Dave Moenning

The Next Problem Could Be…

Don’t look now fans, but bonds may be back on the list of things to worry about in the stock market. Jeff Gundlach, who has apparently been anointed the new king of the bond market, has suggested that bonds are on the precipice of a bear market and that Ten-year Treasury yields are on course to move “toward 3 percent” this year.

Just over two weeks ago, the yield on the U.S. Gov’t 10-Year closed at the low of the year at 2.137%. The thinking at the time was that inflation indicators were wobbling, the economic outlook was mixed, and the chances of Trump getting anything done in 2017 were falling fast. So, despite all the Fedspeak to the contrary, the markets doubted the Fed’s ability to stay the course. Rates looked to be moving in the opposite direction of the general consensus.

Lest we forget, the yield on the 10-year began 2017 at 2.446% and just about everyone on the planet expected that yield to rise steadily throughout the year. So, when yields dropped to a fresh calendar-year low on June 26, it appeared that the prognosticators of doom and gloom in the bond market had once again failed – in rather spectacular fashion.

However, eight days later, the yield on the 10-year had spiked to 2.396% and looked ready to take out important resistance zones. The move was impressive – and global in scope. And those who don’t spend their days watching the action in markets, were left scratching their heads.

Yield of U.S. Gov’t 10-Year – Daily

View Image Online

So, what gives? Why did bond yields reverse course in violent fashion? Why did the sentiment flip completely in such a short period of time?

No, Janet Yellen didn’t change her tune. No, the Fed didn’t surprise the markets at their June meeting. And no, the inflation data hadn’t suddenly reversed.

The answer actually has nothing to do with the United States economic data, nor inflation, oil, or even the Fed. Nope, this situation started across the pond – and not where you might think.

It turns out that a weaker than expected bond auction in France caused traders in Europe to sit up and take notice (and do some serious selling). Next, Super Mario started “talking taper” (or so traders thought). And then, the Bank of England chimed in with some unexpectedly hawkish comments.

The Lightbulb Goes Off

This coupled with the fact that Yellen & Co. appear to be bent on raising rates and unwinding their $4 trillion balance sheet (yes, despite growth and inflation expectations being downgraded almost daily) caused traders to realize that the “QE Era” was coming to an end.

After nearly of decade of unprecedented global central bank intervention, it appears that the most of the globe’s central banks (save Japan of course, which apparently plans to print money until the end of time) have decided that it is time to step aside.

Yep, that’s right; almost in unison, central bankers have started talking about pulling back on their stimulative efforts. As in ending QE. As in selling some of the mountain of paper the banks have acquired while trying to keep the global economy afloat. And as in “normalizing rates” and monetary policy.

So, what do traders do when they realize that the biggest buyers of bonds are going to (a) stop buying in bulk and (b) move toward becoming net sellers of bonds? They sell, of course.

Whether the current spike in rates will continue or not is anybody’s guess. Whether or not Mr. Gundlach and all the other prognosticators calling for the start of the big, bad bond bear will be right anytime soon is also in question.

However, for me, the takeaway is that when investors decide to do the same thing at the same time, things can get ugly – in a hurry. So, as I’ve been lamenting for some time now, I do not believe we are seeing the type of low risk environment that the volatility metrics might imply.

No, the bottom line is I think risk is elevated and one should play the game accordingly.

Thought For The Day:

If you have everything under control, you’re not moving fast enough. -Mario Andretti

Current Market Drivers

We strive to identify the driving forces behind the market action on a daily basis. The thinking is that if we can both identify and understand why stocks are doing what they are doing on a short-term basis; we are not likely to be surprised/blind-sided by a big move. Listed below are what we believe to be the driving forces of the current market (Listed in order of importance).

      1. The State of the U.S. Economic Growth (Strong enough to justify valuations?)

      2. The State of Earnings Growth (Ditto)

      3. The State of Trump Administration Policies

Wishing you green screens and all the best for a great day,

David D. Moenning
Chief Investment Officer
Sowell Management Services

Disclosure: At the time of publication, Mr. Moenning and/or Sowell Management Services held long positions in the following securities mentioned: none. Note that positions may change at any time.


