We have just lived through the most spectacular global bull
market run for the fixed income markets. This bull market rallied the bond market to
the lowest yields ever! Over a third of
all global fixed income was trading with a negative yield. The most accommodative central bank policies
made heroes out of bond fund managers. Bond investors that stayed fully
invested with fingers crossed, hoping for the greater fool theory to eventually
take them out of their overvalued position were rewarded handsomely. These bond managers are now managing hundreds
of billions in assets, have attained rock star status in the investment
community and are living the life of Riley. After such a spectacular run that has spanned
a decade, most fixed income participants have never witnessed losses in their
bond portfolios, never mind a bear market that lasts some time and delivers a
good amount of pain.
This recent back-up in yields has left many bond investors
confused, nervous and unsure what to expect. Well, rest assured, I’m here to
assist. After 25 years managing bond portfolios and trading trillions of
dollars in the bond market, I believe I have perfected my timing model that identifies
when a bond market selloff has run its course.
This proprietary model stands out for being unique,
intuitive and void of the quantitative modeling mistakes and biases. The model is quite qualitative,
psychologically driven and keys off the 7 stages of a bear market for bonds:
Stage 1: Shock. You
can’t lose money in the bond market, right?
Wrong. Losses from the recent
bond market selloff will be staggering. What has been significant double digit returns
over the last decade has ended. Yields
have jumped higher and are still historically low. Longer duration portfolios can be down over
10% in the past couple of months. Losses
have materialized in the most liquid sectors and will eventually spread to less
liquid bonds. Many participants are
dumbfounded, scratching various places but the itch doesn’t subside. The market is at the end of this stage and
there’s six more stages to travel.
Stage 2: Pain and Remorse. As bond managers and investors watch their
bond portfolio decline in real time, the losses hurts. But the real pain starts once these managers
issue their clients statements and the bewildered clients look to the managers
for answers. This gut wrenching pain of
disappointing investors and having a tangible negative impact on their beings
is a visceral hurt. These managers and
investors realize they, not the markets, are the source of these losses. There is an overwhelming feeling of guilt for
these losses and that they were not, somehow, avoided. Should these managers have told their
investors large potential bond market losses compensated by little to no or
negative yield probably wasn’t the soundest investment? Have you ever heard a
manager say you’d be better off taking your money back? Bond yields continue to
rise with no bounces.
Stage 3: Anger and Bargaining. Bond managers will get irate and phones will
be broken. Misplaced anger for losses that are accumulating will keep managers
and investors frozen, unwilling to cut their losses. They start to talk about all the things they
will do if markets reverse to limit their exposures. Too late. Everyone is making the same bargains. This stage sees one last parabolic rise to
higher bond yields impacting less liquid bond markets the most.
Stage 4: Depression and reflection. As losses deepen, the
market comes to the conclusion there is no bounce in bond prices. The prior low yields reflected a mispricing in
the market brought about by exorbitant enthusiasm. Another financial bubble to go down in the
history books. Once confident and
jubilant managers who knew no losses are reclusive, downtrodden and distant. Being a mortal human as opposed to a bond
managing deity is humbling. Bond yields
still grind higher and liquidity remains poor. There is a dearth of confidence.
Stage 5: The Beginning of a New Beginning. Depression starts to lessen and lucky shirts,
ties, socks and rocks start to come out of the drawers and closets. The flickering thoughts of a better future
inside and outside of the financial markets begin to appear. Could there be an end to this ugly chapter? Bond yields are still inching higher and
liquidity remains poor.
Stage 6: Rebuilding & Reflection. New financial conferences
on what went wrong in the bond market and how to avoid it in the future pop up
globally and are fully attended. Surviving
bond managers, albeit with much smaller assets to manage, talk about the bear
bond market and how obvious and avoidable it was. Plans are bounced around for new strategies.
Of course, these are strategies that learns from the past. Volatility in bond yields has now dissipated
and shallow rallies occur.
Stage 7: Acceptance and a New Beginning. Investors and managers agree that the bond
strategies of the past were wrong and new strategies are implemented. Small
amounts of money trickle in the markets. As profits start to materialize,
confidence gets restored. The first
managers to show profits becomes known as the new and improved bond guru du
jour. The market has stabilized to a new
range of yields and a normal amount of volatility. Slowly, liquidity is returning encouraged by
the beginning of positive reported earnings. Stage 7 closes the bond market bear cycle and
begins what I am sure will be the beginning of a new (and never to outdone by
prior) bond bull market.
Bond bull market dynamics have ended and bear market
dynamics will be the norm for some time. The over-subscribed quantitative, backwards
looking models, high volume traders and bond investors that closed their eyes
and played a fool’s game are now feeling pain and guilt. They invested in the most overvalued market
and were caught when the market turned. It
was like playing musical chairs and the music just stopped. Tragically, there is a plethora of players and
only one chair left. Investors discarded
fundamental value investing and pursued other flawed strategies for too long.
They now must experience these seven stages before they can have closure for
The market is just entering stage 2. The most liquid sectors
have come under intense pressure. Less
liquid bond managers are holding their breath with their fingers on the sell
button looking for the first crack in their lofty prices. If that button gets pressed, stage 2 will be
in full swing. So buckle up. As we
travel down this long and windy bear market road for the bond market, it will
have many bumps and a couple pot holes.
Investment veteran and published author, Michael Carino,
prophetically called the timing and amplitude of the recent move in global bond
markets publishing “Global Bond Markets – Skydiving Without a Parachute.” Michael has spent the last 25 years managing
fixed-income hedge funds and trading of over a trillion dollars of investments.
He is the CEO of Greenwich Endeavors, a
financial service firm. He feels
compelled to get his unique and under-reported views on the markets out to the
public. It’s time a voice
contrarian to other self-interested, behemoth Investment Managers’
voices are heard.