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posted on 09 February 2018

The Next Bull Market

Written by , Clarity Financial

We continue to review a recent article on Zerohedge discussing a view of Albert Edwards started earlier this week in A Hint Of 1987. Edwards is correct in many of his arguments. Here we expand upon the future for bonds.

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There are several important points to understand about bonds.

  1. All interest rates are relative. With more than $10-Trillion in debt globally sporting negative interest rates, the assumption that rates in the U.S. are about to spike higher is likely wrong. Higher yields in U.S. debt attracts flows of capital from countries with negative yields which push rates lower in the U.S. Given the current push by Central Banks globally to suppress interest rates to keep nascent economic growth going, an eventual zero-yield on U.S. debt is not unrealistic.
  2. The coming budget deficit balloon. Given the lack of fiscal policy controls in Washington, and promises of continued largesse in the future, the budget deficit is set to swell back to $1 Trillion or more in the coming years. This will require more government bond issuance to fund future expenditures which will be magnified during the next recessionary spat as tax revenue falls.
  3. Central Banks will continue to be a buyer of bonds to maintain the current status quo, but will become more aggressive buyers during the next recession. The next QE program by the Fed to offset the next economic recession will likely be $2-4 Trillion which will push the 10-year yield towards zero.

The next bull market is coming, it just won’t be in stocks.

It will be in the U.S. Treasury market which will coincide with the next recessionary drag in the economy within the next 12-18 months (at the most).

As I have written previously, interest rates have everything to do with economic growth. Since economic growth is almost 70% driven by consumption, with savings rates extraordinarily low and debt hitting record levels, small increases to interest rates will have an immediate negative impact on the consumptive capability of U.S. citizens.

The chart below goes to my point. Currently, interest rates are 4-standard deviations above their 1-year moving average. (For an explanation read this.)

How often has this happened going back to 1965?


Negative events such as the S&L Crisis, Asian Contagion, Long-Term Capital Management, etc. all drove money out of stocks and into bonds pushing rates lower; recessionary environments are especially prone at suppressing rates further. Given the current low level of interest rates, the next recessionary bout in the economy will very likely see rates near zero.

Furthermore, given rates are already negative in many parts of the world, which will likely be even more negative during a global recessionary environment, zero yields will still remain more attractive to foreign investors. This will be from both a potential capital appreciation perspective (expectations of negative rates in the U.S.) and the perceived safety and liquidity of the U.S. Treasury market.

However, what you will notice is that each time rates were as overbought as they are currently, they coincided with either a recession, a correction, or a major market crash.

Could this time be different? Sure. It’s possible.

But probably, it won’t be. The stock market is a reflection of the economy, not the other way around. Higher interest rates are a drag on economic growth which will impact earnings and valuations for the market.

Not tomorrow. Or even next week.

But over the next several months, higher interest rates, if they remain elevated for long, will have a deleterious effect on the economy.

Valuations will become problematic.

Furthermore, the safety of bonds becomes much more attractive when the yield is significantly above the dividend yield in stocks. (Why take the risk in

stocks for a sub-2% yield when I can get 3% in a U.S. Treasury?)

That’s not hard math.

Things are finally starting to get interesting.

See you next week.

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