Items 1 - 6 - Join the Bond Bear Crowd. Ader's Musings⦠⢠The press, blogs and punditry are overwhelming us with bea
Join Titlethe Bond Bear Crowd January 19, 2018 By David Ader, Chief Macro Strategist for Informa Financial Intelligence
Ader’s Musings… • The press, blogs and punditry are overwhelming us with bearish bond stories, -- getting crowded and not a lot of new information behind it, -- can you be bearish on bonds and not worry what that means for stocks? • Rationale for 3.5% 10s-- which would seem to make bonds that much more attractive. • How do older demographics alter spending habits? -- some ideas behind potentially under- and outperforming sectors. • Some pretty big shorts in bond market, • Some pretty overbought sentiment in stocks. Curious, have you come across anything recent about bonds yields rising? A Google search on “end of bond bull market” pulled up 13.3 million articles about that in 0.45 seconds. A search on “bond bear market” came up with 11.4 mn. In context, anything related to bond bull or market came up with 1-4 mn references. I guess that cat is out of the bag, huh? An article, more a blurb, in the WSJ’s Heard on the Street put it succinctly last Tuesday with the headline “In Treasury Market, There Are Reasons to Expect Trouble.” It starts off saying 3.5% 10s is doable by the end of the year. Behind that potential are 1) the price action so far this year, 2) the behavior in TIPS on the back of gains in oil, various wage hikes and bonuses in ‘celebration’ of the tax cuts, 3) the acknowledged ‘dubious’ reports about China buying less and 4) the BoJ buying fewer JGBs. There’s more. It talks about 5) ‘undigested’ factors like more bond issuance to deal with the expanding deficit, 6) the White House’s stance on trade and how that might raise import prices while reducing demand for US assets. Finally, it tackles the term premium, negative, simply rising to zero (from -45 bp). Add all that up and they say 3.5% is ‘within reach.’ And that’s all good and fine and all, and I, too, am somewhat in the bearish camp though not to 3.5%. That level implies a steeper curve, sharply so, assuming the Fund’s rate closes near 2% and change.
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Title I’m not knocking what they wrote at all. However, I didn’t read anything new. I didn’t have chance to read all of the 13mn Google finds on the end of the bond bull market, but enough to give me the gist of that matter. To items 1-6 I can add the 7) the softer tone to the dollar, amidst 8) better global growth, which is provoking 9) tighter monetary policies and less QE in most of the G7. What I’m saying is we know all this and have for a while and that the price action that starts the new year, which is seasonally habitually bearish even in bull markets, is not necessarily prologue especially when risk assets -- read stocks -- are also subject to all of the above. Sauce for the goose and all that. The point is you can’t confidently talk about 3.5% 10s without asking what that means for stocks. Or you shouldn’t. Which, of course, brings up relative valuations. The spread between 10s and the S&P 500 dividend yield is about 60 bp. If 10s were to rise 100 bp and assuming that yield on the S&P 500 was steady, the spread would be 160 bp (check my math if you like). 164 bp is the mean since 2000 and 14 bp is the mean since 2012! My point is that push 10s up and they look quite attractive to stocks surely. 3.5% would be, I think, a gift next Christmas if 10s get there, but let’s not get too greedy. Again, I think we get 10s to 2.85%-ish and stall there in, more or less, the middle of the year. I also think that if all the factors mentioned in WSJ and by 13 mn others come to fruition, the risk is for a more aggressive Fed keeping prospects for a 100-150 bp Funds/10s spread a very unlikely prospect.
As an aside, there is a small worry that came up from various sources from a wonderful, if complicated, chart in the WSJ that I’ve attempted to provide here to an article in BBG ({NSN P2OEK46VDKHY }) on the same topic; corporate cash coming home. Not the best image, I know. Anyway, between this piece and the BBG story, the upshot that this cash isn’t entirely cash but invested in short-term instruments like Treasuries and IG debt. How much of the $3.1 trillion of that will come back or rather how much will be sold if held in debt instruments? No one claims to know the answer, and if indeed it’s short-term it could just be allowed to mature.
