This thing is way too long…Sorry…But, at any rate, I think it’s a good read if you can make it all the way through…
February 8, 2016
I hate to even make the following statement but one thing I always do here
is tell you exactly what I see, feel and believe regarding the markets…
I THINK SHORT BONDS, IMMEDIATELY, IS THE BEST TREASURY BOND TRADE I HAVE EVER SEEN.
I think Bonds...of all types…are currently the worst investment on the planet.
And this is the market that I have traded more often than any other during the past 35 years…This is the only market that you will ever hear me say, without any hesitation whatsoever, “I DO understand why it moves…and how it moves”, FAR…FAR…better than most people in this business…And this is the market that I have made numerous correct predictions, inevitably going TOTALLY against prevailing opinion, going all the way back to 1984 with the first option recommendation I ever made as a broker.
OK, I don’t throw that out there to say, “Look at me. I’m a genius in Bonds”, because, in spite of MANY times having looked like an interest rate genius during those three decades of bond market prognostications, I have also experienced some enormous disasters in precisely this same arena…BUT…as many of you long time friends know, I am extremely comfortable in pointing out that what I have to say regarding the Treasury market is generally always worth listening to…and I AM far more right here than I am wrong (This is not a boast. I still have every newsletter I have ever written and can verify it.)…and inevitably, what I do think seemingly always runs dead opposite all the common analysts’ “wisdom” and “logic”, as, THE BOND MARKET IS THE CONTRARY OPINION MARKET (overwhelmingly dominated by conservative, banker mentality sheep who only get on a trade when they are sure everybody else is thinking the same way…which can be financially fatal in this game), and not surprisingly, this is exactly the case right now…
What is the prevailing WRONG WAY “wisdom” that’s out there right now?
You have recently heard it EVERYWHERE…”Oh, the Fed isn’t going to tighten now. Stocks are going down. The economy is weak. Oil is falling. China is slowing down. There’s no way they are going to raise rates right now.”
AND THAT GROUPTHINK “LOGIC” IS SO, SO WRONG IN SO MANY WAYS…For one, the trillions of dollars in fixed income (bonds, notes, mortgages etc.) that are traded globally EVERY day are NOT controlled by the Fed. The Fed can change the price of overnight money (that’s literally 1 day money borrowed between banks and the Fed) but where long term rates go is TOTALLY determined by the marketplace…by those TRILLIONS of daily dollars of buyers and sellers…and, in fact, HISTORY WILL SHOW YOU THAT THE BOND MARKET USUALLY MOVES LONG BEFORE THE FED DOES...by which I mean, Bonds will fall, and long term interest rates will rise…LONG before you get that headline from a Fed meeting, “The Fed raised rates today.” I could easily expand on this but won’t. Just be assured that’s the way it is…and call me if you want to hear more.
Stocks are going down? What I’d say is, “They WENT down” until mid January, and in those 2 ½ statistically insignificant weeks, SCARED everybody into believing that the US and World economies were going in the tank…and inspired this notion of “The Fed won’t raise rates”, when the truth is, as IMPORTANT as all the yakheads would have you believe it , the move down in Stocks, as big as it may FEEL, appears to be nothing more than normal volatility…just more NOISE that allows all the nitwits to spout more of the negative economic drivel that has been persistently present for virtually the entirety of the bull move we’ve been in since March, 2009.
Here are a few charts for perspective…that do demonstrate, I believe, that all we’ve seen since January 1st is just normal trading…Unmistakably, there IS a lot of mob psychology, media generated FEAR out there, but we all know that the worst thing you can do as an investor is succumb to that fear…which again, IS generated more by raging headlines and bleating TV/Internet commentators than anything else…
I think the current ONGOING recovery is full blown FOR REAL...meaning that the next stage on that 100 year Dow chart is going to be on the upside…And while it is certainly possible that everything I see in the real world can just stop any day now, and even though this next section is 100% anecdotal, here are some purely unscientific observations that fully substantiate, for me, that THE ECONOMY IS BOTH STRONG…AND MOST LIKELY, ACCELERATING:
I have NEVER seen shopping center parking lots as full as they are, to the extent that at two separate locations this weekend, I had to SEARCH for a single space to park in centers that I’ve seen only 30% filled for as far back as I can remember…I mean, I was asking myself, what are all these people buying? And I have NEVER had to park this far away just to pick up Friday night groceries…and this was NOT due to Super Bowl party preparations…Inside the supermarket was normal…All those people were shopping, eating, drinking etc…SPENDING money that formerly was going towards gasoline and energy bills.
