John Paulson Lecture: "Bonds Are Wrong, Stocks Are Right"

Tyler Durden's picture

John Paulson is now 'all in' that for the first time in history bonds are wrong and stocks are right... We'll take the other side of that bet. Of course, this also means that David Tepper is across the table as well. Oh well, we do like to live dangerously. Full notes from Paulson's lecture at the University Club, to a standing audience. Then again, if anyone suspected that JP was actually on the same side of the bet as us, it wouldn't really work now, would it...

Here is today's permabullish elixir from the man who has a $30 billion reflation bet on.

1.    What Happened – We all know what happened in 2006, 2007, and 2008. By end of 2008 they had completely covered their mortgage CDS and had started to buy high-yield Corporates into 2009.  They averaged in at under 55c on the dollar for most of those bonds and sold most over par. There is not much opportunity in high-yield at this point.

2.    Equities – They are now think one of the best places to be is equities, with a strong focus on distressed equities.  Paulson’s case for equities in general focused on the discrepancy between equity earnings yields of about 7% to 8% now compared to the 10-year yield at 3.6%.  This is one of the highest dislocations since they started tracking these numbers.  As such, some equities he owns offer superior returns to long-dated bonds: JNJ: 3.8% yield, 7% earnings growth; KO: 3% yield, 8% growth, PFE: 4% yield, 3% growth.  On distressed equities, they look at bankruptcies and major restructurings.  The most well known examples are his holdings in financials like C and BAC.  They also own STI and RF.  They follow every bankruptcy and will buy the debt in interested.  As the companies come out of bankruptcy, they’ll convert the debt to common stock.  He gave the example of K-Mart, which went into bankruptcy with billions in debt, emerged at $10 a share and debt-free, then eventually went to $190.  Paulson thinks he’ll find more of these over the next few years.

3.    Bonds – The purchase of long-dated bonds, either treasuries or Corporates, should turn out to be a horrible trade.  Rates are at record lows and the economy is turning should continue to churn higher.  Paulson expects roughly 2% GDP growth for both 2011 and 2012.  Quantitative easing should contribute to significant inflation over the next few years, with inflation possibly hitting low-double digits by 2012.  This is bad for the 10-  and 30-year and bad for the USD.  The USD should fall and the yields on long-dated US Treasuries should rise.  Paulson has been buying 5 and 7 year calls on the 30-year bond yield.

4.    Homes – This is the best time 50 years to buy a home.  This thesis is the exact opposite of his thoughts on bonds.  You don’t want to own long-dated debt, you want to issue it.  Buying a home (an asset) with a 30-year mortgage (issuing debt) is exactly that.  Home prices will rise with a better economy and with inflation.  Your debt and interest payments get locked in at record lows.  The price of your home will rise.

5.    Gold – The price of gold has moved in correlation to the monetary base for as long as they have tracked the two data items.  As the Fed prints more money, gold should rise.  If the Fed were to increase the monetary base by 100% over the next 3 years, Gold should increase by that same amount. Additionally, as inflation accelerates, investors tend to push gold higher than its correlation, like in 1980 when it increased an additional 100% above the correlation.  So if gold is at $1,200 now, it should hit $2,400 on the monetary expansion alone, then $4,000 as investors flee inflation. Additionally, he has offered his investors the ability to hold their investment in his fund in either US Dollars denominated or in gold denominated.  Paulson himself has 80% of his assets gold denominated.

Let the debate begin

h/t Mike

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ZeroPower's picture

When have bonds ever been wrong? The big boys control F.I.

Dr. Engali's picture

With the markets as distorted as they are now it's hard to tell who is right. I just know it will all blow up in the end.

Tarheel's picture

I was wondering why the market ramped up at 1pm on a non-POMO day

MarketTruth's picture

Bernanke came right out and said he will not let the market down whatever the costs. Yes, he directly said that in public, so you KNOW the Fed will support the market ramp. So yes, stocks and not bonds.

Better still, due to massive dollar printing to keep the market up, get physical gold/silver due to dollar devaluation.

1984's picture

What's this OR shit?  It's AND.  Both.  Everything goes up, until SHTF.


tmftdoyle's picture

In a market where the technicals are manipulated by the PPT, today's ramp is simple; on friday, despite the huge move, transports "failed to confirm" dow move. PPT will not let that failure continue. So ramp market to get dow theory confirmation. Pathetically obvious.

tmftdoyle's picture

In a market where the technicals are manipulated by the PPT, today's ramp is simple; on friday, despite the huge move, transports "failed to confirm" dow move. PPT will not let that failure continue. So ramp market to get dow theory confirmation. Pathetically obvious.

