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While longer-term bonds were the last Bonds to reverse in trend, we have seen shorter-term bonds moving to higher yields since 2012, the date I drew my line in the sand on the Bond Bear Market.

The Wait Is Over

December 7th, 2016 by Kurt L. Smith
  • I love it when a plan comes together. The August letter, First Bonds, Now Stocks, could not have been more spot on. The latest rally in Bonds began to reverse in July and it appears the first move towards a Bond Bear Market is now in place. And indeed the excitement the markets reserved for Bonds earlier this year did indeed move to Stocks with a recent exclamation point capping a three thousand point move up in the Dow that began in February.

    For those of you reading the press clippings of these latest moves, please remember the narratives are worthless. Trends do not extend forever and long-time readers of this letter know I have been preparing for a change in the long-term trends of Stocks and Bonds for some time.

    My excitement that my long wait may finally be over is based on the excitement both the Stock and Bond markets registered in 2016. Soaring prices, plunging and even negative yields, characterized the Bond market all spring long. Prices topped (and yields bottomed) in July with the bellwether thirty year US Treasury bond at 2.08%; by the first of December it was over 3.08%, an almost 50% jump in yield and 19% plunge in price.

    No market moves in a straight line so I expect this first move to correct over the coming months. While longer-term bonds were the last Bonds to reverse in trend, we have seen shorter-term bonds moving to higher yields since 2012, the date I drew my line in the sand on the Bond Bear Market. Yes, I have been waiting for longer term Bonds to fall in line with other Bonds and now it appears my wait is over.

    In late 2011 the two year treasury note was .14%; in December 2016 it was 1.14%, the highest in over six years. The Federal Reserve raised rates last December from .25% to .50%; expect the Fed to follow the move in rates when it meets this month. Does the Fed rate rise matter to the Bond market? No, the market has already moved. Based on what I said earlier you could expect interest rates to move lower in the coming months, the exact opposite of the projected Fed move.

    As I’ve said before historic, record highs in Stocks and Bond prices are NOT the time to buy, or even hold; they are a time to sell. Why? Three words: historic, record and high, particularly when they occur at the end of something particularly historic like a thirty-plus year trend.

    For perspective, ease of use, and because everyone seems to like ETFs, take a look at MUB, an ETF of large, long-term tax-free bonds. When I drew my line in the sand on the municipal bond market around Thanksgiving 2012, MUB was just below 115. The bond temper-tantrum of 2013 whacked prices into the low 100’s before municipals began their relentless and later manic climb over the next three years. In early July 2016, MUB briefly touched 115. By December MUB traded in the 106 range wiping out most of the past three year rally.

    To summarize, the three year Bond rally, which we thought would be over this summer, is indeed over. The idea of lower rates for longer or forever is also, well, over. The thirty-plus year Bond market rally, the one where I drew the line in the sand in late 2012, well, it is over. But, best of all, my wait for something to change is over. The line in the sand held; interest rates are indeed moving higher.

    For Stocks, it looked like Stocks would enjoy the mania that Bonds had enjoyed earlier in 2016 and about 3000 Dow Jones points later, here we are. Manic enough for you? Well enjoy it while you can (sell it while you can) because a similar ride as Bonds experienced recently should be the first signal that stocks are headed for a reversal of long-term trend.

    All of this discussion without even mentioning the presidential election. This is because the markets for Bonds appeared as if it would change trends (and it did) after experiencing a mania and Stocks appeared as if they would enjoy a brief mania that Stocks had failed to enjoy. Again, the 3000 point Dow move and the Bond sell off were both in play before the election result was known.

    Focus on the market and, please, ignore the narratives. Bonds did not sell off because of inflation, or more spending, or any other reason you can dream up. Stocks did not go manic because we are going to do something or anything. There is no narrative!  However, we do know that manias end badly. That is known throughout history.

    We are four (long) years removed from me drawing my line in the sand regarding a trend reversal in Bonds. That is both the good news and the bad news. I hate to admit that a thirty year trend would probably take time to reverse itself and reveal itself to you and others. But the wait is now over.

    Higher interest rates will not be a good thing for the markets. Should I say that again, slowly? There are too many assumptions in this world tied to the idea that interest rates trend lower. I will leave that discussion for later. We will continue our Select Approach to take advantage of the new opportunities we continue to find, hopefully in even greater numbers.


    Manor Independent School District, Texas GO

    S&P AA- Under

    Due 8/1 Dated 12/1/16 Maturity: 8/1/2046

    Sale Amount: $19,955,000

    1 2017 2.00% 1.10%
    2 2018 3.00% 1.41%
    3 2019 4.00% 1.72%
    4 2020 5.00% 2.00%
    5 2021 3.00% 2.24%
    6 2022 2.25% 2.44%
    7 2023 3.00% 2.62%
    8 2024 4.00% 2.81%
    9 2025 5.00% 2.94%
    10 2026 5.00% 3.02%
    11 2027** 3.00% 3.17%
    12 2028** 3.125% 3.39%
    13 2029** 3.375% 3.55%
    14 2030** 3.50% 3.66%
    15 2031** 3.50% 3.71%
    16 2032** 3.625% 3.80%
    17 2033** 3.75% 3.87%
    18 2034** 5.00% 3.59%
    19 2035** 5.00% 3.63%
    20 2036** 5.00% 3.66%
    24 2040** 4.00% 4.07%
    27 2043** 4.00% 4.09%
    30 2046** 4.00% 4.15%

      *Yield to Worst (Call or Maturity) **Par Call: 8/1/2026

    Source: Bloomberg

    This is an example of a new issue priced the week of 12/5/16

    Prices, yields and availability subject to change


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