In the same vein, the roads are FULL, all day, of cars, trucks AND Semis loaded with goods…leading me to two conclusions…One, that people ARE out…and they are obviously spending money…and two, that the numbers for gasoline and diesel demand, at some point in the very near future, are going to surprise everybody on the upside and blow all the bearish energy analysts out of their chairs…which, as I will address later, is NOT bearish for Crude Oil AND is NOT bullish for Treasury Bonds.
In spite of the fact that airfares are NOT cheap, the planes and airports are just as jammed as the roads and shopping centers.
Believe me, I am not living in some localized boom area but there are NUMEROUS major construction sites opening up in any direction I want to go…where huge tracks of land are suddenly turning into bulldozed red clay layouts for all sorts of projects…And they are appearing en masse after YEARS of seeing NOTHING happening...
Like I said, those observations are definitely unscientific but I absolutely believe the conclusions I am drawing are accurate. The roads ARE jammed. People ARE spending. Construction is ramping up.
Even so, the pundits keep moaning that “the right jobs not being created”, or “growth is too slow”, but the fact is, Unemployment IS 4.9%, which is definitely approaching the economic definition of what constitutes full employment…and I would add, is VASTLY, VASTLY improved from the 10% rate we were enduring just 7 years ago (THAT’S when times were “bad”, NOT now).
And get this…New Houses Sold, New Houses Started , and Total Construction Spending (residential AND commercial) ALL just hit new 8 year highs…Put that together with the fact that Vehicle Sales just hit new 10 year highs and you are talking about TWO MAJOR INDUSTRIES that ARE beginning to really get it going.
And beyond those important sectors, do NOT forget that TWO OTHER MAJOR industries, Technology and Healthcare are ONLY expanding at faster and faster paces…Really, they never seem to slow down…
For sure, the Oil Industry is in the hole, but if you really think it’s going to stay that way, you would have to be ignoring the fact that production HAS been curtailed, while world crude oil demand is making new highs as we speak…And ditto that in the only other major industry I can think of, Agriculture…where, I firmly believe prices already HAVE gone down, and like oil, are NOW ready to start going back up again…And you can be sure that whether its Saudi Arabia, Russia, Iran, Venezuela, Nigeria, Texas, Exxon, BP, or anybody else in the oil business, they are ALL talking behind the scenes and they ALL are interested in getting prices back up…It’s crunch time and they ALL care more about the bucks than their political or religious ideologies… They’ve done it off and on for 35 years…and with world demand hitting record levels…I’m pretty sure they can do it again…And DON'T think any of us are going to get the relevant “announcement” before hand…They will know it’s coming…but we won’t…SO STAY LONG CRUDE.
The point is, if you want to listen to the ALWAYS BACKWARDS “analysts”, go right ahead…Believe that the recovery is “weak”. Believe that China is on shaky legs. Believe that Europe’s “problems” are insurmountable. BELIEVE that Oil (and commodity prices) are going remain low because the world economy is in trouble. And BELIEVE THAT THE LOWEST INTEREST RATES IN AT LEAST 75 YEARS ARE GOING TO REMAIN AT THESE LEVELS (?????)…Again, if you want to buy into all the talking head angst, go ahead…but for my money, I am going the other way.
How I see Treasuries…right here, right now
Among other factors, every time you see some new construction project being started or approved (seems like every big city in America is building new stadiums and skyscrapers btw) it is an indication that The DEMAND for borrowed money is rising…Right now…And this IS an environment when lenders CAN (and WILL) start asking for higher rates from borrowers.
