Is It Time to Finally Short the Long Bond?

Douglas Kass of Seabreeze Partners Management has recommended shorting the Long Bond through the purchase of TBF. Kass went through an exercise, making the case that long-dated U.S. Treasuries are overvalued and then he talked about what could trigger a massive stampede out of the dollar and U.S. Treasuries. Here are a few of his comments that make total sense to me:

“With the U.S. bond market (as measured by the 10-year note yield) discounting only +1.20% U.S. Real GDP growth, I am of the view that owning any U.S. note or bond is like picking up nickels in front of a steamroller.

“Besides being statistically (and even absurdly overpriced), bonds may be vulnerable to two fundamental events over the next few years that could make shorting them an outstanding investment and more than just a trade:

“1. There could be an unscripted burst of prosperity, in which the U.S. actually gets its economic “mojo” back and returns to 3%+ Real GDP growth. (This one I totally discount.)

“2. Market participants could Lose Their Faith in the world’s Central Bankers. I call this the”Ah Ha” Moment.

Bond holders around the world may now be holding “certificates of confiscation” — as they were known in the 1970s and early 1980s. At that point in history (1981), with bond prices continuing their uninterrupted decline, investors gave up on the asset class — just at a time when they shouldn’t have. Today, the movie is in reverse: bond investors have grown far too comfortable with the 34-year bull market move and have embraced the “safety” of the asset class. (This one your editor totally agrees with. It’s a matter of “when not if.”)

But, safety is a tricky investment concept. Safe assets are often the assets that most investors view as hopelessly risky. Unsafe assets are often the assets that investors view as having no risk — like bonds — as my previous muscle memory metaphor applies.

In summary, I am of the view (and this was expressed in my 15 Surprises for 2015) that the three-decade Bull Market in bonds will end this year and that the bond market is currently discounting U.S. Real GDP growth of only +1.2%. It is even possible that we are now about to enter a period that resembles 1946 to 1981, when bond prices tumbled and interest rates persistently rose. Though I think the previous 35-year rise in rates will be more subtle in the next few decades, the difference could be this time compared to the first decade of the rate rise (1946 to 1956) — when rates only rose by 100 basis points — that the initial movement will be more. I suggest this to be the case because dealers no longer carry large inventory of corporate debt — a residue of legislation that followed The Great Decession (Dodd, Frank) — so air pockets might occur if many try to get out at the same time.

Bob Hoye Agrees

On Wednesday of this week, Bob Hoye sent a special missive to his subscribers along with the chart on your left. He stated the following:

“The US Treasury market topped with our upside Exhaustion Alerts in January and then found initial support around the weekly moving averages (30-week average on the long bond and 40- week on the TLT). The bounce was anticipated to provide a selling opportunity in the TLT in the range of 133 to 135. The rally petered out at 132.64 and is now breaking down. The major support will now be at the 100-month moving average around 108 on the TLT. This equates to a 2.7% yield on the 10’s and 3.6% on the 30’s.”

A fall from 132.64 to 108 is quite a decline in the short term. I like to see collaboration before I pull the trigger on a trade.

On the other hand, Michael Oliver does not think it is time yet to short U.S. Treasuries. Here is what he said this past Thursday: “So, what we have going on in T?Notes now is a short term decline which is showing little potency in terms of price consequence ? more or less a congestion zone. If this time next week you still do not see material downside occurring, then it’s probably a good bet that this entire process of short?term momentum pullback was for the purpose of congestion ? within the larger positive upside trend.”

So I’m going to wait another week, as Michael suggested. But I am seriously considering adding TBF to my portfolio. If I do pull the trigger, it will be in next week’s newsletter.