Bond Investors Have Never Been So at Risk

Bond investors have never been so at risk... Duration soars to new all-time highs... 'The worst possible setup in history'... These bonds could plunge no matter what happens next... Is 'soft data' turning lower?...


Investors are piling back into bonds...

As we saw yesterday, they bought up record amounts of new debt – including riskier high-yield bonds and bond funds – over the first three months of the year.

But the sheer volume of bond buying isn't the only record that has fallen of late. Bond market "duration" has soared, too...

As regular Digest readers know, duration is a measure of a bond's interest-rate risk. As we wrote in the May 12, 2016 Digest...

Bonds with longer maturities generally have higher durations. This means they're more sensitive to changes in interest rates.

For example, according to Wall Street Journal data, one-year U.S. Treasurys have effective duration of 0.959 years. In simple terms, this means that one-year Treasurys will fall about 0.96% in price for every percentage point increase in yield.

By comparison, 10-year Treasury notes currently have a duration of 9.184 years (representing a 9.2% decline for every percentage increase in yield) and 30-year Treasurys have a duration of 20.692 years (representing a 20.1% decline for every percentage point increase in yield).

Said another way, the further out in time investors "reach" for yield, the more likely it becomes that even a small increase in rates could create big losses... losses that can dwarf the entire expected yield of those bonds.

Global bond market duration has been moving higher since the financial crisis, as central banks slashed short-term rates...

It hit an all-time high last year as the spread of negative-interest-rate policy ("NIRP") pushed rates to historic lows.

As you might guess, duration had been falling as interest rates rose last fall. But that is no longer the case.

While interest rates remain significantly above last summer's lows, duration has now jumped to new all-time highs...

As "Bond God" Jeffrey Gundlach – CEO of investment firm DoubleLine Capital – noted to the Financial Times this week, this means bond investors have never been more at risk than they are today...

Duration has never been this long in my career. With rates near the lowest levels ever and duration at literally the highest level ever, it is the worst possible setup [in] history. You are [taking] more risk and getting less reward."

The rush back into bonds has coincided with growing doubts about the so-called "Trump Trade"...

After all, if Trump's "big three" policy proposals falter, so, too, could expectations of higher inflation (and therefore interest rates). The weak-growth, low-inflation environment of the past several years could return, and the bull market in bonds could resume.

But we think bond investors betting on this outcome are missing something important. As Porter explained on Friday...

One of two things is about to happen...

Either a significant restructuring of our tax code frees up billions and billions of capital currently stranded overseas and provides big incentives for U.S. corporations to invest heavily in America... or the credit cycle I've been reporting on since late 2015 is going to continue to roll over into a default cycle.

In other words, if Trump fails, we aren't likely to return to last year's "Goldilocks" environment for bonds...

If Trump fails, we're likely headed for a recession... or worse.

This would be a huge problem for bonds, as billions of dollars of corporate debt default and interest rates soar.

In short, in either likely scenario, interest rates could be headed much higher over the next several years... meaning long-duration bonds could suffer huge losses no matter what happens next.

In the meantime, we could already be seeing the first signs of economic weakness...

Earlier this month, we highlighted the record divergence between so-called "soft" economic data – survey-based indicators like consumer sentiment and small-business optimism – and "hard" (or quantitative) data. From the April 3 Digest...

As you can see in the graphic below, soft-data measures have soared since November's election. But hard-data measures have yet to follow...

This gap could now be closing, but not in the way we hoped...

Last week, two widely followed economic surveys – the Markit U.S. Services Purchasing Managers' Index ("PMI") and the Institute for Supply Management's ("ISM") Non-Manufacturing Report on Business – came in below expectations for March.

The Markit PMI fell from 53.8 in February to 52.8 last month, while the ISM's survey fell from 57.6 to 55.2.

While both of these measures remained above the 50 level – meaning they continued to expand – both have fallen significantly from their recent peaks.

The trend has continued this week...

This morning, the National Federation of Independent Business (NFIB) said its monthly survey of small-business sentiment fell to 104.7 in March.

Again, while this measure remained relatively strong in March, it has now declined for two straight months. And some warning signs are beginning to appear. As financial-news site MarketWatch reported...

The uncertainty index rose to 93, its second-highest reading on record. "More small business owners are having a difficult time anticipating the factors that affect their businesses, especially government policy," noted Bill Dunkelberg, the groups' chief economist. But pessimism was widespread in March. Of 10 survey components, only three notched an increase...

The March survey was conducted before Congress' failure to repeal and replace the Affordable Care Act, which has been one of NFIB's biggest complaints since it was first implemented. Much of the post-election bounce in sentiment was due to expectations that Congress would reverse many of the policies small business has chafed against for years.

"Congress' failure to keep its promises could dampen optimism, and that would ripple through the economy," NFIB said in a release.

Yes, these measures remain positive for now. But the recent declines are concerning...

They suggest that the optimism that has helped push markets higher since November is now waning. If these "soft data" indicators continue to fall, the market could soon follow.

New 52-week highs (as of 4/10/17): Alibaba (BABA), National Beverage (FIZZ), JD.com (JD), Nuveen Preferred Securities Income Fund (JPS), and Annaly Capital Management (NLY).

In today's mailbag, praise from a longtime reader... and a dangerous question about gold. Send your questions, comments, and concerns to feedback@stansberryresearch.com.

"Porter, you and the gang are mucho appreciated. I have become fairly educated thanks to your writings and cannot thank you all enough. While my managed retirement plans stay safe and continue along with their mediocre returns, I am taking your teams education and advice to ramp up my life. I am learning and living. Two great things... You all have truly changed our life." – Paid-up subscriber J.W.

"Please respond with the answer to this question... at this time on a low budget what is recommended to buy between these two options... physical gold or gold futures? How/where would you recommend to buy either based off your answer?" – Paid-up subscriber Brad V.

Brill comment: As always, we're unable to provide individual investment advice, but we view gold first and foremost as a form of savings. For most folks, real, "hold in your hand" physical gold – in the form of plain bullion coins – is the best place to start. If you have substantial wealth or wish to speculate, gold futures can be useful. But the nature of your question suggests you have neither the market experience nor the means to safely manage the risks of futures trading.

When buying bullion, the key is not to pay an inflated premium over the spot price of the metal itself. And it always helps to find a dealer you can trust. There are many reputable dealers out there, but one we know well is Van Simmons at David Hall Rare Coins. As always, we receive no compensation for recommending him, but Van has always treated our subscribers well in the past. You can reach Van by phone at (800) 759-7575 or (949) 567-1325, or via e-mail at info@davidhall.com.

Regards,

Justin Brill
Baltimore, Maryland
April 11, 2017