Tuesday, June 11, 2013

The Tepper Rally and the End of the 30 year Bond Bull Market

   From November of last year through May 22nd, equities crawled higher, slowly but consistently for a whopping 26% rally.  The last few days of the move were nicknamed the "Tepper" rally, because hedge fund titan David Tepper went on CNBC to explain why he was bullish.  The doubters were concerned that as the Fed tapers quantitative easing over the next year, the reduction in easy money may prove fatal to equities and possibly most other assets.  The Fed is currently buying $85 billion a month in treasury and mortgage securities and investors wonder how much of the equity rally was because of this buying and if it ends, will the equity rally reverse?
   Tepper explained that while the Fed will be reducing its stimulus, the size of the fiscal deficit is shrinking even faster.  The fiscal deficit has fallen from about a peak of $1.4 trillion in 2009 to $1 trillion in 2012.  Next year was previously projected to fall slightly to $850 billion but the latest estimates put it at closer to $600 billion.  This $400 billion reduction in the deficit from 2012 to 2013 comes primarily from an increase in taxes from higher personal income and corporate profitability.  
   From a basic value investing perspective, the market appears roughly fairly valued.  I think the greatest risk to equity performance is currently Japan.  Japan is the world's third largest economy and if it faces a crisis, the contagion effect will be drastic.  
   Bill Gross is the founder of PIMCO, the word's largest bond fund with $2 trillion in assets under management.  Gross recently said that he thinks the 30 year treasury bull market finally ended this April.  Over the last month we've seen a sharp increase in treasury shields, but they're still quite low in any sort of historical context.  Over the last 50 years, 10-year yields have averaged about 6.6% and they're currently 2.2%.  That 6.6% number is probably a bad anchor since it included the severe inflation of the late 70s and represents the period with the highest consistent GDP growth that humanity has ever seen.  Still, 2.2% 10-year yields are unsustainably low in any sort of growth environment.  
 Gross predicts that while the Bull market ended this April, the Bear market won't start for another 3 to 4 years.  He suggests a generally range bound market in treasuries in the mean time, albeit with higher volatility.  I think Gross is likely right.

Cheers,
Ari

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