Big Bond Bubble Beckons Bears, Buries Treasuries, And Busts Fixed Income Investors

Back in March, Barron’s ran The Case For Bonds, poo-pooing a spate of articles back then on a bond bubble. The expectations were that the ending of Quantitative Easing (QE) would lead to a rise in rates. As we know now, didn’t happen.

What did happen was the Euro debt crisis drove money to safer havens in Treasuries, and the pronouncement of a continuation of QE led observers to expect a bigger QE2 ahead. Bonds soared as rates dropped. In the last few weeks, however, we have seen them reverse dramatically (chart from StockTiming):

Marty Chenard (of StockTiming) notes how the 30-yr has come back to a recent resistance level at 38.34 (see chart), suggesting a break will lead to a bond bust of very broad proportions. The bust is already being felt. Monday’s WSJ will report how the last ten days have shaved 2.5% off the 10-yr, a sharp drop after a five month stunning rise. Bespoke noted late last week how the drop in bonds was already being felt in bond funds, and had raised the spectre of a breakdown in fixed income:

More ominously, the 10-yr has has not broke above the five-month trendline, an indication (if it doesn’t reverse quickly) of a change of trend for a considerable period:

Credit for an auspicious call goes to Jeremy Siegel in the WSJ, whose op-ed The Great american Bond Bubble published on August 18, right as the trend reversal was starting. He noted how a reversal from the 2.8% rate then to the 4% rate of a mere five months ago would cause a capital loss 3x worse than the low yield. This led to a new spate of Bond Bubble articles. An update is here.

An even earlier call came from ZH, which noted that global industrial production got back to pre-recession levels, and drew the implication that a Global Bond Hiccup was soon to come:

Before the bears celebrate, they should ponder what changed: expectations of the double-dip abated around the time the bond yields bottomed. If you have been following my posts on the Double Dip Countdown, I put the count on hold in early August, started it again around August 18, and have it on hold again – reflecting ambiguous economic signals. This has two big implications for rates:

  • a flat patch would cause the Fed to hold off QE2, which suppresses rates
  • a real recovery would cause market rates to rise, and the Fed to follow

Now fixed income investors face a dilemma: if the recovery is on, rates will rise; but if this is a mere blip before negative double-dip news begins to come back, rates will fall back. Should they stay (in bonds) or should they go?

I will comment separately on munis in a later post, bit as to Treasuries, these are the circumstances where technical analysis may give better advice than struggling with conflicting and ambiguous fundamentals. Friday’s STU has a wave count which is pretty daunting: the recent low rates reflect a 62% retracement from the low rates in 2008 to the recent highs in April. This suggest rates are going to continue to rise. Right now the technical indicator to watch is a definitive break of the trendline (see chart above).

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About Duncan Davidson 228 Articles

Affiliation: NetService Ventures

Duncan is an advisor to NetService Ventures, where he focuses on digital media and the mobile Internet.

Previously he was at four start-ups: Xumii, a mobile social service based on a Social Addressbook; SkyPilot Networks, the performance leader of wireless mesh systems for last-mile access, where he was the founding CEO; Covad Communications (Amex: DVW, $9B market cap at the peak), the leading independent DSL access provider, where he was the founding Chairman; InterTrust Technologies ($9B market cap at the peak), the pioneer in digital rights management technologies, now owned by Sony and Philips, where he was SVP Business Development and the pitchman for the IPO.

Before these ventures, Duncan was a partner at Cambridge Venture Partners, an early-stage venture firm, and managing partner of Gemini McKenna, a joint venture between Regis McKenna's marketing firm and Gemini Consulting, the global management consulting arm of Cap Gemini.

He serves on the board or is an adviser to Aggregate Knowledge (content discovery), Livescribe (digital pen), AllVoices (citizen journalism), Xumii (mobile social addressbook), Verismo (Internet settop box), and Widevine (DRM for IPTV).

Visit: Duncan Davidson's Blogs

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