Significant likelihood that we have made the 30-year top in bond prices

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“To be clear, we are more non-ideological and practical/mechanical
because to us economies and markets work like machines
and our job is simply to understand how the levers will be moved
and what outcome the moving of them is likely to produce.”

— Ray Dalio

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Reflections on the Trump Presidency, One Week after the Election

What are the most important investment implications that you and I and your clients might consider post last week’s election?  My intention is to avoid a political discussion and look deeper into what the outcome means for the economy, the direction of interest rates and the direction of the stock market.

Let’s keep the intro short and jump right in.  Grab a coffee and find your favorite chair.  Included are some pretty cool charts (well, at least I think they’re cool).  I hope you find this week’s post helpful.

Included in this week’s On My Radar:

  • Dalio – Reflections on the Trump Presidency, One Week after the Election
  • U.S. Recession (Probabilities), Global Recession (Probabilities) and Inflation
  • Equity Returns During Rising Interest Rate Environments
  • What You Can Do About Your Bond Market Portfolio Exposure
  • Trade Signals – Trend Evidence: Equity Market Bull, Bond Market Bear

Dalio – Reflections on the Trump Presidency, One Week after the Election

In my impatient “get to the point” way, I share with you the key points that Ray Dalio shared in a LinkedIn article this past week.  You’ll find the full link below.  It is worth the read.  What follows are my highlights.

As you read, look past any particular political view you might hold and think in terms of inputs and outputs.  Pull this lever and x will likely happen, pull that lever and y will likely happen.  To this end, we require all of our interns and research team to read “How the Economic Machine Works.”  I also make my young adult children read it… and have gone as far as asking them to share it with their economics teachers.  OK – you get the point.

Following are my bullet points:

  • We think that Trump’s policies will have a big impact on the world.
  • Over the last few days, we have seen very early indications of what a Trump presidency might be like via his progress with appointments and initiatives, as well as other feedback that we are getting from various sources, but clearly it is too early to be confident about any assessments.
  • What follows are simply our preliminary impressions.
  • We want to make clear that we are distinguishing between a) the sensibility of the ideology (e.g., one leader’s policies might be “conservative/right” while another’s might be “liberal/left”) and b) the capabilities of the people driving these policies.
  • To clarify the distinction, one could have capable people driving conservative/right policies or one can have incapable people driving them, and the same is true for liberal/left policies.
  • To understand where we are likely to be headed, we need to assess both.
  • To be clear, we are more non-ideological and practical/mechanical because to us economies and markets work like machines and our job is simply to understand how the levers will be moved and what outcome the moving of them is likely to produce.

The Shift in Ideologies

  • As far as the ideology part of that assessment goes, we believe that we will have a profound president-led ideological shift that is of a magnitude, and in more ways than one, analogous to Ronald Reagan’s shift to the right.
  • Of course, all analogies are also different, so I should be clearer.  Donald Trump is moving forcefully to policies that put the stimulation of traditional domestic manufacturing above all else, that are far more pro-business, that are much more protectionist, etc.  (emphasis mine)
  • Whereas the previous period was characterized by 1) increasing globalization, free trade, and global connectedness, 2) relatively innocuous fiscal policies, and 3) sluggish domestic growth, low inflation, and falling bond yields, the new period is more likely to be characterized by 1) decreasing globalization, free trade, and global connectedness, 2) aggressively stimulative fiscal policies, and 3) increased US growth, higher inflation, and rising bond yields.
  • Of course, there will be other big shifts as well, such as pertaining to business profitability, environmental protection, foreign policies/alliances, etc.

…the main point we’re trying to convey is that:

  • There is a good chance that we are at one of those major reversals that last a decade (like the 1970-71 shift from the 1960s period of non-inflationary growth to the 1970s decade of stagflation, or the 1980s shift to disinflationary strong growth).
  • To be clear, we are not saying that the future will be like any of these mentioned prior periods; we are just saying that there’s a good chance that the economy/market will shift from what we have gotten used to and what we will experience over the next many years will be very different from that.

To give you a sense of this, the table below shows that:

a) these economic environments tend to go on for about a decade or so before reversing,
b) market moves reflect these environments, and
c) extended periods of movements in one direction (which lead to confidence and complacency) tend to lead to big moves in the opposite direction.


