From BTIG's Mike O'Rourke March 24 Note
They gave us the “Minsky Moment.” Its sequel was “Shaking Hands with the Government,” followed by “the New Normal.” As you may know, these are Pimco’s pithy phrases used to describe the investing world as they view it. The first two were notably accurate narratives of what was occurring and how investors should respond. The jury remains out on “The New Normal” since it is a longer term prognostication. Why are we focusing on the etymology employed at Pimco? Unbeknownst to us, in his March commentary, Bill Gross unveiled the latest catch phrase, “Unicredit Bond Market.” Gross explained that “If core sovereigns such as the U.S., Germany, U.K., and Japan ’absorb’ more and more credit risk, then the credit spreads and yields of these sovereigns should look more and more like the markets that they guarantee.” Anyone who has been paying attention in any financial market the past two days will recognize that this trend, which has been developing around the globe over the past several months, has come home to roost in the United States as the 10 year swap spread has inverted.
You obviously don’t need us to tell you to read Bill Gross’ essays, but they do play a role in today’s trading action. Today, Gross followed up on the “Unicredit” theme. Following the 8 am EDT release of Gross’ commentary, the yield on 10 year Treasuries jumped 10 basis points as bonds sold off over the next hour. The selling continued throughout the day as a better than expected Durable Goods Report and a weak 5 year auction in the afternoon fueled the weakness. By the session’s close, the 10 year yield was on the cusp of a major technical breakout. It is hard to expect the largest bond fund manager in the world to say he is outright bearish on Treasuries, but Gross went on television this afternoon and stated he expected stocks to outperform bonds over the next three months. This was an attention getter because part of Pimco’s “New Normal” view of the world was that stocks were on a “Sugar High” in 2009.
In his note this morning, Gross listed the three criteria necessary for a nation to navigate the “structural headwinds” facing global markets today. When speaking specifically about the United States, he stated “But remember – my three conditions just suggest that a country can get out of a debt crisis by creating more debt – they don’t assert that the bonds will be a good investment.” He followed with “U.S. bonds may simply be a ‘less poor’ choice of alternatives.” From an outsider’s perspective, that might be interpreted as bearish a statement on Treasuries as one can expect from the largest bond investor in the world. We also believe that Gross does not love stocks so much, but just that he is bearish on bonds. Gross did spell it out, “Rates face a future bear market as central banks eventually normalize QE policies and 0% yields if global
reflation is successful.”
There is heightened investor uncertainty about the inversion of the 10 year swap spread. Unchartered territory puts investors on edge. In the near term, it has been attributed to hedgers using treasuries for all of the corporate issuances coming to market. We have also noted the strong demand for corporate paper has helped to push those yields down. Longer term, Pimco’s “Unicredit Bond Market” will likely be with us for some time. The good thing is this is not a total surprise, at least it wasn’t to Gross. We interpret these events as one of an increased belief in the recovery. For over a year, we have argued that Large Cap Corporate America was the healthiest and most liquid area of the economy, superior to the Government or Consumers. As belief in the recovery increases, the flight to quality bid in Treasuries slowly diminishes and Pimco’s “Unicredit” world emerges. Investors have every reason to have more confidence in a Warren Buffett or a Steve Ballmer. All of this being said, in order for the bond bear market to emerge and the rise in rates to be sustainable, the economic data needs to be there, or that flight to quality bid will re?emerge.
Mike O’Rourke, CMT
Chief Market Strategist