The Plan Unfolds

It has been twelve months since the end of the hockey-sticked shape mania of long-term bond prices. Markets don’t trend in straight lines, so over the past twelve months I have used this letter to help you navigate where we are on the journey towards a collapse in long-term bond prices.

The July 2017 letter called the top in long-term bond pricing while subsequent letters followed the initial move to December lows and last month’s call that the correction was over. After a correction price high on June 12^th, long-term bonds have declined in price for the past twelve trading days (as of the writing of this letter).

Of course it may be better to be lucky than good, but I will accept any good fortune that comes our way. This letter provides me the opportunity to put forth my opinion, however much in the minority it may be, and I intend to take the opportunity because I believe it is quite important when a collapse in the long-term bond market is involved.

Let me also add that my prognostications about interest rates and bond price trends are not key to our approach in determining what is or is not a worthwhile bond, though it does affect how long a bond we may choose to consider. Trend is important and, I believe, it hasn’t been this important in many years.

The importance of trend is that it underlies almost all assumptions of pricing. Everyone loves ever increasing asset prices, but the reason I throw in an occasional reference to gold or oil prices is because trend is important. Back in 2014, the world was quite okay with oil prices around $100 and couldn’t fathom the 75% decline that soon occurred. Oil was in a downward price decline (remember $140+ in 2008?) and one should never underestimate the power of trend.

Long-time readers know that, I placed 2012 as the top for the thirty-plus year bull market in Bonds. 2012 represents the low yield (high price) for shorter-term bonds as well as Corporates (basis, LQD) and Municipals (MUB). With thirty years of trend behind it, I was under no illusion that everyone would throw in the towel and say it was over for Bonds. I was prepared for a slog.

It took long-bonds four years to complete their final move and here we are another year later at what appears to me to be a pivotal point in bond market history. The market is poised to surprise to the downside, a sentence that probably drips with understatement.

You are hearing the warnings. Bill Gross (the old Bond King), Jeff Gundlach (the new Bond King) and Ray Dalio (because he was on Bloomberg last Friday) have all warned about the Bond market. A Chicken Little reference could be made here but when asset managers of trillions of dollars speak/preach, I will listen, if not just to determine the self-interest involved.

Money managers of trillions, even those of merely billions, have a tremendous challenge on their hands with respect to Bonds. For them, the answer has always been: own Bonds. As interest rates continued lower the tradeoff was to forego quality for the yield. The market recently priced itself into a perfect pricing peak, much like 2007, that has only one way to go now: down.

The trend has turned and we are now twelve months down the road. How many more months may transpire before the oops moment? That is not as important for us as is the acknowledgement, the assumption, that the trend for long-term bonds, (and hence the majority of all fixed income asset management) is down.

The assumptions in the market are wrong. The talk focuses on yields, spreads, supply and demand, inflation or no inflation. The fact is these are markets…markets with prices. The idea that one, or two or all of those reasons would somehow keep oil prices from falling, well that proved to be a ridiculous assumption for oil prices.  I believe it will be similar with Bonds.

Bonds are a market, a gigantic market where trillions have gone to rest (some probably RIP). Markets trend and the financial world and its investors have benefitted from thirty years of trend…that is now over.

Municipal Bonds, certainly not in general but in specific, offer investors a unique opportunity in the coming Bond market debacle. From the best performing asset  class in 2015, to who-knows-what, the municipal bond market will become much maligned and understandably so. Municipal bonds will not be immune to the new trend in place and before it is all over they may even lose their reputation of safest asset class available. Since 2007, I have told you I didn’t trust municipals any further than I can throw them. Others will probably soon understand.