As for the effects of this particular ideological/environmental shift, we think that:

  • There’s a significant likelihood that we have made the 30-year top in bond prices. We probably have made both the secular low in inflation and the secular low in bond yields relative to inflation.
  • When reversals of major moves (like a 30-year bull market) happen, there are many market participants who have skewed their positions (often not knowingly) to be stung and shaken out of them by the move, making the move self-reinforcing until they are shaken out.
  • For example, in this case, many investors have reached for yield with the upward price moves as winds to their backs, many have dynamically hedged the changes in their duration, etc. (SB here: we have talked a great deal about this in recent letters.)
  • They all are being hurt and will become weaker holders or sellers.
  • Because the effective durations of bonds have lengthened, price movements will be big.
  • Also, it’s likely that the Fed (and possibly other central banks) will increasingly tighten and that fiscal and monetary policy will come into conflict down the road.
  • Relatively stronger U.S. growth and relative tightening of U.S. policy versus the rest of world is dollar-bullish.


  • All this, plus fiscal stimulus that will translate to additional economic growth, corporate tax changes, and less regulation will on the margin be good for profitability and stocks, though for domestically-oriented stocks more than multinationals, etc.
  • The question will be when will this move short-circuit itself—i.e., when will the rise in nominal (and, more importantly, real) bond yields and risk premiums start hurting other asset prices.
  • That will depend on a number of things, most importantly how the rise in inflation and growth will be accommodated.

Our very preliminary assessment is that on the economic front:

  • The developments are broadly positive—the straws in the wind suggest that many of the people under consideration have a sufficient understanding of how the economic machine works to run reasonable calculations on the implications of their shifts so that they probably won’t recklessly and stupidly drive the economy into a ditch.
  • To repeat, that is our very preliminary read of the situation, which is too premature to take to the bank.
  • Of course, we should expect big bumps resulting from big shifts regardless of who is engineering this big ideological shift.

So, what are we trying to say?

  • The headline is that the ideological/environmental shifts are clear, their magnitudes will be large, and there’s a good chance that the “craziness” factor will be smaller and play a lesser role in driving outcomes than many had feared.
  • In fact, it is possible that we might have very capable policy makers of the previously mentioned ideological persuasion in control.
  • As always, we will keep you posted of our thinking as it will certainly change as we learn more.

Source © 2016 Bridgewater Associates, LP

Speaking of LinkedIn.  I often share what I am reading.  You can follow me by clicking here and you can follow Ray Dalio by clicking here.

Earlier in the year, I received a call from my longtime friend and client Aram.  We met in 1985 when I was a young Merrill Lynch financial consultant.  Aram said his neighbor was making a killing in high dividend paying stocks.  The chase for yield drove many to such stocks.

Aram was missing out.  My immediate thought was, “That’s it, the secular low in yields is IN.”  I was less sure then.  I’m surer now.  The road to higher rates will not be a straight up path.  If you feel stuck in a fixed income position, I believe you should consider changing path on the next rally in bonds.  Think two steps up, one step back.  More below where I share a few ideas around what you can do.

U.S. Recession (Probabilities), Global Recession (Probabilities) and Inflation

Let’s first take a look at recession probabilities.  Why?  In recessions, equity markets take the most severe hits (think -30%, -40% to -60% or more).

I’m on record saying that the risk of a U.S. recession in 2017 is high.  I hold this view due to the quarter-over-quarter decline in corporate earnings and the length of the current business cycle (simply, it is aged).  We tend to get one to two recessions every decade.  The last was in 2008.

Further, the higher the valuation, the further the equity market will fall when recession strikes.  So we keep it on our radar.  I share several of my favorite recession prediction indicators in this next section.  In short, I see no immediate signs of recession.

Chart 1: Employment Trends Index.  This indicator continues to signal expansion.  Note the signals indicated by up and down arrows.  The shared areas represent past recessions.  I’m watching for a fall in the index by 4.8% to generate a recession signal.


Chart 2: The S&P 500 Index and the Economy.  If I had to pick my favorite “recession” indicator, it might be this next process.  It looks at the stock market as a leading economic forecasting tool.  That makes sense to me as if business turns down, it should show up in equity prices.

Here is how you look at this chart.  Expansion signals occur when the S&P 500 Index rises above its five-month smoothed moving average by 3.6%.  A contraction signal is generated when it falls below its smoothing by 4.8%.