Young's picture

Agreed. His thesis is BS, sure bonds will get hammered in the inflation case, but hey J.P. if it wasn't for extreme availability of cheap money the past two decades, stocks wouldn't have gone anywhere (no credit fueled consumption - nothing!). Now he's ramping stocks in an inflationary environment... Zzz

Equities are dead, who even cares about them anymore. When QE2 is finally announced there will be very little upside left. 'Til then feel free to ride the AAPL and BIDU hockeysticks...

Hephasteus's picture

Do you guys hear yourself. POMO buy stocks POMO buy stocks. The bond market is the stock market and the stock market is the bond market. Microsoft sells 4 billion in bonds to pay stock dividends to avoid repatriating cash that it would have to pay taxes on.

So my dear friends. The stock market crashes the bond market crashes, the bond market crashes the stock market crashes. Now let's move on to the lightening round. Where there is death without ressurection.'s picture

that was a pretty powerful video, gave me goosebumps. never seen it before but knew the song. WOW.

Conrad Murray's picture

You should definitely take the time to watch that movie.  The Wall is a classic.'s picture

ok, thanks a lot. i guess i get christmas every day now.

What_Me_Worry's picture

Well, at least he batted 1-for-5.  Almost good enough for the majors.

Edit: Take that back, he invests in GLD for a bulk of his gold holdings(I believe).

Divided States of America's picture

The Hinderberg Omen headline was used to get the shorts on board while cronies like Tepper and Paulson were buying like a shopping spree. Now these guys are saying stocks are the way to go because they are up to their chins with them and wants to take them off the table. THey need to round up the suckers to pile in and what better way than to show your face on the farce known as CNBC. If these guys are telling you to buy, I am sure they are doing the opposite, or else how could they always end up making money and staying in this rigged game.

Zeilschip's picture

Exactly what I'm thinking.. Even when Tepper on CNBC basically said that it was a no-brainer in early 2009 to buy financial stocks/bonds, in fact I can vividly remember that most people at the time were thinking armageddon. Now with the POMO's and anticipated QE2, it does feel like you can simply front-run the Fed and make an easy buck. Which makes me think, gotta sell this market. There is no such thing as a free lunch. Period.

deliciousirony's picture

well, yeah, if inflation is expected to be in the low double digits (!) then bonds are wrong.

But, I think Ber-spank-me is aiming for more like 3 or 4% inflation.


Clark_Griswold Hedge Mnger's picture

"Paulson himself has 80% of his assets gold denominated."


what does that tell you.

Steaming_Wookie_Doo's picture

He spent 80% of the article talking about 20% of his assets.

I'll go for the gold part. Given a very inflationary environment, I'd also suggest silver, liquor, tampons and weaponry.

Clark_Griswold Hedge Mnger's picture

"...liquor, tampons and weaponry..."

Is there an ETF for that????????

I bet the perspectus is an interesting read

DosZap's picture

There is,soak the Tampoons in liquor,tie onto and pull thru the fouled bore........most excellent idea Ted!.

homersimpson's picture

I believe part of the perspectus states: "The variance in equity risk can be dramatically compounded during specific (and unstated) time periods in a given month. Also investor returns or losses can potentially be highly leveraged and volatile."

The ETF tickers for the fund you seek are WMYN, WSKY, and GUNZ.

Blano's picture

At least during the given month time periods the ETF's won't rip you a new asshole when you say "how was your day?"

slvrizgold's picture

Do I have the right to take delivery of my GUNZ or WSKY?   Would I want to?  Different kinds of whiskey and guns are not what I call fungible.

HedgeFun's picture

I don't understand how all these hedge fund managers are super long gold due to coming (double digit?) inflation and super long equities.  High inflation = higher input costs, lower relative disposable income and ultimately a compression of corporate earnings.  Why does noone talk about this?

hack3434's picture

Because he's probably betting that "investors" will pile into equities since the mantra is that stocks outperform inflation. All the 7% blah...blah...sounds like bs from a salesman. 

MrTrader's picture

Earnings yield 7 / 8 % ? Buahahahahahahahahahaha. You must be kidding me, John ! Guys, do yourself a favor and get out of the stock market. There is only one interpretation possible for this humbug : Paulson is trying to liquidate his portfolio. STRONG SELL.

