From Bond Apathy To Bond Panic

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August 28, 2013 12:44pm NYSE:SHY NYSE:TBF

market bondsYves Lamoureux: We have been glad this year to be on the side of the bull camp. Our job has been an easy one as we pursued the long side of stocks. We remain bullish despite raising big amounts of cash many weeks ago. We think we can redeploy

money shortly once we feel the corrective phase is over.

It has been a much different story on the income side. One that shows only the start of something much bigger. We did forecast long bonds to drop to a yield of 2.5%.

For us that was the marker both in time and price that satisfied our interpretation of the end of the bond bull market.

It is our opinion that we are just in the first leg up in rates. Once completed we favor a correction that can last for a little less than a year. The second wave, we feel, will be as large as this recent move. This is why late last year we urged to look at a new asset allocation system based on credits only. We felt that rates would be at 3.5% mid year 2013 and a target of 4% year end 2013.

Our new forecast for 2014 on the long end now moves to 4.5%

We have had this scenario in mind for many years as past episodes rhyme in time. Our work is both based on comparative money velocities and behavioral economics. We tend to think that fear and greed are always the same. They tend to repeat more frequently than market theory allows us to believe.

Bond Apathy 

In recent presentations, we are amazed to observe the level of apathy toward the recent action of the bond market. It does match up behaviorally speaking with shock and the lack of preparation.

Investors have convinced themselves that rates are staying low for a prolonged amount of time. Of course this conviction will not be proved wrong rapidly. Over time, as we have suggested, money will leave the bond market to head to the safety of a term deposit at a bank.

Having been proved wrong twice about stocks makes the return back for most impossible.

The great difficulty in this environment will be the lack of perceived safe alternative. It is also why midterm we are very bullish on gold even if we have avoided it all year long.

We think there are many pitfalls ahead that people will not avoid. We prefer to stick to being long indices as opposed to stock picking.

Rising rates will reveal the extent of debt levels. It first will be marked by companies cutting dividends. Bankruptcies will follow. It will be harder and harder to perform with the benchmarks.

Being long an index also has a positive survival bias. Bad stocks are replaced with good ones. The odds are in your favor with patience.

It is not the same say in the case of a bond fund. As rising rates will pressure your investments lower and lower. Doing nothing is sure to undermine your strategy and goals.

Dividend stocks are as much in a bubble as bonds are. We think its best to avoid income all together.

This will be a time of reflection. Some investors are not meant to be in the market. We expect a mass exodus of money that will be moving back to bank accounts.

Of course it is not what most in the financial business would like to hear. Markets are markets and they tend to behave in a certain predictable way.

The key to some of our future forecasts come from the inversion of the behavior in the treasury market.

We have been great believers in using treasuries as stock hedges in a portfolio.

We think this era is over as we have predicted well over a year ago. We are of the opinion that treasuries will revert to a positive correlation with stocks.

They will go up and down in price with stocks.

This is far from expected behavior of the last decade when treasuries rose in price when stocks fell.

Asset allocators welcome to your new playing field.

Emerging market implosion

We read with astonishment that deflation is over. The sudden drop in both emerging market currencies and stocks is testament to further aerial bombs we suggested would happen recently.

We are in complete disagreement over this topic as deflation shocks being short and fast creates lasting disinflation

The wipe outs are dramatic in many cases. Caught by surprise many have been.

Where people now see a bust credit cycle we see opportunity. The flow of hot money had created huge imbalances and a perception of superior fundamentals. The king is now naked.

We are taking a hard look at re-balancing our cash into some of those interesting emerging markets.

It reminds us of European markets that nobody   got interested in because of fear. Recent positives on Europe had us unload these plays at much higher prices than a few months ago.

Interesting times indeed!

This article is brought to you courtesy of Yves Lamoureux from Lamoureux & Co.

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