With rates so low, during the past 6-9 months, Corporations have been issuing MOUNTAIN RANGE sized quantities of Bonds and Debt Instruments, to the extent that I would basically say the Fixed Income market is now absolutely loaded with SUPPLY that has been bought by investors at EXORBITANTLY high prices…that those investors have been “persuaded” to buy due to all the ongoing negativity with respect to the economy, that “rates will be staying low”, and that high priced bonds will STAY high priced…Unfortunately, however, I believe that within the next six months (just for starters), ALL of those buyers will already be staring at large percentage PRINCIPAL LOSSES…while earning, after taxes and inflation, virtually NOTHING on their money…and we will see those hoards of expensive bond owners then evolve into a MASSIVE avalanche of sellers.
And most important of all…
THE BOND MARKET HATES INFLATION…
BOND PRICES ARE NEGATIVELY IMPACTED MORE BY INFLATION THAN ANY OTHER SINGLE FACTOR…AND I FIRMLY BELIEVE INFLATION IS COMING…AND IT IS COMING ON TWO MAJOR FRONTS…
World demand for commodities IS setting new records, while at the same time, in many cases, production for all those same commodities is being cut...And this IS the formula for rising prices. IF you really believe all the absurd notions that the WHOLE PLANET EARTH is in the throes of some WORLDWIDE SLOWDOWN, go right ahead and assume that Gold, Oil, Lumber, Copper, Diamonds, Soybeans, Wheat, Corn, Land, Buildings…YOUR HOUSE...and kitchen sink, etc. are going to be declining in value…and that if this is the case, then Bond prices will be staying up and interest rates will be staying low….But if none of that is the case (falling prices), one thing I can assure you is that the values of all those asset classes are NOT just going to sit here in one place…They are either going up or down…And for my money, THE COMBINATION OF RECORD DEMAND, AND PRODUCTION DECLINES….AND A VIBRANT ECONOMY…CAN ONLY MEAN WE ARE GOING TO BE SEEING HIGHER COMMODITY PRICES…ACROSS THE BOARD…AND WITH THEM, SOME VERY UNFRIENDLY-TO-BONDS INFLATION NUMBERS. Really. Do you REALLY believe that the US economy is in BAD shape? And do you REALLY believe the entire rest of the developed world is crumbling? That it’s NO HOPE everywhere? And if you do believe all the talking head crap, isn’t that a little bit like saying, “I want to bet against the whole human race?” I say, “NO WAY.”
The other inflation front is wages…And just putting it quickly, and simply…I firmly believe a 4.9% UNEMPLOYMENT RATE MAKES SOME DEGREE OF WAGE INFLATION almost a certainty…When employers have to compete for employees, irrespective of the debates on minimum wage increases, wages DO go up.
And never forget Healthcare…where NOTHING ever seems to slow price increases in that industry.
Here is why Bonds HATE inflation…
Today’s interest rate (yield) on the 30 Year Treasury Bond is 2.56%. This means that anyone who buys that bond is going to be paid 2.56% every year in interest (which is taxable income so it’s not even 2.56%) for the next 30 years…and so long as there is no inflation, that buyer WILL therefore earn that 2.56% for each year that they own the bond….HOWEVER, if there is ANY inflation at all, this will mean that the annual rate of return (2.56%) is going to be reduced tit for tat by whatever percent the inflation rate might be…In other words, in any year in which the inflation rate is 2.56%, there will be a ZERO return on this investment (again, this is not even considering how much of the interest is lost to taxes)…AND…if the inflation rates exceeds 2.56% the bond will absolutely be losing money…Additionally (it gets WORSE), if inflation does flare up (even slightly), NEW bond buyers will be look at 2.5% and think, “Why should I buy this? Inflation is 1.5%, so what do I want with something that only pays 2.5%?”, WHICH MEANS…NEW BOND BUYERS ARE GOING TO WANT A HIGHER INTEREST RATE…WHICH THEN MEANS LOWER BOND PRICES. In other words, that bond you bought yielding 2.56% is now worth less…and it can be a LOT less…than what you paid for it…More specifically stated: You may be “earning” 2.56% but your initial investment may easily now be worth 10% to 20% less than you paid for it.