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And the use? Well, buybacks and dividends continue to be the main thrust of it, according to various articles, surveys and comments. How much pressure it has on the shorter end of debt markets is, again, hard to decipher but it does mean at least potential selling and less buying. To the extent it’s used for buybacks and dividends it is, obviously, a good thing for the narrow scope of the companies that have all that cash. CHARTS AND THEMATICS: Last week I promised to go over some potential investment ideas for the coming decade, in broad equity categories, and will do so in a moment. But bear with me as I establish the evident macro theory behind that. The St. Louis Fed posted a study, “Older Workers Account for All Net Job Growth Since 2000.” (https://goo.gl/nnGGro). The most obvious reason for this is the aging population. The percent of people 55+ has gone from 27% in 2000 to 36% today. Another reason they provide is that the employment-to-population ratio for the 55+ cohort rose from 31% to 39% over the same time -they’re staying in the workplace longer -- while it dropped from 77% to 72% for you younger folks. While the researchers say the trend probably won’t last at that pace, the projections don’t reverse it. By 2027, the Census Bureau estimates the 55+ cohort will reach 23.7% of the population from 23.1% now, for example. Employment as a % of total for the 65+ cohort will increase to 8.4% from 6.2% today (it was just 3% in 2000). To be sure, the research says that ultimately the shift to stronger gains for people under 55+ will take place and to the extent the aging of the workforce has held back growth, that trend, too, will shift. However, it’s not today’s story. Or tomorrow’s. “The Census Bureau expects the age structure of the population to shift permanently toward and older population, but the most rapid changes relevant for the workforce will have occurred within the next decade or so.”
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Which brings me to the point; there are spending habits that we can anticipate in the coming years that may make certain areas more attractive from an investment POV relative to others. Depends, right? No, I don’t mean a specific product like adult diapers, but whether older people stick to their habits. Let’s establish the trends. This chart shows various cohorts as a % of the total population going forward. Note the two rising lines are for the 55+ category and 65+ category with the projection that the former will reach 36.7% of the population by 2030 from 35% today and 65+ will hit 20.3% from 15.5% today. The highest spending cohorts of 45-54 yrs will decline relative to the rest of the population, to 11.7% from 13%, while the 35-44 yrs will gain to 13.3% from 12.5%. Kids under 25 will fall to 31% from 32.3%.
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Title The next chart is of the big picture showing overall spending by age categories or cohorts. Notably the biggest spending phase is 45-54 with 35-44 close behind. These are the typical years for household formation, kids, home buying and renovation, and all the other junk we accumulate and put away to collect dust because we don’t have the heart to throw it away. Unless you live in the suburbs and frequent garage sales and wonder who would ever buy that stuff in the first place. But I digress. The take away is those spending years giving way to vastly reduced spending years. Do note this is 2016 data.
Now let me get into the nitty-gritty some of which is obvious I admit. But think of it this way, if you and I were to put together a ‘demographic’-based fund or ETF, the following would serve as a guide as to where to under or overweight things. That’s my goal bearing anyway. Starting with clothing, you see readily that buying peaks for the 35-44 yr old cohort and really falls off after 55. This makes sense if you look at the clothing, for instance, that I wear. I mean, you can resole those Bean Boots an awful lot of times and I still wear the suit I wore in January of 2008 when I forced that British Air flight to land in Iceland. (By the way, this week marks the 10th anniversary of that incident and the suit is looking a little ratty. Ask if you’d like to read my “Icelandic Saga” about the event.) In any event, I’d underweight fashion.
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Title Older people eat out less, though knowing the current aging generation I suspect they’ll behave somewhat differently and eat out more. Here the question is where they’ll eat. Fast food for health and taste reasons probably gives way to something a bit more upscale and so I’d put this as a neutral to slight overweight (get it, overweight?) in the portfolio. Oh, digression. I live in tiny Westport and there are a number of nice spots that offer half-off wine on Sunday and Mondays or other deals is growing. Keep an eye on those sorts of places catering to a retiring crowd.
