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Chair Yellen has presided over years of (mostly) peaceful asset appreciation and departs with a plan in place to shrink the mammoth balance sheet of the Federal Reserve. Pity the new chair, as it looks to me that the days of endless financial price appreciation are now over.

Top of Tops

November 6th, 2017 by Kurt L. Smith
  • Relish in all of the good news? Certainly you must be joking? All-time highs for stocks and bond yields seemingly at low-forever yields (meaning high forever prices) and I want to rain on this parade? In a word, just one word, yes!

    The reason why I have been keeping you apprised of the albeit slow changes in the bond market is because the trend change is beyond important: it is generational. Who knew that the next and most impactful move in the bond market would also occur at the all-time high for stock prices?

    We have been keeping score vis-à-vis the ten year US Treasury note. Indeed the note did hit a low of 2.01% on September 8th and yields hit 2.47% on October 27th. Not the radical change I had predicted last month, but not bad and moving in the right direction.

    I am focused on bonds and the bond market as reflected by yields on the ten year treasury. We can also look at the bellwether thirty year which should be at a low here at 2.85% up from 2.63% on September 8th. These low yields certainly fit the narrative of low yields. They will not remain low for much longer; certainly not forever.Why bond yields will rise (soar) and bond prices will fall (plunge) is not important. The point is they have been moving and, well, no one really cares. This will change as stock prices, at all-time historic highs (by any measure), fall. Take note of today’s (November 1) Dow high of about 23,500 or the S&P 500 at 2588 or the NASDAQ composite’s 6750. Remember those levels, they will probably be key levels. As stock indexes fall, more attention will be paid to rising bond yields. You won’t be surprised; we’ve been talking about the turnaround in bond prices for years now.

    By the time this letter is published, we will know who the Federal Reserve chair will be for the next four years. Good luck to the chair, as it looks like years of criticism in my opinion. Chair Yellen has presided over years of (mostly) peaceful asset appreciation and departs with a plan in place to shrink the mammoth balance sheet of the Federal Reserve. Pity the new chair, as it looks to me that the days of endless financial price appreciation are now over.

    The trend is your friend. With respect to bonds, we have been working our plan for years. We are not reliant on the need for someone to buy our bonds from us; we are good with what we have. We are not reliant on a continued strong economy to support our bonds; we have invested in bonds to weather down economies as well. But in the wonderful economy seemingly everyone believes we live in, who is thinking about bonds anyway?

    I don’t know what pie-in-the-sky narrative Wall Street and the pundits will cook up when stocks fall. I can only imagine they will look for something to blame and I will posit they will blame bonds because we have not only been in a topping formation for years, but we have reversed trend. Here to fore, no one has really cared to watch or listen, except you reader. I have made you listen!

    Investors love yield. It (still) amazes me how many bonds were created and sold over the past five years or so with 1%, 2% or 3% coupons. Hundreds of billions of dollars I am sure; many with long maturities. Why not buy these bonds in an environment of low rates forever (high prices forever)? One has stability of principal (per their monthly statement) and all the yield there is to be had.

    Under the low rates forever mantra, these bonds continue to be sold near their coupon because that’s what the market is. As long as investors believe the mantra, they are willing buyers. The trend however is working against them. The market is chipping away at the mantra and, perhaps all of a sudden, the new trend will become apparent to others.

    How many investors will be willing to hold their 1%, 2% and 3% coupons for many, many, years? Probably most. Just like how most stock investors will continue to hold their stocks long after prices begin to fall. It is the sad predicament of most investors. You want to believe the mantra. It has worked for thirty plus years! Trends reverse, be prepared!

    I expected to turn my sights to stocks eventually. I am surprised that the time is now, just as bond yields are really beginning to move higher. Look to be surprised and then you won’t be surprised. We don’t need to make changes; we’ve known this day was coming for several years now. As the markets progress I will continue to let you know how you can continue to be safe.

     

    Bexar County, Texas GO

    Moody Aaa   S&P AAA   Fitch AAA

    Due 6/15 Dated 11/1/17 Maturity: 6/15/2043

    Sale Amount: $40,840,000

    YEAR MATURITY COUPON YTM*
    3 2020 5.00% 1.28%
    4 2021 5.00% 1.38%
    5 2022 5.00% 1.52%
    6 2023 5.00% 1.68%
    7 2024 5.00% 1.82%
    8 2025 5.00% 1.96%
    9 2026 5.00% 2.08%
    10 2027** 5.00% 2.18%
    11 2028** 5.00% 2.29%
    12 2029** 5.00% 2.36%
    13 2030** 5.00% 2.45%
    14 2031** 5.00% 2.52%
    15 2032** 5.00% 2.60%
    16 2033** 5.00% 2.66%
    17 2034** 5.00% 2.72%
    18 2035** 5.00% 2.77%
    19 2036** 5.00% 2.81%
    20

    24

    2037**

    2041**

    5.00%

    5.00%

    2.84%

    2.95%

    26 2043** 4.00% 3.28%

      *Yield to Worst (Call or Maturity) **Par Call: 6/15/2026

    Source: Bloomberg

    This is an example of a new issue priced the week of 10/30/17

    Prices, yields and availability subject to change

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