Disclosures

The opinions and forecasts expressed herein are those of Mr. David Moenning and may not actually come to pass. Mr. Moenning’s opinions and viewpoints regarding the future of the markets should not be construed as recommendations. The analysis and information in this report is for informational purposes only. No part of the material presented in this report is intended as an investment recommendation or investment advice. Neither the information nor any opinion expressed constitutes a solicitation to purchase or sell securities or any investment program.

Any investment decisions must in all cases be made by the reader or by his or her investment adviser. Do NOT ever purchase any security without doing sufficient research. There is no guarantee that the investment objectives outlined will actually come to pass. All opinions expressed herein are subject to change without notice. Neither the editor, employees, nor any of their affiliates shall have any liability for any loss sustained by anyone who has relied on the information provided.

The analysis provided is based on both technical and fundamental research and is provided “as is” without warranty of any kind, either expressed or implied. Although the information contained is derived from sources which are believed to be reliable, they cannot be guaranteed.

David D. Moenning is an investment adviser representative of Sowell Management Services, a registered investment advisor. For a complete description of investment risks, fees and services, review the firm brochure (ADV Part 2) which is available by contacting Sowell. Sowell is not registered as a broker-dealer.

Employees and affiliates of Sowell may at times have positions in the securities referred to and may make purchases or sales of these securities while publications are in circulation. Positions may change at any time.

Investments in equities carry an inherent element of risk including the potential for significant loss of principal. Past performance is not an indication of future results.

Advisory services are offered through Sowell Management Services.

Dave Moenning

How Bad Will The Big, Bad, Bond Bear Get?

In yesterday’s meandering morning market missive, we talked about the possibility of the bond market entering a big, bad bear cycle and how a great many analysts expect things to get ugly in the coming years for bond investors.

The thinking is actually quite logical. The economy is expected to improve, which will cause inflation to rise. And the bottom line is that the bond market hates nothing more than increasing inflation expectations. Now toss in the fact that the Fed wants to start “reducing its balance sheet” (i.e. selling some of the approximately $4 trillion in bonds and other fixed income securities it owns) and you appear to have a perfect storm for bond bears.

Put simply, the stage appears to be set for a rising interest rate environment, which could be accompanied by additional supply (from the Fed). And since bond prices fall when rates rise, it is easy to see how things could get nasty for the owners of bond funds and ETFs.

But before you run out and start loading up on those levered, inverse bond ETFs in the hopes for some “no brainer” gains for many years to come, it might be a good idea to look back at history and see how the bond market acted during periods of rising rates.

How Bad Will It Get?

To review, bonds enjoyed a 35-year secular bull market cycle from 1981 through July 2016. During this period of time, you may be surprised to learn that according to Bloomberg, the worst calendar year for the Barclays Aggregate Bond Index (the generally accepted benchmark for the overall bond market) was 1994, where the “Agg” lost -2.9%. Then in 1999, the Agg lost -0.8%. And in 2013, the bond market declined by -2.0%. That was it for calendar year declines over the 35-year bull cycle. Terrifying, eh?

But… this was during a secular bull phase. Now let’s go back and look at periods of time when rates were generally rising such as 1955-1959, 1967-1969, and 1972-1981.

A Powerful Chart

To aid in the exercise, below is a powerful chart from Fidelity Institutional Asset Management showing the yield of the 10-year Treasury (the black line) as well as the calendar year returns of the Agg going back to 1940. Note that since the Agg didn’t exist prior to 1976, the returns from 1940 through 1975 are based on Fidelity’s “Synthetic Aggregate” which is made up of 67% intermediate government bonds and 33% long-term corporate bonds.

From my seat, this is a VERY powerful chart that EVERY investor and financial advisor needs to see – and study – prior to making ANY moves in preparation for the upcoming bond bear.


View Larger Image

The first big takeaway is the absolute WORST calendar year the bond market (as defined by the Barclays Agg and Fidelity’s synthetic Agg) has seen since 1940 was… wait for it… -3.2%. Yep, that’s right, the biggest decline in modern history for the bond market occurred in 1969, where the market fell a little over 3%.

Folks, a 3.2% decline is a bad week for the stock market indices, a pretty good reaction to a stock missing earnings, and a bad afternoon for a lot of commodities. But the reality is this is the worst calendar year decline the bond market has ever seen. So, my question is, what the heck is everybody so worried about?

