It all goes back to bonds

While stocks continue their momentum-driven run, the bond market is still the ultimate canary in the coal mine.

By Bill_Fleckenstein Aug 2, 2013 1:59PM

canary © Getty ImagesThe stock market has now weathered the bulk of an earnings season that was OK, on the surface, but not so great prospectively. On that note, I was forwarded a link to an article regarding the second-quarter letter from David Einhorn, Greenlight Capital's founder and president, who made a point that I thought was worth sharing:

 

"Indeed, in the recent quarter, 70% of companies in the S&P 500 'beat' the official street estimates, while forward estimates fell for roughly the same percentage of companies. At this point in the cycle, lowering the bar seems to be treated as bullish because it increases the likelihood of future earnings beats."

 

I wasn't aware of that specific percentage of companies that had lowered guidance, but I was obviously aware that it didn't make any difference to the stock prices of the companies involved.

 

There's no doubt this little game has been successful and is reminiscent of other crazy periods we have seen in the last 15 years. There is also no way to know how long it will last, but it is quite possible to know it is abject silliness, unless of course companies have been wrong to lower their guidance and actually do substantially better than they are currently forecasting. In that case, we would have to conclude that the market figured that out ahead of time.

 

That is not my expectation, however. Thus, this is a period of wild speculation that will end badly, as such periods always do, though it is impossible to know when.

 

Aussie dollar goes down under 

An interesting story from the foreign exchange market was that the Australian dollar was hit pretty hard on July 30 thanks to remarks by Glenn Stevens, governor of the Reserve Bank of Australia, who made it clear that he wasn't at all upset by the recent decline in the Aussie dollar and actually thought it would go lower.

 

In other words, he wants a lower currency, as do central bankers in Japan and elsewhere around the planet. The problem they all have is that, in a world where money-printing is perceived to be the solution to all problems, it is difficult for one currency to really decline against another; it can only decline against real goods and services, which has been happening for some time to various degrees, depending on the asset class or particular commodity, service or benefit you might be considering.

 

There is no doubt we have a higher level of inflation than what the Federal Reserve claims to want. However, with the Western world so anesthetized by easy money, none of the problems are taken seriously (for now), and they won't be, until they are.

 

Blood and Treasurys 

As for the ultimate canary in the coal mine (that being the bond market), it will be informative to see where yields are after the market has fully digested today’s nonfarm payroll report. The reason I point out the bond market is because 10-year rates are not too far from the highs they saw in the wake of the start of the Fed's "tapering" talk.

 

Regular readers know my view is that these rates have backed up not simply because of Fed jawboning, but also because of the fact that the bond market is potentially in the early stages of taking away the printing press from the Fed. Five-year rates have risen from about 62 basis points to a high of 1.60%, and are now around 1.47%.

 

So, even though the Fed has made a serious attempt to tell folks that, while it might taper, it surely won't actually tighten for years, the bond market has been unable to rally very far. If Fed Chairman Ben Bernanke makes it clear that he is not going to taper (or is unable to) in September, and if the 5-year note doesn't recapture a huge chunk of this rally (by trading down to, say, 80 basis points), I think a case can be made that the Fed has lost control of the bond market. If by some chance rates start to spike even higher, then we will really know that is the case.

 

It's sure to be a bonding experience 

When the bond market takes the printing press away from the Fed, life in America, and everywhere else where money printing is the main economic policy, is going to be very, very difficult. Bond and stock prices will be lower, which will hurt the asset side of everyone's balance sheet, and of course, rising rates will put a damper on certain aspects of the economy, most notably housing, while increasing the interest expense on government debt (thereby increasing the deficit).

 

When it is understood that the Fed can't solve the problems, there will be much more angst in general and, hopefully, we eventually will deal with the long-running contingent liabilities and deficit problem we have in this country -- though on this, I'm getting rather far ahead of myself. In any case, I believe the Fed has already started to lose control of the bond market, and we might get more information on that topic in the very near future.

 

On the air 

Click here to hear my most recent interviews with Eric King on King World News. We discuss perceptions regarding bubbles, the Fed, money printing, the funding crisis and how those factors might come into play down the road.

