The 10th Man: The Crazy Man’s Guide to the Bond Market

I invite you to inspect the following chart of 10-year interest rates in the US.

If you don’t have a lot of experience with these things, let me clue you in: This is a very scary-looking chart. It’s a classic head-and-shoulders bottom in yields.

If you’re one of those people who’s scornful of technical analysis, don’t be. Now, I don’t pay much attention to complicated stuff like Elliott Wave or Gann Angles, but there are some very basic technical formations that work reliably most of the time.

I had the good fortune of taking out a mortgage when 10-year rates were at 1.9%, which goes to show that the only time you get to top-tick stuff is by accident.

Now, this is actually not the low in yields. 10-year yields got to 1.4% a few years ago.

Of course, interest rates are even lower in Europe. Take Germany, for example:

I think that these interest rates (which are at 700-year lows in Europe) signify a bubble. Other people don’t, though—they point to x, y, and z as signs of deflation.

I’m very weary of the inflation/deflation argument. A lot of people lost a lot of money betting on inflation when there were obvious signs of inflation (QE). And I fear that a lot of people will lose a lot of money betting on deflation when there are obvious signs of deflation.

I’m a trader at heart, and I try not to get too attached to my views. I pay attention to price. And right now, the price action is telling me that the bond market might be in trouble.

Central Banks Buy High and Sell Low

The first thing you need to know about central banks is that they are the worst traders in the world. The worst.

Probably the most famous example in the modern era was the Bank of England under Gordon Brown’s leadership puking its gold holdings—on the absolute lows, between 1999 and 2002. The idea was they had this gold sitting there not generating any yield, so why not sell the gold and buy paper that would generate some yield?

Whoops…

A less famous example of bad trading by public officials would be the US Treasury’s decision to issue floating-rate debt. Now, if the government has floating-rate liabilities, it should want interest rates to stay low, right?

Whoops…

The all-time lows in rates. To the exact day.

So with all this in mind, don’t you think it’s interesting that the ECB is going to buy European debt—at 700-year-low yields? At negative yields, in some cases?

Central banks do not buy things on the lows. They buy things on the highs.

Of course, the ECB is not trying to make money on these transactions. Which is the whole point!

The Worst Investors in US History Strike Again

Betting on the end of what is a 30-year interest rate cycle is not a productive use of our time. This bond market has claimed the careers of many investors. It reportedly hastened the retirement of Stan Druckenmiller, arguably the greatest investor of all time, who bet against bonds heavily, thinking yields could not go any lower. They did.

Let me impart some wisdom here: The first rule of finance is that there are no rules in finance. Nothing works all the time. My favorite dumb rule of finance is the one that says your percentage allocation in bonds should be equal to your age. So if you are 60, you should be 60% in bonds.

My guess is that if interest rates rise 2%-3%, people won’t be saying that anymore.

You know what I worry about? I worry about the baby boomers. I worry about this generation, the worst investors in US history, who got carried out in the tech bear market in 2000 and got caned in the financial crisis of 2008, and after having been hammered twice in the span of 10 years in the stock market, went all-in on bonds.

Why? Bonds are safe. Everyone knows stocks are not safe.

Now, in retirement, none of these people expect their bond mutual funds to get cut in half, which would happen if interest rates went up about 3%-5%.

Imagine if they did!

The disclaimer to all of this is that I’ve been a bond bear for many years, and I’ve been wrong. But for the first time, I think we have something approaching consensus that yields will stay low forever. People who think interest rates are going up are starting to sound crazy. I am starting to sound crazy. That probably means I’m close to being right.

If 10-year rates get above 3%, the previous high, we will know for sure. If that happens, pick up the Batphone, call the White House, sell everything. Why?

If you are still ignoring charts when they are making higher lows and higher highs, God help you.

Jared Dillian