Digging deeper, we find that there have been other tough times to own bonds. For example, in 1955, the synthetic Agg lost -0.3%. Then in 1956, it fell -2.6%. 1958 saw a decline of -1.6% and 1959 lost -0.6%. As such, bond investors saw declines in four out of five years. Ughh.

However, in 1957, bonds rallied about 8%. So, according to my calculator, the cumulative return for the five-year period was somewhere in the vicinity of +2.5%.

Then there was another rough patch for bond investors in the late 1960’s. In 1967, the synthetic agg fell -1.0%. And in 1969 bonds had their worst year ever at -3.2%.

And then there was the 1972 through 1981 period, where the yield on the 10-year rose significantly from about 6% to nearly 15%. And how did bonds do during what can only be described as a horrific period of rising rates and runaway inflation? They rose. Every single year. So, again, what exactly is everyone so freaked out about?

Bonds Will Still Be Bonds

It is also worth noting that one of the major reasons to own bonds in a diversified portfolio (besides the production of income, that is) is bonds (especially government bonds) remain the one asset class that is truly non-correlated to the stock market. I.E. when the stock market tanks as it did in 1987, 1990, 1998, 2000-02, and 2008-09, bonds rose – every single time.

So, unlike developed foreign markets, emerging markets, commodities, real estate, junk, lots of alts, etc., high quality bonds provide a hedge against the big, bad stock market bears, which unlike their bond counterparts, have actually done a great deal of damage to portfolios over the years.

For me, the bottom line here is simple. While the outlook for the bond market can be made to look bleak, I’m not sure there is a whole lot to fret about. Sure, bonds will experience stiff headwinds at times and may even produce record calendar year declines. But even if the Agg doubles its worst year in history, the benefits would seem to outweigh the costs – well, in my book anyway.

Thought For The Day:

May your actions speak louder than your words. May your life preach louder than your lips. May your success be your noise in the end.

Current Market Drivers

We strive to identify the driving forces behind the market action on a daily basis. The thinking is that if we can both identify and understand why stocks are doing what they are doing on a short-term basis; we are not likely to be surprised/blind-sided by a big move. Listed below are what we believe to be the driving forces of the current market (Listed in order of importance).

      1. The State of Trump Administration Policies

      2. The State of the U.S. Economy

      3. The State of Earning Season

Wishing you green screens and all the best for a great day,

David D. Moenning
Chief Investment Officer
Sowell Management Services

Disclosure: At the time of publication, Mr. Moenning and/or Sowell Management Services held long positions in the following securities mentioned: none. Note that positions may change at any time.

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Disclosures

The opinions and forecasts expressed herein are those of Mr. David Moenning and may not actually come to pass. Mr. Moenning’s opinions and viewpoints regarding the future of the markets should not be construed as recommendations. The analysis and information in this report is for informational purposes only. No part of the material presented in this report is intended as an investment recommendation or investment advice. Neither the information nor any opinion expressed constitutes a solicitation to purchase or sell securities or any investment program.

Any investment decisions must in all cases be made by the reader or by his or her investment adviser. Do NOT ever purchase any security without doing sufficient research. There is no guarantee that the investment objectives outlined will actually come to pass. All opinions expressed herein are subject to change without notice. Neither the editor, employees, nor any of their affiliates shall have any liability for any loss sustained by anyone who has relied on the information provided.

The analysis provided is based on both technical and fundamental research and is provided “as is” without warranty of any kind, either expressed or implied. Although the information contained is derived from sources which are believed to be reliable, they cannot be guaranteed.

David D. Moenning is an investment adviser representative of Sowell Management Services, a registered investment advisor. For a complete description of investment risks, fees and services, review the firm brochure (ADV Part 2) which is available by contacting Sowell. Sowell is not registered as a broker-dealer.

Employees and affiliates of Sowell may at times have positions in the securities referred to and may make purchases or sales of these securities while publications are in circulation. Positions may change at any time.

Investments in equities carry an inherent element of risk including the potential for significant loss of principal. Past performance is not an indication of future results.

Advisory services are offered through Sowell Management Services.