Now It Gets Interesting

The Dow shed 1500 points last month and all of a sudden we can focus on something other than congratulating policymakers on keeping stock prices high and bond yields low.  The financial world has been changing in rather dramatic ways but as long as stocks levitated and defied gravity no one seemed to care.

Growth is nonexistent, unless you choose to count in fractions of one percent.  Ditto for inflation.  History is history and hopes are, excuse me, were, like stock prices in that they remained elevated for no apparent reason.

If Federal Reserve policy worked, we would have growth.  If Fed policy worked we would have inflation.  Both growth and inflation are needed to raise incomes and make our debts manageable, yet obviously we are left empty-handed.  The Fed has one achievement: it now owns several trillion dollars in treasury notes and bonds.  These are not the results the Fed sought; the policy only appeared to work because you hoped it would.  This was the hope that levitated stocks; evidently the hope is disappearing and disappearing quickly.

I am and continue to be concerned about the new trend in bonds: the developing bear market.  The bear market for bonds began in 2012 and continued throughout 2013 but has spent almost all of 2014 in correction mode.  Prices for bonds were primarily rising in 2014 even though bonds were in a new bear market.

On October 15, 2014 the bond market correction ended.  The rising bond prices of 2014 suddenly and violently reversed course on October 15th, kicking off what I believe will be the most destructive phase of the new bear market.

Whether US Treasury notes and bonds, corporate bonds, junk bonds or municipal bonds, bond prices are now falling and yields on bonds are rising.  The assumption that interest rates will remain low is an assumption I believe is based on our faith in the policymakers of the Federal Reserve and our faith and our optimism in the relevancy of the Federal Reserve is now in doubt.  Just look at stock prices.

This is not the narrative you read about in the financial pages nor is it the narrative I expect you to read months from now.  I believe it is most important to look at the markets and their prices; we can and will build a story to fit the price movements later.

What is important now is no growth, no inflation and an important reversal in bond prices on October 15th.  If any of the conventional wisdom stories of our day are correct, then they would fail to explain why bond prices all of a sudden failed to continue to go up but instead plunged in price.  Market action is telling you something significant and I believe it is that the bond bear market is entering its next phase.  With falling bond prices, the implications and the direct financial loss could be utterly huge.

You may be asking yourself how could bond prices, primarily long-term bond prices plunge in price?  After all the Fed owns trillions of dollars of long-term bonds, as does PIMCO and every other gigantic money management firm.  There are tens of trillions of dollars in bonds outstanding and certainly the Fed would do something if prices continued to collapse.

Really?  What did policymakers do for you in 2008 when stocks and bonds started to collapse?  The Fed certainly didn’t forestall the collapse.  And although the bond market later proved to continue to be in the last years of a tremendous thirty year bull market, not all bonds rebounded (mortgage bonds being example one).

While the Federal Reserve, PIMCO and all other gigantic money managers may be willing to bet the bond bull market continues, I do not.  I believe the bond market’s (former) strength came from the same faith and optimism that formerly levitated stocks.  Therefore the new direction of both stocks and bonds is now down.

Our mood is shifting.  We’ve discussed chinks in the armor for months.  Gold has plunged, oil has plunged, bonds are volatile and the US Dollar is stronger when everyone believed it would or should become weaker.  As our optimism begins to fade and fear grows, we lose 1500 points in the Dow.

As investors of bonds we have seen periods of time like this before.  We will continue to hold large amounts of Cash and will only look to buy short-term bonds that have the wherewithal to withstand turbulent economic times.  I hope to find these types of bonds in the marketplace each and every day.  We cannot manufacture these bonds; we can only hope these types of bonds come into the marketplace and we are able to buy them.

After a period of market calm and primarily rising stock prices, I expect the volatility of the past month to continue and unfortunately increase.  As optimism fades and fear increases we will probably see panic as well.  We have no reason to panic; we have a plan: keep our Cash unless we can find compelling short-term bond alternatives.

I believe it is the holders of stocks, the holders of long-term bonds, the owners of commodities and the owners of managed money that should be fearful because I see potential tremendous losses forthcoming.  Long-held assumptions about the market will not only be challenged; I believe they will be determined to be false.  You should be extremely careful with your investments.