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posted on 18 April 2017

Bond Bull Is Back

Written by , Clarity Financial

I have been unabashedly bullish bonds since 2013, when calls from Gundlach, Gross, and others have declared the early death of the bond bull.


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The reason is simple, and something I have discussed many times in the past, interest rates are NOT going to rise much given the long-term downtrend in economic growth, inflation and wages and rising debt. As I addressed in "The Long View":

"Today, the U.S. is no longer the manufacturing epicenter of the world. Labor and capital flows to the lowest cost providers so that inflation is effectively exported from the U.S. and deflation can be imported. Technology and productivity gains ultimately suppress labor and wage growth rates over time. The chart below shows this dynamic change which began in 1980. A surge in consumer debt was the offset between lower rates of economic growth and incomes in order to maintain the 'American lifestyle.'"

The problem with most of the forecasts for the end of the bond bubble is the assumption that we are only talking about the isolated case of a shifting of asset classes between stocks and bonds.

However, the issue of rising borrowing costs spreads through the entire financial ecosystem like a virus. The rise and fall of stock prices have very little to do with the average American and their participation in the domestic economy. Interest rates, however, are an entirely different matter.

"While there is not much downside left for interest rates to fall in the current environment, there is also not a tremendous amount of room for increases. Since interest rates affect 'payments,' increases in rates quickly have negative impacts on consumption, housing, and investment."

It is not surprising that even given the small bump in rates since the election that mortgage-related transactions, auto and retail sales, and economic growth have all slipped. The consumer is directly tied to the level and direction of rates from both a fiscal and psychological perspective.

  1. People buy payments - not houses, cars or phones. Therefore, rising rates put payments out of reach of many Americans.

  2. Psychologically, when rates rise, people hold off purchasing items "hoping" rates will come back down again.

Therefore, when rates recently went to 2.6% and the bond bears once again growled their assertion rates could only go higher - I was aggressively buying bonds into portfolios. Since then, rates have fallen and have, on a weekly basis, pushed bonds back onto a "buy signal" as shown below.

The "red dashed" lines denote all the "sell signals" going back to 2007. The last time interest rates tripped a signal from a similarly high level was in 2013 where rates fell from 3.0% to 1.6%.

Given the still large short position in bonds, although it has been reduced substantially from its recent record levels, suggests that a run down in rates towards 2% or less is highly likely.

However, in the very short-term, the move in rates, and subsequent rise in bonds, has gotten a bit stretched. Therefore, IF we get a short-term reflexive rally in stocks next week, I would expect some selling pressure in bonds to emerge.

The recent gains from the "rotation" trade, as I discussed at the beginning of this year, has been largely capitalized on. Therefore, some profit taking and rebalancing portfolio weightings in bonds makes sense.

Will the "bond bull" market eventually come to an end? Yes, eventually. However, the catalysts needed to create the type of economic growth required to drive interest rates substantially higher, as we saw previous to 1980, are simply not available today. This will likely be the case for many years to come as the Fed, and the administration, come to the inevitable conclusion that we are now caught in a "liquidity trap" along with the bulk of developed countries.

I am long bonds, and will continue to buy more whenever someone claims:

"The Great Bond Bull Market Is Dead."

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