Long time since I last updated the blog. I have to admit to a little laziness creeping into me because I was on leave for 3 days last week and I did not even update even once. The truth was I was taking some time off to manage my own portfolio. Heh heh. So you guys miss me?
My favourite protege even smsed me to ask if everything was alright with me, after he did not see any new posts for more than a week. Ok ok I promise I will try to update more often, how about once a week? Fair? In my own admission, I have left out a stock or two which I have been accumulating over the past few weeks. Only my broker (whom I would like to express my condolences to, as his grand dad passed away this week) knew how I was positioning my portfolio.
I will probably try to post my biggest position on this blog tomorrow, but no promises on that. I need to talk about something which I feel more concerned with going into the 2nd quarter of 2010. First and foremost, I was having drinks with my protege yesterday and he was very happy that his baby stock was finally moving and I would like to thank him for having the patience to believe in the stock for so long. There was however one question he had on his mind that was bothering him. He asked " when will the music end". So my boy, I am here to give you the answer. Heh heh. No I am not. As I have said many times, I do not have a crystal ball, but I will continue to look out for signs and update all of you as and when I see them.
Before I begin, I would like to ask, what would you do if one day the best and most famous fruit seller tells you that all fruits are toxic now and if you eat them, you will suffer from poisoning or even end in death? Most of you would probably stop buying the fruits and steer clear of them like a plague. But how many of you would wonder, why would a fruit seller be the one telling you that the only thing he sells is poisonous? That is like shooting yourself in the foot. That is exactly what the greatest Bond fund manager has said in his latest market outlook for April 2010. He said that the 30 year rally in the bond market has probably come to an end and he believes that the bear market has arrived for bonds. That is rather interesting because he currently runs the largest bond fund in the world, at US$250 billion managed under the Total Return Bond fund, he has the most to lose.
From my experience, whenever the great Bill Gross warns of something, he tends to be right. I am pretty sure he is too. I have always been an advocate for equities and never a fan of fixed income. The issuance of bonds have been growing over the past 30 years exponentially, as corporates, governments, municipals etc raised money to expand, not needing to worry about whether they will be able to finance the bonds because they knew that they could issue new bonds to pay off the new ones. Just when you thought that Madoff was the biggest ponzi scheme ever. Enough of slagging fixed income. The reason to why I am writing about this is, if the bond market is going to be in a bear market soon, what is going to happen to equities?
Lets look at the reason to why Bill Gross believes that the bond party is ending.
1. Interest rates are going to rise soon.
2. Sovereign risks are rising.
3. Inflation or shadow inflation is going to erode all your yields.
4. Deficits are growing too quickly, leading to investors demanding higher yields on newer issues thus affecting the prices of older issues.
In the past, before the bond market rally started, there was an inverse correlation between bonds and equities. Whenever one did well, the other did not. Will this negative correlation continue to be relevant? I think the 2007-08 crisis has shown that correlation between asset classes have become intertwined. The globalisation of money flows has allowed money to flow into almost every asset class simultaneously, and when the music ended, money was withdrawn altogether. Will that happen now? Here is what I think.
The strong correlation seen during the crisis was due to risk aversion hitting a level which the world has not seen since 1929. When the chips fell, everyone and anyone just withdrew all their money from anything that had risks and went into safe havens like the Yen, USD and Gold. Many investors sold off assets that were in the money to pay for the losses sustained by other assets. That was why the good, bad and the ugly all ended up in the same place and one asset class could not be differentiated from the other.
My view on this revelation by Bill Gross only applies to the bond markets, more specifically developed bond markets. In the longer term, equities will be deemed more attractive, but in the short term, as bonds get sold off, there could be some weakness in equities. There is however a disclaimer I would like to make, that is, if the treasury market tumbles and we start to see hedge funds or large sovereign wealth funds get into liquidity issues, all bets are off. In short, equities will do well in a slowing bond market where yields rise slowly and bond prices fall in a stable manner. If the bond market ends up selling off in a frenzy, we could see another crisis like the one that passed recently. Why do I say that? Its because the global debt market is many many many more times the size of the global equity market and if it melts down, its going to cause another contagion.
From recent weeks, emerging market bonds have seen strong interest and issuance has been heavy. The demand of emerging market bonds is due to their stronger fiscal positions and better growth prospects. While at the same time, the past 3 US treasury auctions have seen very poor response. Many market watchers view this as the beginning of the end for the US treasury bills as a reserve asset. Expect higher yields on them going forward as the US govt will have to entice investors with higher yields to get them to buy the debt. In my view, investors are starting to see emerging markets as lower risk investments compared to developed markets like the US, Europe and UK. This bodes well for us, because it has been proven that emerging markets especially Asia has been very much unaffected by the credit crisis. So if the money flows away from developed markets, we will be the main beneficiaries.
The only wild card that could hit us hard will be China's problems. Trust me, if they have plenty of problems, its just that we do not get to read about them. Why do you think that Google has to leave?
The next hurdle we have now is the end of mortgage buybacks by the Federal Reserve next week. Once that ends, the other will be the end of other quantitative measures in June. We are in for a volatile ride, but the signs are still positive for equity markets.
Thats all I have.
Best,
SVI
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