Monday, December 01, 2008

The Massive Charge of the Bull Continues!

Several Big Bond Bulls continue to charge. These "Treasury Bond Bulls" are winning against all opponents. In less than 3 months, the Euro 30-year bond has soared 26% in price! The yield on the 5 year went from 4.75% 6 months ago to the current rate of 2.65% a 44% move! The five year in England was at 5.8% in June 2007 and at 3.2% today! The US 30-year and 10-year are at levels not reached in at least 50 years! BOND BULLS are CHARGING! All the while, corporate bonds, commodities, real estate, most stocks and central bankers are getting their fannies whacked. Or are they? The REZ REIT, after falling from 53 to 20, has bounced.

Thirty years ago, as General Manager of the Wake Forest University Credit Union, I helped a number of people who were head over heels in debt. One learns much by working closely with those who are financially upside down. I went against conventional wisdom and used debt to assist these folks to get out of debt while helping them learn that you cannot borrow your way out of debt? The conventional wisdom is that if you are in a hole, stop digging. I don't believe in giving up.

I was not able to help everyone but I'll never forget helping a lady who repeatedly pawned her wedding ring mid month. She raised a little cash to buy groceries and bought her ring back on payday. In six months she paid enough interest and fees to buy three wedding rings but this one was hers. She and her husband had good jobs, but neither understood why they were always broke.

The Credit Union was able to replace a lot of bad debt with better debt and ultimately with good debt. It took five years but ultimately, instead of paying the interest on her ring, a beat up old car and several credit cards, she and her husband bought a house and set up automatic deposits into 401-K retirement plans. Ten years latter their kids were in college and they were on top of the world.

There has been a lot of talk that the "next tool" of central bankers will be "quantitative easing". The idea is for central banks to make targeted asset buys, instead of just flooding the market with extra reserves. The US FOMC and other central bankers have been making such buys for weeks. The Fed has dramatically increased its balance sheet. It is helping banks replace bad debts with good. The Fed is temporarily "holding" the bad loans and replacing them with "good loans". Banks are enjoying extra interest earnings while they wait to get back the "cheap rings" they have hocked. The FOMC is acting as a benevolent pawn shop owner. The pawn shop charged my lady friend about 40% in interest and fees while the FOMC is paying banks to "take the money". The FOMC is paying banks interest on their reserves while making swaps to give them extra reserves. Yes, the whole deal is so complicated that you will hear three newscasters offer 7 opinions about what is going on, but after being such a mean old grumpy uncle for months on end, our Uncle Sam has turned into the best friend the banks have ever had.


Using Marty Pring's methodology, there are six phases to the commodity,bond, stocks cycle. He gets to six by including overlaps; the times when one move is in full swing and the next move is just starting. Today, we are seeing a continuation of the commodities bust even though the bond market rally is in full bloom. It took 17 interest rate increases in China to pop the commodities bubble. Since the bubble has popped, there has been a dramatic turn in interest rates around the world. Short term interest rates take hikes with commodities. In the short term, long bonds rates trade down with the decline in short rates and commodity prices but, the lower the price of commodities, the more the economy is stimulated, the greater the GDP, the greater corporate profits and, ultimately, the higher the long rates will go.

Today, we are in a period of deflation. Commodities, including money, are in abundant supply. Bond rates are going down at the same time that commodity prices are falling. Each of these represent a decline in input costs to businesses. Put another way, last year when the PPI grew at a much higher rate than the CPI, businesses were squeezed, but now the squeeze has lifted. Consumer prices are not rising fast but they are rising much faster than input prices. As businesses, including banks, "process" lower input prices, profits will rise. Banks are enjoying the receipt of money at very low rates and, as is evidenced by numbers available from the St. Louis Federal Reserve, banks are lending this money at very substantial spreads. Lending has not died, some lenders are contracting their loan portfolios rapidly but others are growing theirs. It is a myth that lending has died.

Commodities down, Bonds Up and then Stocks Up is the cycle and we have seen the momentum of the commodities move die and the momentum of the bond move accelerate. In July the bubble was in commodities; now, the bubble is in bonds. The spreads between government bonds and corporate bonds is huge. As the input costs flow through the product cycle, corporations are going to be rapidly nursed back to health. Banks and corporations are going to report huge profit jumps by late 2009. Many a company has recently thrown every loss into the mix they can possible justify. When the profits turn hits, it will continue for several years.

It is time for the Stock Bulls to Charge. The significant stock market rally of last week did not corral the Bond Bulls. Huge chunks of real estate are being absorbed. Many a property is underwater but in a holding pattern. Again, the monthly payment to buy the average home is at or near a record low. Houses are very affordable. The Bond Bulls are feeding the Real Estate Bulls!