71Comments
Aug 2, 2013 7:25PM
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Devaluing the US dollar is the government's solution to the debt. Our creditors know they have a tiger by the tail in the short haul but see a great advantage in the long.  They know that when inflation devastates U.S. fixed income households, the political fallout will involve more promises that can't be kept, sending our credit further down the hole. In the mean time, the new Americans, who won't look like the baby boomers, or even share the language, will balk. At some point in time, our population will lose interest in preserving the republic. Look at Rome.

    

Aug 2, 2013 5:00PM
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I can't say for sure what will be the Canary in the Coal mine but you can be darn sure that what caused the Problem was never fixed. Talk of the Scam Derivatives on Big Banks balance sheet is virtually non-existent. Talk of the growing size of the FED's balance sheet is virtually non-existent. Seeing that Rates are still remarkably low relative to historical standards, rates might have to jump much higher to be viewed as a major indicator. It has been stated that as much as 60% of earning makes have been derived via Stock Buybacks. That in itself could be the Canary.
Aug 3, 2013 1:18PM
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I work as a real estate appraiser and I can tell you something is happening and it is not good, since interest rates on mortgage rates increased, (about 1%) volume has dropped dramatically. In discussions with  banks they told me that mortgage applications and volume have dropped over 50%. I think what this means is that any rate increase will cause tremendous damage to the economy, the Fed has it's hands tied if rates increase the economy will collapse and if they continue to print money they will be forced to raise rates. This is a classic catch 22, I guess after all the stimulus, nothing has really changed. 

Aug 2, 2013 7:14PM
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We're all just puppets on the big bankers strings!  No truth just manipulation.
Aug 3, 2013 1:09AM
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I have pulled a large percent of my investments out of bonds.  The future doesn't look to good for bonds.  Then, again, that's just my "guess" as there are so many manipulators and manipulations in the market, a single investor is at their mercy.
Aug 3, 2013 10:59AM
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If the U.S. Dollar should ever lose it's position as the top world currency, life in the United States could get real ugly, real fast.

 

Right now oil is still priced globally in U.S. Dollars. Countries like Russia, China and Iran would like nothing more than to get oil priced in something other than U.S. Dollars. If they should ever succeed in this regard, all the financial shenanigans of creating money out of thin air by Benji and his disciples on the FOMC will be meaningless as the value of the U.S. Dollar will plummet.

 

Paper dollars in the U.S will start to go the way of Germany's Weimar mark or Zimbabwe's dollar. If that should happen, in honor on Benji's contributions to our dilemna, I recommend his picture appear on the $1,000,000 dollar note.

Aug 3, 2013 6:15AM
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The progressives and liberal monetary policy makers are scared stiff of what could lead to an unraveling economy.  Any sudden world event that effects a commodity such as oil or food will lead to a devastating economic disaster.  Talk about recovery.....where is it?  Even this week in the background the BLS and Dept. of Labor are retraining figures to skew the numbers.  As Bill points out in the article the largest effect will be inflation, people are outside the box to realize it is devastating the currency.  The simple solution to wiping out the debt is to print money, but the large amount necessary makes a paper dollar worth a grain of sand. 
Aug 2, 2013 8:30PM
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I think the interest rates will go higher even is the fed continues buying bonds.>the oil price will continue to go higher as well as agriculture land prces.higher oil and higher land prices will make food and fish go higher.housing and rents are higher everywhere now.gold mines arre reducing gold output to adjust it to new demand.that will make gold prices go sky high soon together with palladium.AT that point all the world will begin duming us bonds.if fed keeps printing evem more money ,more  countries will dump us bonds and inflation  will never end.
Aug 3, 2013 2:35AM
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the canary in the coal mine is this health care law that was conceived in 08 and still not implemented yet because they are scared of the impact it will have on the economy think about it if you are a young person it would be better to pay a $99 dollar fine every year especially because you don't get sick as often and it would be better as a employer to pay a $2000 fine because getting health care for you're employee can cost as much as $15000 a year so the only ones getting the subsidize health care plans will be the people who need it  with pre conditions so when employees and employers only pay a combined $2100 but health care costs $15000 a year and that's only for now who's paying the tab again?
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Just about every country is trying to devalue their dollar so everyone will buy from them. Cheaper money means more goods can be bought, but it eventually leads to everyone's money not being worth anything.

When money is no longer worth anything we will have a World Depression greater than the Great Depression of the 1930s. It will be greater as more countries and their people are involved than ever before.

