JG, i would agree that bonds look good under all the proposed scenarios - however, there is a lot of agreement on that point as the latest Rydex bond ratio shows. the big fly in the ointment are foreign money flows, for the first time in 20 years foreigners have been net sellers of t-bonds. to be bullish on bonds you have to either assume that domestic demand will more than make up for this or that foreign funds will return to the bond market. a big sell-off in equities would certainly be supportive for bonds, but barring that, the fundamental picture keeps deteriorating imo. while inflation has yet to show up in PPI and CPI, it is already a very real phenomenon in terms of money supply expansion in recent years. another problem is the ballooning trade deficit; it pressures the dollar, which in turn leads to more selling of bonds by foreign accounts. should Japan continue to recover, Japanese institutions will keep on repatriating funds. should the Yen continue to strengthen, the unwinding of Yen carry trade positions will also put pressure on bonds. the governments proposed reduction of issuance in light of the budget surplus is a big positive of course - if the surplus projections turn out to be true; they are based on the assumption that "Goldilocks" is here to stay, complete with eternally rising stock prices, no inflation and the willingness of foreign capital to bankroll the burgeoning current account deficit. a strong positive for bonds can be espied in Market Vanes bullish consensus data, which show a very low percentage of bond bulls, approximately 23%. however, the above mentioned Rydex ratio may be a better reflection of actual bond sentiment, as it shows the actual proportion of funds committed to either the short or long side on the bond. there is an interesting theory by Jim Bianco, who argues that bond prices will continue to go lower as long as stock prices stay high or go higher, as the stock market (in his opinion) has become the primary force driving the real economy via the wealth effect.
in view of all this, your best bet remains a correction in stocks - foreign inflows into U.S. equities have proceeded at a record clip this year, and should the stock market tank, some of this money will almost certainly be shifted into bonds.
so the question is: will the stock market tank? at some point it surely will, but i am far from certain that we have reached that point already. long term bull markets usually extend much further than most people expect, and since no rational argument is left to justify the markets valuation ever since past traditional 'high marks' in p/e's, price to book, dividend yields, etc. have been surpassed, we are reduced to look at the market mania from a purely psychological, or TA point of view. in the recent correction, important 'lines in the sand' or support levels, have held up to now,leaving the primary trend (=up) intact. at the same time, an increase in bearishness has put a floor under prices - arguing for yet another leg up. possibly, recent lows will be tested once more and only if that test fails will an argument for a larger decline be sound. certainly a 1/2 point rate hike would deal the market a major blow - which is why we won't get one. and a 1/4 point hike will be taken in stride - there is no telling how high rates have to climb over time to stop the market from continuing higher.
another possibility that has to be kept in mind is an as-of-yet unforeseeable exogenous event such as a major hedge fund collapse or the like, which could bring stocks down and produce the flight to quality you alluded to.
decisionpoint.com
regards,
hb
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