February 7, 2014
By Steve Blumenthal
What trips the wire? The bubble is in the bond market and it just might be the biggest bubble of them all.
The headlock we find ourselves in is caused by the massive weight of debt. We owe too much, we have promised too much and are not making enough. Out of sync, in steps the Fed and global central banks. We are desperate to find a way out. QE is powerful but comes with consequences.
I shared a great piece from Greg Weldon a few weeks ago. In it Greg smartly shared, “we theorize that there is significant risk associated with tapering, particularly when tapering turns into ‘tapping out’, when the Fed reaches the point where they are no longer buying to accumulate any assets. There is risk that ‘extends’ to the stock market, for its tight, reliant relationship with the Fed’s Balance Sheet. But more pointedly the risk emanates from the potential impact on US Treasury Bond and Note yields, as a result of an eventual ‘tap out’ by the Fed.” Click here for that full piece.
All eyes, from every corner of the globe, are on QE and the Fed. The problem is debt.
This week I share an excellent piece from my research partner, Niels Jensen, titled Challenging the Consensus and Dr. Lacy Hunt’s 2014 outlook.
I hope you enjoy this week’s On My Radar:
- Challenging the Consensus, by Niels Jensen
- Dr. Lacy Hunt
- Trade Signals – Pessimism Rising (a weekly piece on proactive risk management)
Challenging the Consensus
Investors are overwhelmingly bearish on bonds going into 2014. In this month’s Absolute Return Letter we challenge that view and look at various reasons why the bond market may surprise most people and deliver a positive return this year. In no particular order, those reasons are:
- The emerging market crisis escalates further;
- The Eurozone crisis re-ignites;
- The disinflationary trend intensifies and potentially turns into deflation;
- The economic recovery currently underway proves unsustainable; and/or
- Flow of funds provides more support for bonds than anticipated.
Click here for the full piece.
Dr. Lacy Hunt
As Niels points out, it is unusual to see such consensus on anything in Wall Street. In fact, every Wall Street analyst polled sees interest rates on the 10-year between 3.25% and 3.75%. Not one predicts rates below 3%. Lacy sees rates lower.
- If the debt-to-GDP ratio were currently the same as the average from 1871 to 1999, total debt would be only $30.5 trillion, or almost half of the existing level. The debt-to-GDP ratio declined since peaking in 2009, but not enough to reenter the normal range. Moreover, the ratio resumed its upward trajectory in 2013. Thus, the US appears to be following the Japanese example of trying to cure a debt problem by accumulating more debt.
- Scholarly research conducted in the US and Europe over the past three years indicates that the amount of government debt relative to GDP has reached levels that historically have produced a deleterious effect on economic growth. This effect has historically lasted two decades or longer. As termed by European researchers, the current levels have reached the “non-linear zone.” This means that the negative effects on growth are likely to intensify as this debt ratio moves higher.
- Ignoring this research is ill advised, especially since the debt levels are still advancing. Although the US budget deficit was smaller last year, the more critical debt ratio continued to rise.
- New research shows that the world average of total public debt, expressed as a percent of global GDP, is approximating its highest level since 1826 (IMF Working Paper WP/13/266, “Financial and Sovereign Debt Crises: Some Lessons Learned and Those Forgotten,” December 2013, by Carmen M. Reinhart and Kenneth S. Rogoff). Private debt to GDP in the Eurozone and the UK (and interestingly, in Japan) are all higher than in the US and even further above the levels that research has identified as being detrimental to growth.
- Concluding: The slow nominal growth rate anticipated for 2014 should continue to put downward pressure on the inflation rate as insufficient demand continues to foster highly competitive markets. With slower inflation, lower long-term interest rates are a probable outcome.
Trade Signals – Pessimism Rising (a weekly piece on proactive risk management)
Click here for a link to Wednesday’s Trade Signals.
Trade Signals identifies the equity and fixed income markets’ cyclical trend and suggests ways to hedge your long-term focused equity exposure tied to periods of excessive investor optimism. Charts are posted weekly on Wednesdays.
Powder SNOW!
It’s very early Friday morning and excitement is in the air. I’m in Bend, Oregon with my good friend and mentor, Jim Ruff. While en route yesterday, I received an email from Jim: “the big storm we’ve been waiting for is here”. Wifi at 33,000 feet – I about jumped out of my seat. To a skier there is nothing in the world quite like fresh powder snow.
Last night’s meeting ran long and we finished at Deschutes Brewery. With more than two feet of snow, we decided to push today’s meeting to 2:00 pm. Dressed with skis and helmets in hand, we are heading to ski Mt. Bachelor. Hopefully first in line! More snow is on the way for the weekend! Like a kid on a snow day, I am totally excited.
Wishing you an equally great and fun filled weekend!
With warm regards,
Steve
Stephen B. Blumenthal
Founder & CEO
CMG Capital Management Group, Inc.
Philadelphia – King of Prussia, PA
steve@cmgwealth.com
610-989-9090 Phone
610-989-9092 Fax
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