Entertainment holds pretty steady until you hit the 75+ folks. This would be an overweight. I was impressed that the 55-74 crowd spent so much on entertainment and have to imagine this continues or expands into the golden years. My dearly departed mother would call me and rave after seeing Charo perform at various locales in Florida and cost was no issue after the early-bird specials. In the recent past or so I’ve seen 10,000 Maniacs, The Weight, the Fab Faux, the Guess Who, John Fogerty, Blondie and met Paul and Ringo in a men’s room…the new normal I guess. Consider the convenience of, “Alexa…turn on Stranger Things, turn the heat up to 68, call Dr. Horn and schedule a flu shot….” I think that constitutes entertainment.
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Title This is no surprise, but spending on health rises and holds steady at a very high level. Indeed, this is the biggest spend for older cohorts. Big pharm is an obvious spot -- overweight and I like the dividends AND the rest of the world is aging and getting wealthy so there’s that angle. I assume assisted living goes into this, and I’d look to things from PT/OT centers, home health aides, and the like so it’s a broad category.
Spending on shelter declines, though the absolute dollars hold quite high. I think this is a negative for homebuilders and suburbs, but a positive for multi-family companies and, obviously, those that cater to assisted living types of facilities. Too, I imagine that the sort of senior communities that they made fun of in Seinfeld will do well though perhaps with a tad more, err, umm, sophistication. Given the recent tax changes and the evident threat to senior entitlements in the years to come, low tax states and/or those with good retiree benefits should outperform. Think about 6-month and 1 day leases for snowbirds trying to take advantage of those tax ideas.
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Title This was a bigger category than I expected; Spending on Pensions and Insurance Premiums, but nonetheless slides precipitously as you would expect. That is, once you hit your older years you’re not putting away so much for pensions and insurance. Thus, I would tend to underweight these sorts of sectors as assets would tend to decline as retirees live off their savings. Then there’s the whole roboinvesting side of things, but that’s another matter.
There are vastly more categories I could go over but that would give away the founding tenets of the fund we’re starting up. For instance, transportation, audio visual equipment, types of food. You might be surprised how much older people spend on cars. But we can discuss all that at the board meeting. IN OTHER NEWS: I want to get back to the litany of bond bearish news out there to tease that it’s not really new news but adding to bearish momentum already in place. Thus, there’s a technical element to it. But back to the theme. The FT ran a story, “Bank of Japan spooks nervous bond investors” and it was, naturally, about the BoJ trimming its purchases. (https://goo.gl/3uwXNk). Here’s the thing; the same article downplayed some of those fears. In reference to Kuroda talking about the ‘adverse’ economic effects of low rates, the FT’s writers suggested this exacerbated market fears about scaling back accommodation. They then wrote, however, “This is mistaken, say BoJ officials. Since September 2016, they say, the basis for BoJ policy is to keep 10-yr bond yields on Japanese government bonds at ‘around zero per cent.’ It now buys as many bonds as necessary to keep yields at the target.” Later they cite a strategist saying it would be suicidal for the BoJ to do anything that would strengthen the yen. Sticking with the theme here, the WSJ has a lot of variations of rate-related news. It’s lead Opinion piece Wednesday was about “The Tax-Reform Stock Rally” but in its depth posed the very relevant question, “But if QE lifted stocks as it expanded, will the reverse happen as it unwinds?” The Fed, they suggest, might be the biggest risk to growth and financial markets. That very same day, Martin Feldstein wrote a rather non-cryptic headline, “Stocks Are Headed for a Fall.” (https://goo.gl/uV8sZi). He gives four reasons, most of them related to higher interest rates. But his idea is that as rates normalize stock P/Es, too, will normalize. (In context, his normal is a 2% real yield on 10s which given about a 2.5% yield today implies 4.5%). So, if P/Es move, i.e. decline, to historic norms his math says that would reduce the value of household equities by $10 trillion. That would incur a $400 bn drop in consumption due to the wealth effect, or more than 2% of GDP.
