Delation-hue and cry increase//CBS-Of bonds, bears and deflation
By Peter Brimelow, CBS.MarketWatch.com
Last Update: 12:02 AM ET Dec. 5, 2002
NEW YORK (CBS.MW) -- The other boot has dropped. That's bad for bonds -- but might also mean some unexpected nasty surprises ahead.
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Boot No. 1, of course, was Fed Governor Ben Bernanke's Nov. 20 speech, in which he promised that the Fed would "take what ever means necessary" to prevent deflation. See full story.
The investment letters have been chewing on it ever since. Consensus: the Fed means it.
Boot No. 2 is Pimco's Bill Gross. This fall, the "best bond fund manager the mutual fund world has ever seen" annoyed younger Wall Streeters by predicting a Dow decline to 5,000. (Read Brimelow's Sept. 19 column).
Now, in his monthly letter to clients, he has said that the bond market run is nearing its end. See full story.
As it happens, Mark Hulbert, through the Hulbert Financial Digest, calculates that bond timers' exposure is currently -20 percent.
That means they're bearish too, but not at the extremes that would allow Hulbert to take a contrary opinion interpretation. Unlike stock timers' exposure - Read Hulbert's Dec. 4 column.
There's an inexorable logic to these dropping boots. With interest rates as low as they are now, the only way to get substantial capital gains from bonds is through deflation.
Which the Fed doesn't want. And which it certainly can prevent -- but probably at the price of precipitating inflation. Remember inflation? A Wall Street generation has grown up that doesn't (Read Brimelow's Nov. 21 column)
Gross is old enough to remember inflation, though, as well as the 1940s-1980s bond bear market that accompanied it -- arguably the greatest bear market in the history of the world.
Do the math. Higher nominal interest rates must mean lower bond prices. And inflation drives nominal rates ever higher.
What caught my eye was this crashing sound from Boot No. 2's monthly letter:
"Bernanke listed several heretofore rarely used policies that would be emphatically employed by the Fed to avoid deflation: (1) should conventional open market purchases of Treasuries not do the trick, the Fed would extend out on the yield curve to include even long-term bonds, (2) the Fed could influence the yields on privately issued securities -- corporates and mortgages -- in order to lower the cost of private credit, (3) the Fed would buy foreign government debt in a thinly disguised attempt to lower the dollar and increase U.S. competitiveness and inflation at the same time."
Gross could have added Bernanke also remarked in passing that in 1933-34 the Fed finally ended U.S. inflation by... buying gold.
This type of "rarely used policy" is exactly what has been surmised by investment letters and others who suspect there has been significant market manipulation in recent years.
And in fact it is exactly what was going on, it now seems clear, in the 1998 Fed-orchestrated bailout of the Long-Term Capital Management hedge funds.
If the market bubble of the 1990s was kept going by "rarely used policies," its bursting could be even nastier than anyone suspects.
Except possibly Dow Theory Letters' septuagenarian superbear, Richard Russell.
Russell has been saying that this rally will end eventually and the bear market will resume.
And if it goes below 6,149, he recently said for the first time, "I can't discount the possibility of the Dow ultimately testing the 1974 low of [wait for it!] 577." |
