Tags: bonds | bubble | growth | GDP

Beware of the Bear Trap in Bonds

By    |   Wednesday, 29 May 2013 08:04 AM

The signs of a spring are everywhere. I am talking about the financial markets as much as the rose bushes in my back yard. The weather is warm, BBQ scents waft through the air and the moods are effervescent. And stock portfolios are surging.

I am being told that the housing market here in Atlanta is now a seller's market and that houses are being snapped up in a week with multiple bids on each home. Homes are selling for well above asking price in many cases.

Sigh. It would take a realist like me to puncture your happy-day scenario. So I can understand if you do not want to read anymore and enjoy that feel-good mood. But if you want to be cautious and not get caught by a bear trap, I would recommend you continue to read.

Glad you are still with me.

The reality of the fact is that I have not seen any sustainable reason why the stock markets are up and the housing markets are heating up. While the U.S. gross domestic product (GDP) for the first quarter was 2.5 percent, the number by itself should not cause optimism. It missed the estimates, which indicated we should see 3 percent growth. Next, it also indicated there was a build-up of inventories, which is a seasonal effect that helps a GDP reading but is not a sustainable effect.

Most economists believe that the 2.5 percent growth will not be sustained. The projections for GDP growth for the remainder of the year are below 2 percent. If the forecasts are true, we are still in real trouble. Most times I have seen the forecasts be too optimistic anyway, so I suspect we will under-perform the below-2-percent-growth forecasts as well. Yet, the stock markets continue to run away at a tear.

When I dig deeper into what is driving the markets, the only real thing I come away with is that it has been so long since we have felt "normal" (read as excessive buying) that the pent up demand in all markets are driving the prices higher on the "hope" that the real recovery is finally here.

Auto sales are reaching levels not seen in five to six years.

What concerns me most is the bonds market. We have seen the 10-year bond yields soar to 2.14 percent from a low of 1.6 percent just a few weeks ago. Astounding!

From smart to dumb traders, they are all espousing that the bond bubble is losing steam and that it will gradually deflate, that it has now started and will have an orderly exit and that it is time to reallocate funds to stocks.

Well, I hope that you will also concede that it is your hope that the above scenario will happen.

Firstly, I have never heard of an orderly exit from a bubble. Given that we are so very deep in bubble territory, I cannot imagine that traders will have the discipline to exit gradually. Next, the whole premise of growth in the United States is based on "hope." With Europe firmly in recession, China and India showing slow growth and struggling, Japan "hoping" the insane bond-buying program will spark inflation after 20+ years of deflation, I cannot see how the U.S. growth story will sustain.

Here is what I think: By the end of summer, the optimism around U.S. growth will tank and realism will set in that we are still stuck in a rut. First thing to grow will be the bond markets as we will see fresh, renewed buying, which will collapse yields again. Stock markets will go next when corporates cannot deliver any more productivity gains. Employees are reaching the capacity of how much they can give.

With reported inflation hovering at such low levels, I cannot see sustained bond market normalization.

While I do believe that the bond market will correct violently, I do not believe it is happening now. Beware of being suckered into selling the bonds to make money as you can be caught short and end up losing even more money.

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Advani
While I do believe that the bond market will correct violently, I do not believe it is happening now. Beware of being suckered into selling the bonds to make money as you can be caught short and end up losing even more money.
bonds,bubble,growth,GDP
683
2013-04-29
Wednesday, 29 May 2013 08:04 AM
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