Note the up and down arrows.  Again, recession is shaded.  Not all signals are perfect but overall a 79% hit rate is pretty darn good.  Today, no sign of recession.


Chart 3: Unemployment and 12-month moving average (read the notes in the chart for clarity.)

Chart 4: After five quarters in a row of declining earnings, we should have at least one eyebrow raised.  This past quarter showed stronger earnings and, as of yet, we haven’t seen (as indicated in Chart 3 above) a decline in equities below the five-month smoothed moving average.  However, an earnings recession of the magnitude we have witnessed over the last year and a half typically signals a coming economic recession.  So stay tuned…


Chart 5:  Global Recession Probability

Risk of global recession has improved.  Note the blue line in the following chart.  The data is based on a composite of leading indicators created by OECD for 35 countries – such as money supply, yield curve, building permits, consumer and business sentiment, share prices and manufacturing production.  Ned Davis Research (NDR) then weighs and scores these indicators to create a probability of recession model.

A score above 70 signals high recession risks, while a score below 30 means low risk.  Note in the box in the bottom right of the chart the percentage of time recession occurred when the score was above 70, between 30 and 70 (that’s where we are today) and below 30.

In short, odds of a global recession have decreased from 81.46% probability to somewhere between 46.41% recession to 53.59% no recession.  Shaded areas indicate past periods of global recession.


Let’s next take a look at what the data is telling us in regards to rising inflation.

Inflation Probabilities

Monitoring inflation is critical for investors because turning points in inflation often determine turning points in the financial markets.

Chart 1: My go-to chart on inflation probabilities is the NDR Inflation Timing Model (it is currently signaling “high inflationary pressures.”


Here is how the NDR Inflation Timing Model works: It consists of 22 indicators that primarily measure the various rates of change of such indicators as commodity prices, consumer prices, producer prices, and industrial production.  The model totals all the indicator readings and provides a score ranging from +22 (strong inflationary pressures) to -22 (strong disinflationary pressures).  High inflationary pressures are signaled when the model rises to +6 or above.  Low inflationary pressures are indicated when the model falls to zero or less.

As you probability know by now, I’m a big NDR fan.  I’ve been a client for years and share this information with you.  They provide independent data-driven advice.  My account rep is Dan Dortona ([email protected]).  Email him if you’d like to know more about their services.  (I do not get paid for this endorsement.  Just a big fan.)

The current state of rising inflation is a concern.  Keep this on your radar.

You’ll see in the interest rate charts that follow below that this is being expressed in higher rates.  Buy-and-hold bond investors are feeling the pain (loss).

Chart 2: This next chart takes a look at future inflation expectations.  Note how much it has risen since June:


Chart 3: Next is a look at CPI Services Index, the Consumer Price Index and CPI Commodities Index (note the rising trend of each – lower right-hand section of chart):


Chart 4: A look at the spike in the 10-year Treasury Yield:


Chart 5: The 30-year Treasury (a double bottom?)


Chart 6: Loss of Principal when rates rise.  I created this next chart and shared it in OMR when yields hit recent lows.  The 30-year yield has risen from a low below 2.20% to nearly 3% today.  That is a loss of approximately 16% in value.


Chart 7: Spike in Mortgage Rates


I’m really glad I refinanced my mortgage a few months ago.  2.75% on a 15-year mortgage has me feeling a bit better – especially when I see the spike in the above chart.

My thoughts on inflation.  Clearly, there is a pick up in inflation and the recent trend bears watching.  My view is that high debt (here, there and everywhere), higher interest rates and the strong U.S. dollar will keep a lid on inflation.  I share a few ideas what to do about your bond exposure below.

Equity Returns During Rising Interest Rate Environments

Recessions have proven to be the most difficult environment for owning equities.  I’m often asked about rising interest rate environments.  Many investors believe rising rate environments are bad for equities.

Following is some evidence that is not always the case (in short, not so bad – though some caution given our current starting place of ultra-low yields):


Many investors still follow the 60% stocks/40% bonds portfolio mix.  Periods of rising rates are disastrous for the 40% allocated to bonds.  And I’m not sure how well that 2.20% yield in 10-year Treasury bonds will help you in a rising interest rate, rising inflation world.

