,” said Fred Opondo, a fund manager at Standard Investment Bank, in April.
Or as the Asia Times put it: “The Fed does not accept the traditional role of a central bank - maintaining monetary stability with low inflation, and not managing the economy. It would be impossible to direct the Fed from its present policy of re-inflating the economy, and debasing the value of money and destroying savings in the process. The inflationary effects of this policy, its implied burden on taxation and its distortions will gain momentum over time, damaging economic growth and employment.”
"This drop in the rate of returns for government paper to below the inflation rate is a Bernanke ploy to fuel the financials' stock market--the only sector for which he has concern. "
There's another sector he cares for deeply. Government. Low rates of return on treasuries help maintain the fiction that Obama as not run up an utterly unsustainable deficit. As soon as treasuries return to long term mean, the US government is out of business because the interest on the debt overwhelms everything else.
Jesus, rippin' Treasury auction result. Santelli
going nuts!
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It all hinges on this guy's theory that money is actually being destroyed. Banks losing bets is not money being destroyed. That is banks losing money to someone else.
>>
No, pal. You have that wrong. A defaulted mortgage, the totals of which add or will add to trillions, is not money a bank lost to someone else. It's not in someone else's pocket. It is indeed destroyed money. It was created when the loan was granted to the borrower, and it was destroyed when defaulted.
That's why money printing hasn't caused the devastation expected. It's not added money. It's replacement money.
"cover the inflation basis"
It's cover the bases, not basis. Anybody who uses spots analogies incorrectly cannot be taken seriously.
mkkby is base and he's spot wrong with word usuage, an utterly baseless critique. Though it did get me thinking for a moment. This isn't baseball. Lay off the investopedia and give MW a read. Let's see what the hell bonds do in the next couple of months. I could be in big for a while . . . but that too will end badly, like everything in life eventually does.
Sorry, not buying it. At some point in our lifetime the UST will lose credibility as a flight to quality, and you will see a Greek Tragedy on a grand scale unfold. As for deflation, the only deflation I can see is perhaps in wages ... everything else you can buy, except perhaps for housing, is inflating. It is indeed the worst of all worlds.
Since the dollar is the bond, thus Treasury bonds are priced in themselves, I see no reason why interest rates going up or down should signify anything much.
I think a better metric is to watch spreads on COMEX gold, backwardation would imply that Treasury bonds are depreciating (against gold) faster than gold bonds. To better explain; government issued paper gold is depreciating faster than other paper gold.
Anyone else notice the recent collapse in spreads?