Bond Market Recovery - Real or Not?

The bond market is currently enjoying a decent recovery from a sharp selloff it experienced over the summer on Federal Reserve taper talk.  As welcome as this recovery will be for many bond holders, it in no way gives this market the all clear going forwards. It is a very common characteristic of early stages in bear markets of asset classes that the initial break comes rather quickly and without prior warning.  We can bet that almost nobody predicted the sharp spike higher in yields over the summer.  And that once it has run its course is followed by a strong rally (which we are likely now experiencing) that can remain in place for many weeks or even months.

Unfortunately this period of low volatility and recovery is rarely used by investors as an opportunity to sell positions; instead investors typically pour money back to the asset class in question arguing that they are buying a favored asset class at a discount.  Ironically, this was the case with gold in 2012 when holdings of the metal peaked in late December some several months after the price had already peaked at a significantly higher level. This allowed losses in the metal to remain fairly muted before its sudden collapse in earlier this year, which was matched by substantial liquidation of gold holdings.

Over the next several months, it is likely the bond market currently offers little upside and is far more dependent on the actions of central banks than the equity market.  While positions in individual bonds with short-term maturities and reasonable yields should hold up well, the high grade corporate bond market, bond funds, as well as the Treasury markets are likely to have significant downside volatility at some point in the future.  We will keep an open mind about how much longer this period can last, but the likelihood of a happy ending for those investors that take it for granted looks increasingly remote.

Politics, Politics, Politics...

After more than two weeks of a government shutdown and threats by Congressional Republicans to not raise the debt limit without serious spending cuts, Republicans conceded late Wednesday in their bitter fight with President Obama over the new health care law.  The House and Senate approved last-minute legislation ending a 16-day government shutdown and extending federal borrowing power to avert a financial default.

The shutdown sent Republican poll ratings plunging and this is the main reason an agreement was reached.  Most Americans believe it is the Republicans who are at fault.  However, everyone is at fault when House and Senate members put politics over progress.  The shut down cost the government billions of dollars and damaged the nation’s international credibility.

In the end President Obama refused to compromise so Republican leaders had to back down from their hard line stand and compromise on a deal.  Under the agreement to reopen the government, the House and Senate are directed to hold talks and reach accord by Dec. 13 (right before their holiday break) on a long-term blueprint for tax and spending policies over the next decade.  President Obama said stated that he is willing to talk about the budget once the government was reopened and the debt limit raised.

Unfortunately, there are absolutely no guarantees that Congress can work out a deal before mid-January, and there is deep skepticism in both parties that those involved in the budget negotiations, can bridge the divide between the two parties. It is possible we will go through the same process again in less than 90 days; which could rattle the markets especially if the government shuts down again.

Gov't Shutdown Actually Positive for Markets

The U.S. congressional standoff that shut down the government for the first time in 17 years could be considered an opportunity for investors, if history is any guide.
The Standard & Poor’s 500 Index has risen 11 percent on average in the 12 months following a government shutdown, according to data compiled by Bloomberg on instances since 1976. There have been 17 government shutdowns since 1976, with five of them occurring within three months of each other, according to data compiled by Bloomberg.

The last time there was speculation about a U.S. government shutdown was in August 2011, when the S&P 500 fell more than 11 percent in three days.  Stocks tumbled during the stalemate between President Barack Obama and Congress over whether to raise the debt ceiling and S&P stripped the U.S. of its AAA credit rating during the month.

The losses were later reversed over the next few months, as the Federal Reserve pledged to hold the benchmark interest rate near zero and maintain bond purchases to support the economy.

Although analysts’ have reduced earnings estimates for Q3 for the S&P 500, they still expect a significant improvement in earnings growth in the fourth quarter of this year (current quarter).  Earnings growth is expected to be up 10% in the fourth quarter vs. 3.2% growth for the third quarter.  This should add support to the stock market after the debates in Congress are resolved.  

Hopefully, when all of the silly games by Congress have concluded, the markets will rebound in the coming months, assuming earnings growth in the fourth quarter is strong.

Too bad this wasn’t an election year…