The paragraphs below are excerpts from a recent report by David Rosenberg, chief economist and strategist of Gluskin Sheff & Associates.
The consensus says that the era of the secular decline in government bond yields has come to an end because of the very low yields and the massive reflation efforts from governments everywhere. The consensus is that inflation is going to have to show up somewhere at some point. That may well be true, but despite huge policy initiatives, long-term bond yields did not hit their bottom in the US until late 1941 at below 2% and this was a good 12 years after the initial shock.
Nobody built more bridges or paved more river beds than the LDP did in the 1990s in Japan, and despite a doubling in the government debt-to-GDP ratio and multiple credit downgrades, the yield on the 10-year JGB did not hit their lows at less than 1% until 2003 - again, this was 13 years after the initial shock. To be sure, there were selloffs and spasms along the way, but it took years for fiscal and monetary policy to finally break the downtrend in bond yields.
To be sure, this has been a brutal year for US Treasuries, with the yield on the 10-year note nearly doubling this year at the June 10 peak of 3.98% (though the Treasury market has generated a +2% return so far in July - the first positive showing since March). From our lens, it cannot be said that the secular bull market in bonds is over until the 10-year breaks above 5.26% because then and only then will we be able to say that for the first time in this 28-year secular bull phase, the prior interim high was 'taken out'. Look at the time series below and you will see that ever since bond yields peaked during the inflation bubble of 1981 they kept on hitting lower and lower 'highs' during the eight cyclical selloffs, and they continuously made lower 'lows' during the intermittent eight cyclical rallies. That is how a secular bull market is ultimately defined:
October 26, 1981 (High): 15.60%
October 13, 1982 (Low): 10.39%
June 25, 1982 (H): 14.76%
May 4, 1983 (L): 10.12%
August 8, 1983(H): 12.20%
April 6, 1986 (L): 6.98%
March 20. 1989 (H): 9.53%
October 15, 1993 (L): 5.19%
November 7, 1994 (H): 8.05%
October 5, 1998 (L): 4.16%
January 20, 2000 (H): 6.79%
June 13, 2003 (L): 3.13%
June 12, 2007 (H): 5.26%
December 8, 2008 (L) 2.08%
June 10, 2009 (H): 3.98%
Keep in mind that over half the time, bond yields hit their fundamental lows in the June-December period; and we also know that Treasuries have rallied in 15 of the last 20 third quarters. So the seasonals, if nothing else, are quite positive for the fixed-income market during this time of year.
Will Rosie be on the money? I am not so sure. The graph below shows the historical relationship between the US GDP-weighted Purchasing Managers Index (PMI) and the yield on 10-year Treasuries. Should the PMI show further improvement and break above 50 (indicating expansion), long bond yields may not have much downside potential. In any event, I am not sure who wants to sink money into a 10-year T-Note with a 4% coupon that is losing 6-8% a year as a result of dollar depreciation.
Source: Plexus Asset Management (based on data from I-Net Bridge).