Bond Guru Gary Shilling Thinks This Bond Rally Is Alive And Well by John Mauldin, Mauldin Economics

In 1981, as inflation and Treasury yields were screaming to new heights, my good friend Gary Shilling announced, “We’re entering the bond rally of a lifetime.” He was right. That bond rally is already 35 years old, and I think it will continue.

Gary also thinks the rally is still underway. He backs up that claim with a compelling case for Treasurys and for the “long bond” (the 30 year).

Gary recalls his famous public debate on stocks versus bonds with Professor Jeremy Siegel of Wharton, in 2006. This was just before the Great Recession kicked in and sent Treasury prices sky-high. Siegel remarked to the audience, “I don’t know why anyone in their right mind would tie up their money for 30 years for a 4.75% yield” (the then-yield on the 30-year Treasury).

Then Gary asked the audience, “What’s the maturity on stocks?”

He got no answer. Gary pointed out that unless a company merges or goes bankrupt, the maturity on its stock is infinity. It has no maturity.

His follow-up question was, “What is the yield on stocks?” To which someone correctly replied, “It’s 2% on the S&P 500.”

Gary continued, “I don’t know why anyone would tie up money for infinity for a 2% yield. I’ve never, never, never bought Treasury bonds for yield, but for appreciation, the same reason that most people buy stocks. I couldn’t care less what the yield is, as long as it’s going down since, then, Treasury prices are rising.”

Here is a whole list of excellent reasons to give Treasurys the respect they so richly deserve.

“The Bond Rally of a Lifetime”

By A. Gary Shilling

(excerpted from the August 2016 edition of A. Gary Shilling’s INSIGHT)

We’ve been bulls on 30-year Treasury bonds since 1981 when we stated, “We’re entering the bond rally of a lifetime.” It’s still under way, in our opinion. Their yields back then were 15.2%, but our forecast called for huge declines in inflation and, with it, a gigantic fall in bond yields to our then-target of 3%.

The Cause of Inflation

We’ve argued that the root of inflation is excess demand, and historically it’s caused by huge government spending on top of a fully-employed economy. That happens during wars, and so inflation and wars always go together—going back to the French and Indian War, the Revolutionary War, the War of 1812, the Mexican War of 1846, the Civil War, the Spanish American War of 1898, World Wars I and II, and the Korean War. In the late 1960s and 1970s, huge government spending—and the associated double-digit inflation (Chart 1)—from the Vietnam War topped LBJ’s War on Poverty.

Gary Shilling, Bond Rally

By the late 1970s, however, the frustrations over military stalemate and loss of American lives in Vietnam as well as the failures of the War on Poverty and Great Society programs to propel lower-income folks led to a rejection of voters’ belief that government could aid Americans and solve major problems. The first clear manifestation of this switch in conviction was Proposition 13 in California, which limited residential real estate taxes. That was followed by the 1980 election of Ronald Reagan, who declared that government was the basic problem, not the solution to the nation’s woes.

This belief convinced us that Washington’s involvement in the economy would atrophy and so would inflation. Given the close correlation between inflation and Treasury bond yields (Chart 1), we then forecast the unwinding of inflation—disinflation—and a related breathtaking decline in Treasury bond yields to 3%, as noted earlier. At that time, virtually no one believed our forecast since most thought that double-digit inflation would last indefinitely.

Lock Up for Infinity?

Despite the high initial yields on “the long bond” (as the most recently issued 30-year Treasury is called), our focus has always been on price appreciation as yields drop, not on yields, per se. A vivid example of this strategy occurred in March 2006—before the 2007–2009 Great Recession promoted the nosedive in stocks and leap in Treasury bond prices. I was invited by Professor Jeremy Siegel of Wharton for a public debate on stocks versus bonds. He, of course, favored stocks and I advocated Treasury bonds.

At one point, he addressed the audience of about 500 and said, “I don’t know why anyone in their right mind would tie up their money for 30 years for a 4.75% yield [the then-yield on the 30-year Treasury].” When it came my turn to reply, I asked the audience, “What’s the maturity on stocks?” I got no answer, but pointed out that unless a company merges or goes bankrupt, the maturity on its stock is infinity—it has no maturity. My follow-up question was, “What is the yield on stocks?” to which someone correctly replied, “It’s 2% on the S&P 500 Index.”

So I continued, “I don’t know why anyone would tie up money for infinity for a 2% yield.” I was putting the query, apples to apples, in the same framework as Professor Siegel’s rhetorical question. “I’ve never, never, never bought Treasury bonds for yield, but for appreciation, the same reason that most people buy stocks. I couldn’t care less what the yield is, as long as it’s going down since, then, Treasury prices are rising.”

Of course, Siegel isn’t the only one who hates bonds in general and Treasurys in particular. And because of that, Treasurys, unlike stocks, are seldom the subject of irrational exuberance. Their leap in price in the dark days in late 2008 (Chart 2) is a rare exception to a market that seldom gets giddy, despite the declining trend in yields and related decline in prices for almost three decades.

Gary Shilling, Bond Rally

Treasury Haters

Stockholders inherently hate Treasurys. They say they don’t understand them. But their quality is unquestioned, and Treasurys and the forces that move yields are well-defined—Fed policy and inflation or deflation (Chart 1) are among the few important factors. Stock prices, by contrast, depend on the business cycle, conditions in that particular industry, Congressional legislation, the quality of company management, merger and acquisition possibilities, corporate accounting, company pricing power, new and old product potentials, and myriad other variables.

Also, many others may see bonds—except for junk, which really are equities in disguise—as uniform and gray. It’s a lot more interesting at a cocktail party to talk about the unlimited potential of a new online retailer that sells dog food to Alaskan dogsledders than to discuss the different trading characteristics of a Treasury of 20- compared to 30-year maturity. In addition, many brokers have traditionally refrained from recommending or even discussing bonds with clients. Commissions are much lower and turnover tends to be much slower than with stocks.

Stockholders also understand that Treasurys normally rally in weak economic conditions, which are negative for stock prices, so declining Treasury yields are a bad omen. It was only individual investors’ extreme distaste for stocks in 2009 after their bloodbath collapse that precipitated the rush into bond mutual funds that year. They plowed $69 billion into long-term municipal bond funds alone in 2009, up from only $8 billion in 2008 and $11 billion in 2007.

Another reason that

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