A Breakdown in Fixed Income?

The recent pullback in the fixed income market is starting to put a dent in the long-term uptrend for the asset class.  For the last six months, Treasuries and most corporates have traded upward in a very tight ordely channel.  As shown below in the chart of the Vanguard Total Bond Market ETF (BND), however, the bottom of the uptrend has been broken in recent days.  Conversely, the 10-Year Treasury Yield broke above the top of its downtrend channel in recent days as well.  If the pattern doesn't correct quickly, the technicals suggest that fixed income could be in store for some rough action going forward.

Comments

[WDW]

The YTD % Change column appears to be way off. For example, AGG Total Return is more like 7.6% YTD than the 36.4% shown above.

[Sia]

I think the trend it was on was unmaintainable. You can't just expect something to follow a trend forever, needs to reset, and either continue the upward trend or reverse.

[theyenguy]

Risks have risen for those investing In bonds as the US Sovereign Debt 30-10 Yield Curve has flattened and as the European Bank Stress Tests have prove unreliable.

The bond market place called interest rates higher on September 1, 2010, in response to the US Federal Chairman Ben Bernanke announced intentions to buy mortgage backed securities on not only one but on two occasions.

High grade corporate debt, LQD, fell parabolically lower on September 1, 2010, with the purchase of the yen based carry trades, on September 1, 2010, which rallied stocks, ACWI; and turned the tide on bonds, BND, sending them lower, establishing August 31, 2010 as a high in bonds at 82.66, that is, ”establishing August 31, 2010 as peak credit” … bond deflation has been underway since September 1, 2010.

High grade corporate debt, LQD, peaked on August 31, 2010 at 112.58. And longer maturity corporate bonds, BLV, peaked August 31, 2010 at 87.22. These have the same wave structure as BND; so any comments about bonds, BND, apply directly to both LQD and BLV as well.

Sorting on the MSN.com ETF Report Section for 3 year returns, shows LQD with a 7.57% return, which is quite good; sorting all the way to the bottom one find such things as Natural Gas and Financial Services, providing poor returns.

The comparison of LQD, with bonds of greater maturity, LQD, BLV, TLT, ZROZ, shows the tremendous fall potential of bonds, specifically the fall potential of longer out maturity.

I believe that LQD’s returns will be influenced by a flattening of the 30-10 US Sovereign Debt Curve, $TYX:$TNX, and by rising credit default swaps, CDS.

The interest rate on the 30 Year US Government bond, $TYX, rose strongly September 1, 2010. And the interest rate on the US 10 Year Note, $TNX, also rose strongly September 1, 2010.

September 1, 2010 marks the transition from “the age of neoliberal Milton Friedman based credit liquidity” to “the age of the end of credit”; this also means ”the end of entitlements” and “the beginning of world-wide austerity”.

The 30-10 yield curve,$TYX:$TNX, began to flatten on August 11, 2010, reversing a trend that goes back to early 2000. This signals risk aversion to sovereign debt. The flattening of the yield curve came as a result of the Federal Reserve Chairman’s announcement of August 10, 2010 of the purchase of mortgage-backed securities. Then on August 27, 2010, the Federal Reserve Chairman stated the possibility of an even larger purchase of debt.

The Fed Chairman’s announcement of purchase of mortgage backed securities caused the bond rally in US Treasuries, TLT, and Zeroes, ZROZ, HIgh Grade Corporate Bonds, LQD, that began April 6, 2010, to fail September 1, 2010, sending bond prices lower and interest rates higher.

The safe haven rally in debt, and the low-interest rates available to corporations, that began with the onset of the European Sovereign Debt Crisis is over, repeat over and done, through and finished. Investors see Mr Bernanke’s plans as monetization of debt; and have gone short US Treasuries, especially the longer out ones such as ZROZ.

Bloomberg reported September, 8, 2010, that the cost of protecting corporate bonds in the U.S. from default rose after falling for four straight days.

FibsAndWaves reports that iTraxx SovX Western Europe spreads are widening, indicating heightened default risk concerns; that CDS rates are rising for peripheral Europe; and that European Senior Financial spreads are widening as well.