What You Can Do About Your Bond Market Portfolio Exposure

If we are at a secular low in yields, then that spells trouble, as Ray Dalio pointed out, for the millions of unsuspecting and ill-prepared investors.

  • There’s a significant likelihood that we have made the 30-year top in bond prices. We probably have made both the secular low in inflation and the secular low in bond yields relative to inflation.
  • When reversals of major moves (like a 30-year bull market) happen, there are many market participants who have skewed their positions (often not knowingly) to be stung and shaken out of them by the move, making the move self-reinforcing until they are shaken out.

There is no need for you to get run over.  Change your mind set on fixed income.  Look to trend following processes.

Recall in late 2014 that 25 out of 25 Wall Street economists predicted that interest rates would rise from a then 2.75% 10-year Treasury yield to 3.25%.  They were all wrong.  Rates finished 2015 at 2.25%.  One of the best return years for bonds – ever.

Here’s the point.  I too felt rates would rise.  That was my fundamental view, but I followed the Zweig Bond Model indicator and it kept me invested in bonds.  You can go back and see the model here.  Page down to the ZBM chart.

So what are our models showing today?

  • The Zweig Bond Model remains in a sell signal, suggesting a position in short-term Treasury bond exposure or “BIL.”
  • High yield bond prices appear to be stabilizing but remain in a “sell.” Thus, our CMG Managed High Yield Bond Program is positioned in cash (via the ETF “BIL”).

I’ve been in the “lower for longer” camp on interest rates; however, evidence is beginning to suggest otherwise.  I believe that the low in interest rates is in!  That doesn’t mean you should avoid bonds all together, it just means that you should trade them tactically.

Rising interest rates can be hazardous to your financial health!

Email me if you’d like to learn more about our tactical fixed income strategies: CMG Managed High Yield Bond Program and how you can follow the Zweig Bond Model on your own.

As you’ll see in the next section, Trade Signals, the equity model trend indicators remain bullish, while our go-to fixed income indicator, the Zweig Bond Model, remains bearish.  You’ll need to click through on the provided link to view the most recently posted charts.

Finally, rising interest rates are having an extremely bullish impact on the U.S. dollar.


Trade Signals – Trend Evidence: Equity Market Bull, Bond Market Bear – 11-16-2016

S&P 500 Index — 2,180 (11-16-16)

Posted each Wednesday, Trade Signals looks at several of my favorite stock, investor sentiment and bond market indicators.  It is my weekly risk management dashboard, designed to keep me better in sync with the major technical trends.  I hope you find the information helpful in your work.

Click here for the most recent Trade Signals blog.

Personal Note


Happiness is when what you think, what you say, and what you do are in harmony.
? Mahatma Gandhi

Remember that happiness is a way of travel, not a destination.
– Roy Goodman

Motivation is a fire from within.  If someone else tries to light that fire under you, chances are it will burn very briefly.
– Stephen Covey

The only way to do great work is to love what you do.  If you haven’t found it yet, keep looking.  Don’t settle.
– Steve Jobs

I was in Boston on Wednesday visiting my friends at 3Edge.  Love that city.  I’m traveling to New York on Monday for meetings and a few interviews and in Chicago on December 7-8.  And I’ll be speaking at the Inside ETFs 2017 Conference in Hollywood, Florida.  If you are planning on attending, please let me know.  I’d love to grab a coffee or better yet a good beer with you.

The DC area is in my immediate future – a weekend soccer tournament for one of our boys.  Susan is driving down today and my plan is to grab a train tomorrow morning and Uber to the field.  She’s lined up a few good restaurants.  Happy!

Speaking of happy.  Next week is Thanksgiving!  A wonderful time to be with those in your life you love the most.  I’ll be off next Friday so look for OMR in your inbox the following week. I will be updating Trade Signals, as usual, next Wednesday.

I was in search of a little motivation lift and came across the above quotes… With this in mind – raise your cup of coffee, cold beer or glass of fine wine:  Here is a toast to your happiness, your fire within and loving what you do!

If you find the On My Radar weekly research letter helpful, please tell a friend … also note the social media links below.  I often share articles and charts via Twitter that I feel may be worth your time.  You can follow me @SBlumenthalCMG.

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Wishing you a wonderful Thanksgiving holiday!


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