USA: Bonds and the crash of '09
Summary
Readers know that we are sticking our necks out by forecasting a stock market tumble within the next couple of months. We have given our subscribers three reasons to switch from greed to fear. And we have had a closer look at China from this angle. Today, we take a closer look at what is going on in the bond market and surmise what could happen....Topics Covered
- The good, the bad...
- and the ugly
- How to make money off this idea
Background
1. The good, the bad...
Last week, the stock market rose by 0.8%, but bonds stumbled by nearly four per cent over the week. Indeed, according to today's Bloomberg, ten-year yields climbed by 37 basis points last week, "...the most since July 2003. More ominously, current yields of about 3.75% "...represent a 50 per cent retracement of the decline in yields that began in June 2007 and ended at a record low of 2.04 per cent in December...", according to said Bloomberg article.
2. and the ugly
The headline reason for a terrible bond market was that last week, the Treasury slated a record $75 bn in Treasury sales for this week, the one that we are living in now.
It is not so much the current quarter's borrowing requirements of $406 bn that concerned the market. But the outlook for the federal budget deficit does. Indeed, the Treasury is bracing itself for having to finance ever-higher deficits by doing the following:
- one measure is that the Treasury now has doubled the number of note and bond auctions to 72, according to the Financial Times (FT) of 6th August 2009;
- another is that the Treasury will increase the amount of Treasury Inflation-Protected Securities (TIPS) as of the new fiscal year starting this October. In addition, it may replace the current 20-year TIPS with 30-year ones, and
- finally, the Treasury will increase the value of paper issued at each auction. For instance, 10-year bonds used to be issued for $10 bn; that now has been increased by 70%, to $17 bn.
All of this means that more and more paper is going to be issued: watch out for a supply bottleneck. That is the "ugly" in our heading. Indeed, just watch out for one failed auction and the market will crash, taking stocks down with it. One "left field" trigger might be that it becomes public that the Chinese have not bought as many bonds as before...
What we are implying is that inflation is not really a reason to get worried about bonds. That is important. If people focus on inflation, and it goes away, they will keep buying bonds. But if people disregard the "ugly" - a rising U.S. Federal deficit worsened by less tax income due to a worsening Economic Time® - they will be caught by surprise at the bond market crash. The ensuing bond market crash thus has to translate into a stock market crash, what with the herd bolting for the door.
3. How to Make Money Off This Idea
- Always consult your financial adviser first.
- Get into an ETF through which you can short 20 year US government bonds, TBT:US. We have owned this since February and have gained about eight per cent. Indeed, since we recommended it to our readers on 22nd December 2008 it has gained a stellar 39.9%; indeed, that is over double the S&P 500's gain of 14.1% over the same period!
- Short those stocks of companies that are heavily into long-term, variable debt: their burdens only can increase.