Risk aversion to investing long in stocks took a step forward on September 7, 2010, as EuroIntelligence relates that the Wall Street Journal reported that the European Financial Institutions, EUFN, stress tests were essentially a fraud. This revelation sends bond spreads to new records, the latest ten year spreads: Ireland 372 bp, Greece 9 44 bp, Portugal 355 bp, all up substantially yesterday, in the case of Portugal and Ireland to new record levels. The FT reports that Portuguese banks borrow a record amount from the ECB in August because they could not access capital markets.

I believe a sovereign debt crisis, is coming soon, as well as a global financial collapse, where there will be no liquidity to buy or sell paper assets; I want something liquid like gold of silver as an investment.

Some say systemic risk is quite high. I say we have reached the peak of systemic risk. Liquidity evaporation could happen quite easily, either coming through a failed Treasury auction or a situation where there may not be enough buyers of investment securities to meet sellers demand.

I believe that sovereign debt buyers have had enough of the governments’ debt bubble which has come by the policy of “stimulate and spend”.

Furthermore, I believe that soon, out of a liquidity evaporation and a bond, BND, liquidity crisis, stemming from a fast fall in bond and/or stock values, that here in the US, a Financial Regulator will be announced who will oversee lending and credit, as well as money market and brokerage accounts.

He will be what I call the credit boss or the credit seignior who funds economic operations with an emphasis on seeing that the strategic needs of the country are met and that monies for food stamps keeps flowing. I believe the government will become the first, last and only provider of liquidity and money.

I believe the intensity of onset of the coming credit crunch will come with a great rush and that the corporate bond market, LQD, will shut down very quickly. Like I say, I believe a lending boss will be announced and pretty much only natural resource companies and defense contractors and food producers will have credit liquidity.

Furthermore, I see a coming ”see-saw” exhaustion of fiat wealth with stocks, ACWI, and then bonds, BND, alternatively falling lower. There may be days when both fall lower. The chart of Bonds, BND, for September 7, 2010 shows three black crows, with a fall in value to a head and shoulders pattern at roughly 82.00 and then a rise to 82.44.

The chart of world stocks, ACWI, as well as the S&P, SPY, as of September 7, 2010, shows that the world stocks enter an Elliott Wave 3 of 3 of 3 down having completed a three white soldiers pattern, and a one day down — ACWI closed down 1.28% and SPY closed down 1.13% on September 7, 2010.

As the value of stocks falls lower, so will the value of corporate bonds, as they will fall under the influence of a flattening 30-10 US Treasuries curve, $TYX:$TNX seen in Stockcharts.com chart and as they come under attack from CDS on both sovereign and corporate debt, more-so of the former than the latter.

So like what is the investment application?

We will now have a see-saw destruction of fiat wealth, meaning BND will at times be going down; then ACWI will be going down, primarily driven down by KBE and EUFN falling lower.
Debt deflation will literally be cutting fiat wealth asunder causing Bonds, BND, and stocks, ACWI, to alternatively falling lower.

Debt deflation is the contraction and crisis that follows credit expansion. One of the most famous quotations of Austrian economist Ludwig von Mises is from page 572 of Human Action: “There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion or later as a final and total catastrophe of the currency involved.”

Global Debt Deflation commenced on April 26, 2010, when the value shares failed to outperform the growth shares. It was on April 26, 2010, the currency traders went long the yen and short the global currencies as is seen in this MSN Finance chart of FXA, FXE, FXM, FXC, ICN, FXB, FXS, SZR, FXF, BZF, XRU, FXY causing the US Dollar to rise; as can be seen in this chart from April 26, 2010 to June 7, 2010. On June 7, 2010, the US Dollar, $USD, turned down as the Euro, FXE, rallied on news of the call for the EFSF Monetary Authority to be established, it as of yet, still has to be approved by member states.

The European sovereign debt crisis and competitive currency devaluation has created an investment demand for gold. Gold has risen as the sovereign world currency and storehouse of investment value. Currencies, sovereign debt, stocks and bonds are all headed off to the pit of investment abandon.

The ETFdb 60 Index reports that gold has provided a 14.35% YTD return; and that BLV a 12.00% return; the latter performed well as the Yield Curve steepened. I fully expect gold to be the premier investment in a debt deflation investment world.

Gold bullion, $GOLD, will provide protection from debt deflation which comes from currencies falling lower in price — gold with perhaps for now