Frank Thoughts : The Bond Market
Frank Boland
March 15, 2010

Earlier this week, Bill Gross, manager of the world’s biggest bond fund at Pacific Investment Management Co., said the almost three-decade bond market rally may be drawing to a close.  This might have a lot of investors worried considering they have poured $89 billion into bond funds so far this year!  Is this the end of the bull market for bonds?  Should investors be looking to allocate back to equities? Our Contravisory market veteran Frank Boland says "yes" and explains why in this edition of Frank Thoughts

THE BIGGEST MARGIN CALL IN HISTORY … is over

   There is a critical difference between cause and effect.  At the moment, in the financial world, people have it backwards.  Investors have continued --- for the past two years--- to flee the stock market and embrace the bond market.  The stock market having been driven down over 50% by bond market debt, has now risen 68% in the past 12 months.  Yet the fear and disbelief have only increased.  The public continues to buy bonds in the mistaken belief that their money will be safe.  Risk is perceived to be in the stock market.  Never will so many people be proven wrong ... on both markets.

 

  This was a debt crisis, not an equity crisis.  Too many people had borrowed too much money to buy real estate.  It had absolutely nothing to do with the stock market.  Clearly these individuals were aided and abetted by a myriad of financial institutions.  And therein lies what, I believe, is the yet untold story.

  When financial institutions realized many of their securitized loans had little or no value, they entered into a corporate nightmare of two dimensions.  First they were leveraged on their balance sheets 30 to 1 with these debt obligations.  But the reality of something far worse was inescapable!  They had lent billions and billions to over 8,000+ hedge fund clients who held the same, essentially worthless, debt … and were equally leveraged.  Worse yet, under Basel 57 International Accounting Rules, the lending institutions were forced to mark to market these unmarketable, and in many cases unsellable, securities.  In real terms, banks and brokerage firms were gone -wiped-out unless their clients could produce more money to cover the decreasing value of their Collateralized Debt Obligations.  Of course, in a rapidly declining market, they could not.   And therein was the genesis for the greatest margin call in history ...   debt calls that were met by the sale of equities.

  Stocks were the only knowable, and marketable, asset of value.  They were also the easiest-to-sell. Mutual fund liquidations by a fearful public increased the downward spiral.  And now, a year later from the bottom, the biggest margin call in history is finally over.  The bond market is about to enter a secular bear market that will go on for decades.  The stock market is in the early stages of a secular bull market … secular as in years to come.   Never have so many investors had it so wrong.

 

FRANCIS PATRICK BOLAND

3-15-10  

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