The Real Fake Economy's picture

exactly my thoughts.  I read somewhere recently (probably DB) that his funds were down for the year.  He's probably making an end of year effort to get his performance up, because if he doesn't after incredible returns in '08 and '09, investors may question who was pulling the strings at Paulson (considering Pelligrini left last year to set up his own shop only to realize correlations amongst asset classes were too much in line to really make money for his investors)  So this is Paulson's shot at telling investors, "I was responsible for '08 and '09, not mr. psqr."  Of course if he finishes down next year, do we begin to see redemptions?  old clients may stick around, newer clients may bail.   Either way, if you have a guy like Paulson trying to exit equities and insiders selling shares at ridiculous rates vs buying, that should be all the lack of confidence in the market you need.  (and btw L ellison probably thought, i get $1 a year in salary and there's just no way my shares are going any higher bc this is just too rough of a business environment, so let me cash out right now before it's too late)

Millivanilli's picture

The whole notion of some rich asshole giving a lecture on how to be a fat cat like me is patently stupid.   Guys like Soros, Buffet, and Paulson are so full of shit it makes my colon envious.    Buy gold, silver.   Take delivery.  These fuckers are at the end of their ropes.


From the Financial Times: Brazil warns of ‘currency war’

Guido Mantega, Brazil’s finance minister, said on Monday the world was in an “international currency war” ... Mr Mantega, who has made increasingly aggressive comments recently about the need to control Brazil’s currency, said governments around the world were trying to weaken their currencies to promote competitiveness.

"We’re in the midst of an international currency war, a general weakening of currency. This threatens us because it takes away our competitiveness,” he said ...
excerpt with permission

It seems everyone wants to devalue to export more.

bronzie's picture

"so full of shit it makes my colon envious"


hedgeless_horseman's picture

bonds are wrong and stocks are right

What was the question?  If it is, "Which is broke, the equity markets or the USA?"  Then the answer is, "Yes," and both bonds and stocks are wrong.

TheMonetaryRed's picture

"The price of gold has moved in correlation to the monetary base for as long as they have tracked the two data items."

Proof for this? Chart?


TheMonetaryRed's picture

Um, I don't see anything that seems like correlation between the monetary base and the price of gold on that site.

Is there some evidence of a correlation some place else?

TheMonetaryRed's picture

Sorry, that has nothing to do with it.

I'm just looking for a chart of the gold price against a measure of the monetary base that shows correlation. I'm not trying to make an argument get into an argument. I'm looking for data. 

Dr. Richard Head's picture

I understand, no argument sought.  i am trying to find anything remotely close to such a chart.  Would be worthy along with the fridge art collection from my kiddos. 

snowball777's picture

Total credit bubble size from 1915 to now (note the flattish area from 1970 to now):

Inflation-adjusted gold price (note the sharp peak during high inflation in the late 70s):

I think you can make much better arguments for the gold price tracking inflation (since that's when people buy it as a hedge against same) than any correlation to M1-M3 per se.


RobD's picture

Um, I thought that if interest rates rise, home prices would really tank. What am I missing?

bulldung's picture

If you are in the market for a home there is no time pressure as long as rates remain low.As soon as rates begin to rise the buyer becomes motivated to "lock in" before borrowing costs go up. This is the only way I can see rising sales and is dependent on how many are in the market and the rate of increase.It will certainly have a diminishing effect,and then prices tank.

99er's picture

Chart: DX

Stocks or bonds? Let the USD decide.

truont's picture

"for the first time in history bonds are wrong and stocks are right... We'll take the other side of that bet."

Tyler, we aren't comparing apples to apples here.

Historically, bond and equity pricing were not nearly as manipulated by PPT-HFT-POMO-Shitsorm as it is today.

So, all the market's signals are wrong--we are flying blind since both bonds and equities are artificial constructs of our politburo.

In other words, "ya pays your money, and ya takes your chances."  "Step right on up, folks!  Take your chances on the market from hell!

Sudden Debt's picture

Right or wrong, the DOW is green and if it holds this week at this rate, we are heading into shortsqueezes all around the board.

Sudden Debt's picture

I'll repeat what I said: Right or Wrong, if green for this week, major shortsqueezes around the board


RobotTrader's picture

I guess there remains an acute shortage of shopping malls, office buildlings, retail centers, etc.

Yet another new high for Jones Lang LaSalle.

goldmiddelfinger's picture

Not in Florida there isn't. Half of em are closed weed factories, You know what an eyesore is?

Hephasteus's picture

Weeds are good for florida. The weeds that grow there process silica. They are slowly converting sandy soil. I think flordians will learn that sea grapes are edible just not very tasty.