(This article was later published on Seeking Alpha titled "Pessimistic Investors Are Missing the Boat in 2010, Again.")
There is an abundance of pessimism in the investment crowd. Unemployment, foreclosure waves, federal deficits, enemic home sales, ... there is little wonder why so many commentators dwell on the negative side of every piece of economic data. If you go with the wisdom of this crowd, you should be shorting the market in general.
Yet short sellers have been frustrated so far this year. Nothing seems to work. In particular, the home building sector has been one of the top performers of the year so far (simply check LEN, DHI, SPF, PHM, or XHB). It is truely frustrating for investors who just cannot see any light in the housing sector, and cannot accept the fact that government support is sometimes necessary.
After a disasterous 2008, investors pulled record amount of money out of equities, and put them into bond funds and/or cash. Despite a roaring "V-shape" recovery in the equity market in 2009, narrowed credit spreads and expected rise in the yield curve, investors continued to pour $89 billions into bond funds in the first quarter of 2010.
PIMCO has been the prime beneficiary of this inflow. Its "new normal" thesis has been well-argued and publicized which has also help draw money into bond funds. All this money however may make it extremely hard to keep up with the performance, given the potential inflation and potential rise in rates.
Finally, PIMCO warned that bond funds may have seen best days. They have even started to offer stock funds.
One clearly can see at least two different types of herds here: the avoid-equity-at-all-cost crowd that stampeded into bond funds and the pessimism-dwelling short-selling crowd. One would think that the second crowd may be more sophisticated and better informed, yet they may be just one-year behind the curve after investor like John Paulson has already made his killing in 2007-2008 and went long into financials.
The trait of the investment sheep makes them dwell on one direction for too long. Such sheep showed up in force in the last housing boom. And we may be seeing them again in the abundance of extreme pessimism in 2010.
Subscribe to:
Post Comments (Atom)
Kehong,
ReplyDeleteI agree that investors have been chasing the wrong money in bonds which is good because it sets up a great trade to short bond prices thru higher bond yields.
This can be done thru either the cash or futures markets. Low repo rates and coupons allow for good shorts in bonds. Bonds futures are also a good mechanism to take advantage of higher rates as long as futures traders understand the Cheapest-to-Deliver mechanism in bond futures.
However, it will be harder for 30year yields to rise much further until the 2-year can be moved higher. The 30-2 yr spread is very high at 375 bps. Over the past 20 years, each time it has reached this level it likes to come back in.
MO
Michael,
ReplyDeleteSo glad to see your comment here. You taught me a great deal about the swap market back in the good old days at KMV. I see now you are putting your understanding and skill into practice.
I like your point about the yield spread. Important to note though that the Fed is anchoring the short end down at zero. So the curve is rotating counter-clock-wise when there is inflation expectation or there is weak demand. And this is probably special this time around. That may imply that the 30-2 yr spread can rise even further before all is done.
Besides the Fed and deficit, external demands are crucial as well. I'd watch China (and Japan).
Best luck...
Kehong,
ReplyDeleteI agree the 30-2yr has some room to widen. The 2yr-Fed Funds spreads is at 78 bps and may go to 100 which will give the 30-year yield to move up.
China is definitely on my radar screen as is Japan. Both have over USD 2 Trillion in foreign currency reserves with the middle east coming in third. I know they are not eager to purchase more US debt. The St. Louis Fed put out a piece that without the purchasing power of China rates would be 100-150 bps higher.
Just some thoughts. Sounds like you are doing great.
Xie xie.
谢谢！Are you learning some Chinese, Michael?
ReplyDeleteThanks for your thoughts. I'm doing just fine. Can't complain when I'm actually making money out of the crisis.
These foreign reserves (Thrift dollars and petrodollars) help finance the U.S. deficits. Some (like Paul Krugman) say it's a liquidity trap that prevents U.S. from recovering faster. Pretty absurd claim, I'd say. If the rates are 200 bp higher, housing could be sent into another big dip... so another reason for your trade is the rising protectionism. If that noise gets louder, I may actually short the long T bonds for a change.
I have been taking Mandarin. Good language to know. I can read and write it much better than I can pronounce it. I can never get the 4 tones correct. Ma flat, Ma up and down, Ma up, Ma Down.
ReplyDeleteMichael
妈麻马骂。I think the best way is to relate to specific examples that know well.
ReplyDeleteMy kids are going to Chinese school every week. For them, the problem is opposite: They can say and hear very well, but much harder to read and write.
Great effort, Michael. It's never too late for another language. You should do it together with your kids (got some already?).
I have a 4 1/2 year old. I actually took him to chinese class, unfortunately, they were having much more fun in the spanish and italian classes. So that is where he wanted to be.
ReplyDeleteIt's great that your children will grow up bilingual.
Michael.