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Title Let’s get back to rates rising. He cites four reasons. One I don’t quite get so let’s start there. He says the Fed’s boosting short-term rates and will do so until inflation gets to 2% -- “higher short rates will cause long rates to rise even if the slope of the yield curve does not increase.” Huh? Surely raising rates is not the way to boost inflation but maybe I’m just old fashioned? Too, raising short-term rates tends to flatten the yield curve, but there you go, and he does have a PhD after all. The other reasons are more to my liking. He brings up the shrinking balance sheet as meaning more bonds for the market to buy. He talks about the Federal deficit as a % of GDP rising sharply over the coming decade and thinks even the CBOs dire forecast (from 77% of GDP to 97% and that’s only debt held by the public, overall debt now is near 105%) is optimistic as discretionary spending and defense are shrinking as a % of GDP and there’s a need to reverse that trend boosting the deficit even further. Finally, he says that too easy monetary policy is created an overly tight labor market thus creating the risk that inflation will ‘shoot upwards.’ This all well and good and has merits which have been cited before. But that’s the thing, don’t we know this? At what point to we say it’s been well discounted and when do bonds attract the anticipated rout in stocks?
NEAR-TERM MARKET THOUGHTS: I imagine that most of what I’ve written already spells out the very consensus view, and repeats its themes that yields are headed higher. I’ve read more about a bond bear market than I have about overvalued equities in the last few weeks. I’m not sure that reflects complacency over stocks or economic optimism from sources as varied as global growth, the softer dollar and anticipation of the impact of the tax laws coming into play. Maybe equity cautionaries are tired of repeating themselves? It’s worth a look at sentiment measures, of which there are many, in thinking about the stock market. DSIs, the Daily Sentiment Index, is at a lofty 90.4% on a 5-day MA basis. It was 92.4% on Jan 11. How lofty is that? Anything over 80% is overbought and those sorts of reads match or slightly exceed the peaks of 2006-7. I’ve overlaid the DSIs with an 8-week % change in the S&P 500 to show this provides a very good contrarian read.
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Let me second guess myself a bit. This next chart looks at the same thing but from 2005-2008. Note that September ’06 through February ’07, the DSIs remained extremely overbought while stocks eked out further gains into the middle of 2007.
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Title By the way, the DSIs on TY and US are not so egregious. At 46% for US they’re quite neutral and at 21.8% for TY simply edging towards oversold territory, but not quite there. In other words, we don’t have a major contrarian alert on yields from these measures though technically and sentimentally 10s are really into oversold terrain. Which brings me to my near-term expectations. The market doesn’t seem concerned with what may inevitably prove a short-term government shut, if it happens, and neither will I. Data this week has been second tier and anyway the Citi Economic Surprise measure simply ground sideways (albeit at a high level) and next week’s data is pretty dull as well until Q4 GDP on Friday. This is all to say, there doesn’t appear to be a lot of external influences of an economic or political sort. Then there’s the Fed. In December, the Fed’s projection for the Funds rate at the end of 2018 was 2.1%. January 2019 Funds are 2.05% and the average rate for Dec ’18 is put at 2%. The point being is that we do have about three hikes priced in; I don’t see that changing in the next few weeks even if Trump errs on the side of the seemingly hawkish Vice Chairman. As I write that I guess I’m saying that the front end is relatively stable vis a vis monetary policy, so the risk moves out the curve. Technically, things are oversold. Fixed-income folks are talking about the dollar, oil, TIPs and ECB. These latter markets, too, seem a bit overdone; I mean, aren’t higher yields already reflecting tapering of QE from various sources? I’m not all that bullish. In fact, I still think yields will edge up to 2.85% and am prepared to push those goalposts closer to 3%. But for the near term, I don’t find too much new bearish inspiration, and the charts tell me we consolidate if not find a bit of footing. There is a high volume mode at 2.54+% in 10s built over the last several sessions that I expect will over stiff resistance if we can get there.
Curve-wise I like a bit of 10s/30s steepening to keep myself busy, and target 32 bp for a correction. 5s look like they can outperform, but they’ve looked that way for a while to little avail; however, I’ll stick with that one a bit longer. Vs 2s/10s I target 10.5 to 12.5 bp.
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Bringing 30 years of investment strategy experience to his role at Informa Financial Intelligence, David Ader has held senior positions at major investment banks and financial information firms as well as serving on investment policy committees and management teams. Most recently Partner, Head of Government Bond Strategy for CRT Capital, he headed the team voted #1 in U.S. Rates Strategy for 11 years and #1 in Technical Analysis for five years in Institutional Investor’s annual survey.
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David Ader is Chief Macro Strategist for Informa Financial Intelligence. For further information on our products and services, please see: https://financialintelligence.informa.com/
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