Farrell: What Bubble?

I saw no less than three articles over the weekend talking about the bond bubble. The bond market is not in a bubble phase. Bubbles are events like the South Sea Company fraud in 1720, when the South Sea Company bought up most of the British government debt. They negotiated an interest rate and got trading privileges to ports in China and Peru. Everyone knew there were pots of gold to be had and nobody paid attention to the Spanish government restricting the number of trading ships in and out of South America. As the history books tell us, some politicians were in on the deal. Imagine that. The stock of the South Sea Company went from £128 to £1000 and back, in nine months. The small investor who tried to go along for the ride on this, or on many other trading companies that raised capital and disappeared, got devastated. Most "investors" were wiped out.

The Tulip Bulb Mania struck Holland around 1637, and it got so out of hand that some tulip bulbs cost ten times the annual salary of a skilled craftsman. Records show twelve acres of land were once offered for one bulb. Some recent historical reinterpretation has taken a calmer look at the period, but the point is that many investors were wiped out.

We all know about the dot.com bubble. Companies with no revenues and no earnings were being valued on "eyeballs" and the "new economy" was going to rule and the "old economy" was done for. And millions got wiped out. And more millions got steamrollered and lost their homes in the real estate bubble. That one really hurt because we all knew you couldn't lose money in real estate.

Bubbles require excessive speculation, extreme leverage, and the possibility of complete loss of investment. Then, to complete the cycle, you need actual loss of capital. If you buy ten-year government bonds, for example, you might lose buying power if inflation were to return. But if you hold them to maturity you will get your principal back. You might have gotten a disappointing inflation-adjusted return, but I suspect a lot of dot.comers wish that were the worst of their experiences. Sorry, no bubble.

There is now consideration being given to selling 100-year bonds. It sounds crazy on the face of it, but insurance companies and pension funds could be eager buyers to be able to match their liabilities. They have been sold before, as an article in Monday's Wall Street Journal pointed out. They are most often offered by high-quality corporations. But with trillion-dollar deficits staring at us and with the average maturity of US debt being less than five years, the US government should sell every 100-year bond the market will take. Financing the deficit in the short end with rates so low is appealing. But some day rates won't be so low and we will have to turn the entire debt over in a very narrow window. It could/will get expensive. The aforementioned article referred to bankers who think it would take 0.75 basis points more than 30-year debt to entice buyers. It makes sense to me.

"Even though we are perilously close to 1040 on the S&P, I'll stay with my fervent hope we are in a trading range with 1040 the bottom end of the range" -Soleil Securities Group, Vince Farrell

The stock market makes sense as well, but it's bad sense. With truly lousy housing numbers on Tuesday regarding existing home sales, the market took a bit of a swoon. However the Richmond Fed Index(like the Empire State Index or the Phillie Index, but smaller) was off from last month but still in positive territory for the seventh month in a row. Now that's going some, to find positive news. I have never, and I mean never, quoted the Richmond Index, but straws are hard to find in winter and Richmond is now my favorite index.

The housing numbers were so bad it could give you a headache. What is also discouraging beyond the 3.83 million annual rate of sales number is the inventory of unsold homes rose to 12.5 months. I believe that is a record. That represents just shy of 4 million homes. In addition, there are still somewhere between 4 and 5 million homes in "shadow inventory." As we know, those are homes that are somewhere in the delinquency/foreclosure process. But let me say it again: This isn't new news, and if I know it, the market has probably priced it in.

I do confess that we have escaped back to my idea of paradise, Nantucket, and I am not right now able to get all the final things I usually get. But during the day Tuesday after the horrible housing news, the homebuilder stocks were up. There was a merger rumor whispered about between Pulte (PHM-rated Hold by Soleil/Torma Research, LLC) and Ryland (or Ryland and Pulte), and that maybe accounted for the uptick. Or maybe they are just sold out and are cheap. But it is interesting to have homebuilder stocks up on such depressing news.

Even though we are perilously close to 1040 on the S&P, I'll stay with my fervent hope we are in a trading range with 1040 the bottom end of the range. +/- 3% is allowed. My range, my rules. If we can hold above that the next two weeks while we struggle with a lot of market players away with the kids for the last gasp of summer, we might be OK. A decisive break-through this and statistical attractiveness or not, I fear a much lower market. Big market moves as we had from March 2009 are often, indeed usually, corrected by 1/3rd. That would be the move back to 1040. We went through this level earlier but recovered. It sometimes happens that a 1/2 correction hits you and that takes us back to about 950. I will be working diligently this week and then hiding my head in the sand next week. But I won't do any gasping while so hidden (which I know, dear readers, will disappoint some of you).