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Subject:  Re: A Market Top for Bonds? Date:  5/8/2013  6:01 PM
Author:  globalist2013 Number:  34905 of 36385


Prices for key bond instruments create confusing charts. Every time I look at one I have to remind myself, “Interes -rates are the inverse of price. So ‘up’ is ‘down’.” Here’s an example of what I mean.^TNX+Interactive#symbol=^...

ARRGH! Let’s see. Last August’s low of 1.40 in yield had to also be the nearby high in prices for whatever price the 10-year contract was trading for at that time. So let’s pull a 6-month chart for ZN. Opps, no can do, because the relevant contract expired Sept ’12, or at least, I can’t do it through my account at IB, and to pull historical data at CME requires a subscription. OK, so it’s back to charts based on yield, instead of the price of the underlying. But the conclusion is the same. We’re long past a high in that market. Now, let’s ask “Why?” Why did yields -- and therefore prices -- reverse at Support/Resistance? Why did the yield on the 10-year fail to penetrate the 1.60 support level and go on to retest the 1.40? Why is it moving back up to 1.80?

Again, this where this “up is down” stuff confuses me. Does the Fed want higher interest-rates? No, that’s a certainty. As their balance sheet expands, what they have to pay to borrow expands linearly. But if rates rise, then the expansion becomes geometric ,and pretty soon borrowing costs alone will exceed revenues, never mind being able to repay principal. OTOH, the Fed wants inflation to rise, so they can pay off their borrowing with cheaper money. When faced with the prospect of higher inflation, the rational response on the part of lenders would be to demand a compensating yield. OTOH, when those with cash get scared, they will pay any prices they have to in order to park that cash. So, Risk on = falling bond prices, and Risk on = rising bond prices.

ARRGH! This is a world only an economist could love. The rest of us, those trying to make a living from our investing, look at the matter differently. Bonds are like bell peppers and broccoli. If the price was $1.19 last week, and $1.29 this week, we conclude that prices are rising. If the same bond that offered us 7% last week is now offering just 6.5% this week, we conclude that prices are rising. But when average quality, invest-grade debt has become so disconnected from inflation that new issues can come onto the market offering what are in effect negative yields, but the issue is 2x/3x over-subscribed, you’ve gotta conclude we’re in the mother of all buying panics that characterizes market tops.

Consider some more anecdotal evidence. There’s roughly 250 market days per year. If your bond portfolio averages 3 bps per market day, you’re making 7.5% per year, which is a reasonable benchmark for average quality invest-grade debt, or it used to be. If you’re running a properly diversified, multi-sector bond portfolio, a not unreasonable benchmark would be 10% per year, or 4 bps per market day. But if, in fact, your average gains per market day are tagging double, triple, quadruple, quintuple of that, you’ve gotta conclude that ”things aren’t normal” and the sand is going to hit the fan soon, because those kinds of returns are the sort of unsustainable froth that characterizes market tops.

Thanks for the kind wishes for my family and the fishing season. As can be inferred from another post, my daughter is doing well. She got herself lost and had to retrace a day's worth of hiking. But she’s reporting no health issues like blisters or sore knees that have already sidelined a group she fell into and was enjoying their company. In a normal year, about 300 permits are issued for the PCT. This year, the number is about 1,000. That’s just for the through hikers. Another 500 have been issued for section hikers. So she’ll find plenty of other company.

As for fishing, the season doesn’t begin for us who fish the Mt. Hood watershed until the end of May. But I “blessed” a neighbor’s rod this morning as we fished for lawn trout. He’s the far more experienced builder. But I’m the more experimental, and I discovered that decent, small creek rods can be built by dropping sections of longer piece blanks. E.g., a 7pc, 3wt 8’0” makes a 4pc 4’8” or a 5pc 5’3”. The engineers all scream that such a thing shouldn’t done. “You’re destroying the design taper.” But if you want a 30-gram rod that will throw 40 feet of line, but the 10’-15’ of line the rod was really built for on tiny, brushy waters for native fish, you do the hack. Paired with a 2.2oz reel (that nonetheless holds a full line) you’ve got a sweet rig no one sells commercially.

He’d taped on guides and was wondering whether his placement was optimal. The customary formula is to round up the rod length to the next even foot, add one, and then distribute them parabolicly. The Dale Clemens way is to place the guides using a combo of formula and field testing. Doing the numbers by hand is tedious. So I use software and often ignore field testing. My buddy is old school and does everything by hand. But he remembered I had used 6 guides on my 4’8”, whereas he came up with just 5. So we threw line with his and mine, and he really had nailed it exactly right for that blank. That’s going to be a sweet, sweet rod. The reel he’s hanging on it is way too heavy. He needs to pick up one of J Austin Forbes’ 2.2ozers. But it’s not likely that he’ll use the rod more than four times a season. So he doesn’t want to increase his costs. Me? I did eBay thing and bought a handful of them, just because good-quality, light-weight reels are impossible to find at affordable prices. (e.g., an Orvis Battenkill Barstock I is $125 and 3.2oz, but the Forbes 2.2oz can be found for around $80 from time to time. So “value investing” isn’t restricted to just stocks and bonds. LOL)

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