Mint - Blain’s Morning Porridge
For the avoidance of doubt – the Morning Porridge is unrestricted market commentary, it is not investment advice…
Despite the rather flippant first few paragraphs – this might actually be the most important Porridge I’ve written in a while. So Pay Attention!
We are all DOOOMED, DOOOMED! But as I look out the window I don’t see any signs of panic on the street. Which is much like the global bond markets.
Everyone is fretting about the European Central Bank taper declaration tomorrow, Thursday. You would think the phased exit of the single biggest buyer that’s being powering up the European bond markets these last six years (since the launch of targeted long-term refinancing operations, TLTROs), the force that has caused the greatest spread compression and price distortion in recorded history, might just cause a mild flutter of alarm among bond buyers?
Apparently not. Folk are actually buying Spanish regional bonds…If you are a buyer of European agency and covered bonds, give me a shout! I guess everyone figures the ECB will keep kicking the can down the road, pull the wool over the Germans’ eyes, and won’t risk everything on turning off the bond-buying money spigot.
But, maybe we are looking at the wrong thing? The ECB on Thursday is just one small part of a larger global equational shift…Two weeks ago I mentioned my stockpicking colleague, Steve Previs, is very concerned about stock market cycles pointing to a correction. I then wrote about the long-term Kondratieff Cycle, an item that was picked up in a number of articles by other writers and magazines.
However, my very own Private James Frazer, macroeconomist Martin Malone, says we’ve been looking at the wrong set of cycles. It’s not the stock market we should worry about – but the end of the 36-year bond market bull market – which probably peaked last August when the 10-year US treasury hit 1.36%.
While everyone is watching the stock markets looking for a bubble to burst, or stressing about Europe, the real risk is probably complete mayhem in bond markets.
In terms of bond market cycles – brace yourself, and breathe deep – Martin has looked back over 700 years. (Yes.. right the way back to the bond market crash of 1314 – triggered by the usual general famine and plague, but mainly the Scots crushing England’s King Edward II at Bannockburn thus precipitating an English default and a financial crisis in Italy.. (Nothing ever really changes..! Newer readers might need reminding that Bill is Scottish...)
What Martin has uncovered by looking at nominal rates and inflation over the last 700 years is fascinating. There is a clear 55-60-year bond cycle: the average length of nine nominal bull markets has been 32 years, with an average rally of 22 basis points per annum. Bear markets last 26 years on average, and yields rise 50 bps per annum.
Guess what, the 1981-2017 rally that’s just ended lasted 36 years completes the current cycle that began in the 1960s (between 1965-1970 US bonds gave us a negative real return of -36%!) The 1960-80 bear phase was triggered by a wider fiscal deficit, tussles between the White House and Federal Reserve, and the tight labour market triggering massive wage inflation.
If you want fuller details of Martin’s 700-year analysis let me know. It would simply block the email servers if I send it to everyone!
Let’s come back to today, and most folk don’t yet realise the bond party is over. As they wake up and smell the coffee, Martin and I are looking for complacent bond markets to spike 100 bps or more in the medium term. The chart shows we’ve just made a long-term BEAR “DEAD CROSS” on the 10-year treasury. That’s significant as it’s only happened twice before: in 2007 – and we all know what happened then – and the mid-1960s when the bear market at the start of this cycle took hold.
A 100 bps yield spike in treasuries could spell disaster for the over-frothy corporate bond markets. At the moment we’re still seeing a flood of deals hit the street, and it’s the unspoken truth many high-yield zombie plays won’t last a moment if rates rise.
Through this year the central bank community has shifted from ease to tightening, and the distortion of quantitative easing is ending. We expect most global central banks to follow the nine who have already tightened this year. Of course, central banks aren’t shouting this from the rooftops – they don’t want panic. They are using the language of slow and gradual – everyone learnt something from the taper caper a few years back.
But rates are going to rise. And it’s going to hurt! Does that spell disaster for stocks and other valuations? A major bond crash is going to impact short-term sentiment – but rising rates aren’t the end of everything. In a rising positive gross domestic product environment, then stocks and alternative real assets are going to be the hot spot to invest for the coming bond bear cycle.
And on that happy note… back to the day job.
Head of Capital Markets/Alternative Assets