If that didn’t make sense to you, here it is another way…If we get even 2-3% inflation, it will most likely KILL the Bond Market. Nobody will want to buy a piece of paper that is losing money from the moment you buy it…
Check this out…I’ve added a title that I think is accurate…DO NOT SKIM OVER THIS ONE…This IS what bond prices are really about…
THE DEATH KNELL FOR
And here is what rates look like over the long term…
The bottom line is this. If we are going to see some inflation, even just moderately so, I see nowhere for bonds to go but SHARPLY LOWER…and believe me, the way it DOESN’T work is that Bonds will just sit here at these INCREDIBLY HIGH RECORD PRICES while inflation sneaks up, month by month, on the world. Be assured that there is some smart money that IS selling NOW…far ahead of the masses…but for those masses, by the time the actual inflation numbers start appearing, their bonds will most likely have already taken a big hit…and then they will get hit even worse as the pundits all begin to “change their forecasts”…I mean really, that’s the way it works isn’t it? Whether it’s stocks, bonds, or some special fund that the brokerages are touting with the idea that “everybody should some have in their portfolio”? For one easy example, remember GOLD in 2011-12 when GLD was the most widely held…and RECOMMENDED…ETF on the planet? Look what happened there…What sort of “return” has that yielded for the past 4-5 years?...And I say that today’s Bond market is just the next example of ANOTHER (similar to gold) investment accident about to happen.
I am not an investment adviser, but I started telling my family to buy Treasuries over 25 years ago…and hold them “forever”. But the fact is, my recommendation to them has recently become, “SELL THEM ALL”, as I now do believe that bonds are the most overvalued paper instrument on the planet…The interest they pay has become truly negligible and the ONLY way you can expect a small principal gain is if long term rates go even lower…AND stay there…which I consider basically IMPOSSIBLE…and personally, I therefore think that is a lousy, lousy bet, especially when you consider that, in my opinion, ANY bond you buy here could easily have lost 20-25% of its principal before we get to 2017. Maybe I’m dead wrong but I think there is an absolute debacle ahead in this market…
And I am therefore shorting this market in any way I can…and I am NOT sitting here thinking, “Maybe I can do it higher”. This market typically turns from one day to the next, and as I have previously written, if you aren’t there when it does turn, it can be awfully hard to get on after it has dropped 4-5 or 6 points in a matter of days.
Just for a refresher, here is another look at EVERY bond top we have had since 1981…DO note how quickly they get started on the downside…and BELIEVE ME, THERE WAS NO “REASON” BEING GIVEN TO SUGGEST BONDS WERE ABOUT TO GET CRACKED…In every case, it was very much the same as now…with all the so “smart” talking heads yapping something akin to, “The Fed doesn’t need to tighten”.
On all these charts – 1 point move = $1000 per futures contract
So, there are lots of ways they do end…but most of them reverse dead off the high tick, starting from one day to the next, VERY quickly…And PLEASE, do not sit there and think you are going to figure out if the high is here, or a little higher, or whatever…THAT is a crapshoot…What isn’t a wild guess, I believe, is to simply get your positions on here…and knowing that if it does manage to go higher, it WON’T be doing it for long…AGAIN...BONDS TURN QUICKLY, AND MORE OFTEN THAN NOT, THEY DO IT ON A DIME…WHEN NOBODY IS EXPECTING IT.
Here is the long term chart of Treasury Bond Futures…
And here’s one way to go…There are many really, but I’m out of energy and too tired to outline more…
To me, it’s just a matter of getting short, managing your risk…and STAYING SHORT...I may be dead wrong, which can mean losing everything you invest, but I do think this IS the best bond trade EVER…and I do think this has truly monster potential. In my opinion, TRADES LIKE THIS DON’T COME ALONG VERY OFTEN…AT ALL.
But you do have to be there to have it happen…
Give me a ring and get the numbers…
All option prices in this newsletter include all fees and commissions.
The author of this piece currently trades for his own account and has financial interest in the following derivative products mentioned within: Treasury Bonds