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Bonds, Lame Bonds
Welcome to the first bear market in bonds in a generation
(Source: Getty Images)
Bill Bonner, reckoning today from Poitou, France...
The most important story in finance was hardly mentioned in the popular press. But Bloomberg is on the case:
Global Bonds Tumble Into Their First Bear Market in a Generation
Under pressure from central bankers determined to quash inflation even at the cost of a recession, global bonds slumped into their first bear market in a generation.
The Bloomberg Global Aggregate Total Return Index of government and investment-grade corporate bonds has fallen more than 20% below its 2021 peak, the biggest drawdown since its 1990 inception…
Soaring inflation and the steep interest-rate hikes deployed by policy makers in response have brought to an end a four-decade bull market in bonds. That’s creating a particularly difficult environment for investors this year, with bonds and stocks sinking in tandem.
…Bloomberg’s bond gauge is down 16% in 2022, while MSCI Inc.’s index of global stocks has seen a larger decline.
Dear Readers are reminded that we play the long game, here at Bonner Private Research. We have no idea what stocks will do tomorrow… nor can our guesses about tomorrow’s inflation be relied upon.
Instead, we just try to ‘connect the dots’ in order to understand what is going on. We look for the Primary Trend… the deep tide beneath the waves… the one that will raise our boats for many years – or sink them.
Here is what we see:
The stock market topped out in December, 2021, with the Dow over 36,000.
The bond market topped out in the summer of 2020, with the yield on the 10-year Treasury well below 1%.
This is not just a pause in the Bull Market of the last 4 decades; it marks a new Primary Trend.
A 700 Year Drop
Bonds – and the interest rates they reveal – tell us which way the strong undercurrents are running. They measure (indirectly) how much capital is available and (directly) how much it costs. A place like Switzerland, with abundant savings and reliable borrowers, typically enjoys low interest rates. A West Baltimore, ‘payday loan’ joint or a poor country such as Haiti or Burkina Faso will have much higher rates, because there is less capital available… and borrowers might not pay it back. And generally, as the world grew richer, interest rates went down. Paul Schmelzing, at the Bank of England, showed them falling for the last 700 years.
But the Fed got up to mischief 20 years ago – dropping its key rate from above 6% to below 1%. Was the country suddenly richer? Were savings more abundant?
Of course not. The Fed was giving out a lie. What is important about interest rates is not that they are high or low, but that they are honest. And the Fed was manipulating credit prices in order to give the impression that we were richer than we really were. The idea was to boost stock prices, increase spending and stimulate the economy. Then in 2008, it repeated the scam, this time pushing rates down to ‘effectively zero.’ In real terms, adjusted for inflation, the Fed Funds rate stayed below zero for more than a decade – where it remains still.
No wonder speculators acted as though money had no value – bidding up prices of meme stocks and cryptos to preposterous levels. No wonder businesses borrowed to buy back their overpriced shares. And no wonder the US government spent trillions on unwinnable wars abroad and jackass boondoggles at home.
And no wonder, the country now has $90 trillion of debt – public and private… so much that the pain of reducing inflation will now be likely more than the elite can stand. In order to stop inflation, the Fed must raise interest rates. And every 1% increase – if applied to the whole debt load – would add $900 billion in extra expense annually.
Dow Below 20,000?
Alert readers will wonder: where does the money go? If debtors pay out an additional $900 billion, creditors must take in an additional $900 billion. The economy has lost not a single penny, right?
Not exactly. As interest rates rise, fewer people borrow and more existing credits are canceled or go bad. Our monetary system is based on credit; a decline in the amount of credit outstanding is the same as a contraction in the money supply…
…so, a decline in the bond market tells us that the tide of credit, on which the whole economy – real and fake – floats, is going out.
Already, the Dow boats are down 15%. The 10-year Treasury bond yield has more than quadrupled from its 2020 low. And mortgage rates have doubled.
But these are, so far, just mild corrections. If this is the Primary Trend we think it is, it may take us all the way down to where the last one began – in 1980. If so…
The Dow will keep dropping… down below 20,000.
Bonds will be crushed. Low coupon bonds will once again be regarded as “certificates of guaranteed confiscation” as they were in the ‘70s.
Mortgage rates will shoot up over 18%.
And America – economically and politically – will turn into a quivering jello of confusion and despair.
We remind readers too of a Bonner dictum: the force of a correction is equal and opposite to the claptrap that preceded it. By that alone, the developing Primary Trend should be one for the record books.
Joel’s Note: Speaking of record books, Charlie Bilello, Founder and CEO of Compound Capital Advisors and FinTwit man of numbers (h/t @charliebilello) did some crunching…
Using monthly return data, this is the longest (25 months) and largest (-12.3%) bond market 'drawdown' since 1980
Measured by Bloomberg's Aggregate Bond Index, US bonds are down 11.6% in the last two years, their worst two-year return in history
The correlation between stocks and bonds is .64, the highest since 1995-1997. They're moving in the same direction (up AND DOWN), which means bonds are not an effective portfolio diversifier. And they don't seem a lot less risky now either.
A 60/40 portfolio (stocks represented by the S&P 500 and bonds by the Aggregate index) is down 13.9% year-to-date. Going back to 1976, that's the worst year-to-date return of any year (and the only one in double digits)
The S&P 500 is down 17% year-to-date, the 5th worst start to a year in history (1974, 2002, 1966, and 1962). Stocks finished in the red for the year all four previous times. They finished even lower than August in 1974 (-29.7%) and 2002 (-23.4), while they rallied slightly in 1966 and 1962 but still closed down for the year (-13.1% and -11.8%)
What does all this mean, in practical terms, you ask?
“The main takeaway is that nearly everything was correlated in the 'upside' years,” observes BPR macro strategist, Dan Denning. “It seems correlated in the 'downside' years too. Conventional diversification strategies aren't working. And if real rates have to get past real inflation before the Fed is done swinging its wrecking ball, it's hard to see either stocks or bonds finishing the year in the green.”
Which is not to say we might not get a rally along the way. Even a very powerful one. The S&P 500 bounced almost exactly 20% of its June lows, the classical definition of a bear market rally. It’s since fizzled, down about 2.8% over the past month. In any case, according to Dan, those should be seen as “tactical trading events,” not indicative of any long term trend.
“It's better to understand them for what they are and not try and market time them,” he writes. “Preserve capital. Maximum safety mode.”
And that, of course, is the #1 priority for Dan and Tom. Survive the coming storm with purchasing power intact and emerge ready to scoop up high-quality bargains on the other side. Continues Dan…
“Tom and I are revising the Strategy Report this month. We've had zero allocation to bonds for almost two years now. I don't see that changing. The main issue will be our allocations to stocks, gold, and cash. You have rip roaring inflation, which argues against too much cash. But you have a record strong US dollar and the 'optionality' cash gives you. There is also the unfolding crash in house prices to consider, which I'll get into in my weekly update later today...”
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