Watch out for the changes in the Gov't wanting to "control" more of what we do in "trying to save us" from ourselves.    When depressions come, more dictators come out of the closets to protect us.  You can see hints of it now without even looking hard for them.

Aug 4, 2013 9:56PM
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Bonds are debt!  Until there are good debts to buy, bonds are not going anywhere!  Could USA infra-structure be good debt (by Feds, States, Counties, Cities, and Corporations)?  Growth and building attitude needs to all come from all levels and put people back to work!  Tax revenues will flow even at existing levels to pay government bonds off into the future!  Great article Bill and expand the subject with ongoing coverage!
Aug 4, 2013 10:49PM
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Municipal bonds have already taken a pounding.  Detroit is about to go bankrupt.  If Mr. Fleckentstein is right the bond bubble is about to burst.
Aug 3, 2013 9:03AM
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Be careful right now - we are buying like mad! -
Aug 5, 2013 12:15PM
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We have been postponing the inevitable for five years now and it is about time to pay the piper. Band-aids such as Fed stimulus only work tempoarily. Eventually we will have to accept the fact the economy has to bottom out and start walking on its own before it will be able to get legs and run again. It will be painful for many of us but as the old saying goes, "no pain, no gain".
Aug 10, 2013 9:05AM
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Considering most central bankers are, in well-coordinated global moves, printing currency to "fix" the problems of too much debt, the quote of Herb Stein seems apt: "If something cannot go on forever, it will stop".  And it will not stop until the moment that they can no longer do so, and not a moment sooner.  I am very worried about the time when the U.S. Treasury can no longer pay retirees & especially those at the bottom of our economic ladder.  When people have empty stomachs, they become very angry, irrational & violent.    
Aug 7, 2013 10:30AM
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I hardly consider 2.6% on a 10 yr note to be the apocalypse. Rates are going to rise and actually need to. The stock market will adjust.
Aug 3, 2013 12:23PM
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Kevin Orr- the illegal Emergency Manager who filed the illegal Bankruptcy for the destitute City of Detroit- remarked yesterday that even when whatever happens is all said and done, the population will be untrained and incapable of filling job openings and frankly, no one else will be able to either. The gross disconnect is- that there is no business platform currently engaging in administration and Kool Aid financial gambling, that can convert to enterprise. Simply-- they are inept at actual tangible work and those who can do work are either enterprising or wallowing in the death throes from forced retirement. The stock and bond economies are fully adverse to the real people economy. Do you honestly see any balloon juice addicts giving themselves an 80% haircut like the one forced on the rest of the world? Do not kid yourselves with a condescending fantasy answer. Bonds- in and of their own ineptitude, have not fulfilled the promise of achievement that is the nature of a bond. All else is junk. Until we hear that major investors, institutions, nations, oligarchies and cartels will all take major losses, the prospect of a massive civil war that targets: lawyers, accountants, bankers, politicians, financiers, paper, button pushers and the worldwide web itself... is way more credible than an all-out world war 3. It's a cycle folks. We were supposed to take the best of the last one and create a new cycle on the theme. Instead, we kept the crap, it is stinking badly, and octogenarian billionaires wearing Depends are controlling the outcome for the next century. If you don't like it, WE have to stop it. My words are my rifle... what about YOU?  
Aug 6, 2013 5:03PM
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Good points Bill.  I had money in gold, and took half out recently. locking in my investment.  I am waiting for the Fed to fess up and admit that it is powerless to right the American economy.
Aug 3, 2013 10:01AM
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More advice designed to frighten the fixed income investor.  For the foreseeable future money printing will continue at a pace that will restrain rates (as well as the economy).  The Fed's only tool is the monetary gas pedal since it will take another election to bring some semblance of fiscal discipline to Washington.  Cheap money is either an elixir or a poison. So far the elixir crowd is in charge and the bond market is a follower not a leader.  "Don't fight the Fed".
Aug 3, 2013 8:32PM
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I have seen that when currencies devaluate prices of goods and services in that country go up through the roof. So when you go visit, any little ol' thing costs a bunch of their washers, but when you translate that number into dollars the price is still quite high and usually more than in the States. Travelers beware.
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This column is a synopsis of Bill Fleckenstein's daily column on his website, FleckensteinCapital.com, which he's been writing on the Internet since 1996. Click here to find Fleckenstein's most recent articles.

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