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Those Smart Bond Traders

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There seems to be a consensus that bond traders are smarter than stock traders.  Consider this thought from Investopedia’s Financial Edge website:

Many investors believe bond traders understand the economy better than equity traders.  Bond traders pay very close attention to any economic factor that might affect interest rates.  Equity traders recognize that changes in bond prices provide a good indication of what bond traders think of the economy.

Widespread belief that Ben Bernanke’s Zero Interest Rate Policy (ZIRP) has created a stock market “bubble” has led to fear that the bubble may soon pop and cause the market to crash.  It was strange to see that subject discussed by John Melloy at CNBC, given the news outlet’s reputation for stock market cheerleading. Nevertheless, Mr. Melloy recently presented us with some ominous information:

The Yale School of Management since 1989 has asked wealthy individual investors monthly to give the “probability of a catastrophic stock market crash in the U.S. in the next six months.”

In the latest survey in December, almost 75 percent of respondents gave it at least a 10 percent chance of happening.  That’s up from 68 percent who gave it a 10 percent probability last April, just before the events of May 6, 2010.

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The Flash Crash Commission – containing members of the CFTC and SEC – made a series of recommendations for improving market structure Friday, including single stock circuit breakers, a more reliable audit trail on trades, and curbing the use of cancelled trades by high-frequency traders.  They still don’t know what actually caused the nearly 1,000-point drop in the Dow Jones Industrial Average in a matter of minutes.

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Overall volume has been very light in the market though, as the individual investor put more money into bonds last year than stocks in spite of the gains.  Strategists said this has been one of the longer bull markets (starting in March 2009) with barely any retail participation.  Flows into equity mutual funds did turn positive in January and have continued this month however, according to ICI and TrimTabs.com.  Yet the fear of a crash persists.

Whether or not one is concerned about the possibility of a market crash, consensual ambivalence toward equities is on the rise.  Felix Salmon recently wrote an article for The New York Times entitled, “Wall Street’s Dead End”, which began with the observation that the number of companies listed on the major domestic exchanges peaked in 1997 and has been declining ever since.  Mr. Salmon discussed the recent trend toward private financing of corporations, as opposed to the tradition of raising capital by offering shares for sale on the stock exchanges:

Only the biggest and oldest companies are happy being listed on public markets today.  As a result, the stock market as a whole increasingly fails to reflect the vibrancy and heterogeneity of the broader economy.  To invest in younger, smaller companies, you increasingly need to be a member of the ultra-rich elite.

At risk, then, is the shareholder democracy that America forged, slowly, over the past 50 years.  Civilians, rather than plutocrats, controlled corporate America, and that relationship improved standards of living and usually kept the worst of corporate abuses in check.  With America Inc. owned by its citizens, the success of American business translated into large gains in the stock portfolios of anybody who put his savings in the market over most of the postwar period.

Today, however, stock markets, once the bedrock of American capitalism, are slowly becoming a noisy sideshow that churns out increasingly meager returns.  The show still gets lots of attention, but the real business of the global economy is inexorably leaving the stock market — and the vast majority of us — behind.

Investors who decided to keep their money in bonds, heard some discouraging news from bond guru Bill Gross of PIMCO on February 2.   Gus Lubin of The Business Insider provided a good summary of what Bill Gross had to say:

His latest investment letter identifies four scenarios in which bondholders would get burned.  Basically these are sovereign default, currency devaluation, inflation, and poor returns relative to other asset classes.

In other words, you can’t win.  Gross compares Ben Bernanke to the devil and calls ZIRP a devil’s haircut:  “This is not God’s work – it has the unmistakable odor of Mammon.”

Gross recommends putting money in foreign bonds and other assets that yield more than Treasuries.

I was particularly impressed with what Bill Gross had to say about the necessary steps for making America more competitive in the global marketplace:

We need to find a new economic Keynes or at least elect a chastened Congress that can take our structurally unemployed and give them a chance to be productive workers again.  We must have a President whose idea of “centrist” policy is not to hand out presents to the right and the left and then altruistically proclaim the benefits of bipartisanship.  We need a President who does more than propose “Win The Future” at annual State of the Union addresses without policy follow-up.  America requires more than a makeover or a facelift.  It needs a heart transplant absent the contagious antibodies of money and finance filtering through the system.  It needs a Congress that cannot be bought and sold by lobbyists on K Street, whose pockets in turn are stuffed with corporate and special interest group payola.  Are record corporate profits a fair price for America’s soul?  A devil’s bargain more than likely.

You can’t discuss bond fund managers these days, without mentioning Jeffrey Gundlach, who recently founded DoubleLine Capital.  Jonathan Laing of Barron’s wrote a great article about Gundlach entitled “The King of Bonds”.  When I reached the third paragraph of that piece, I had to re-read this startling fact:

His DoubleLine Total Return Bond Fund (DBLTX), with $4.5 billion of assets as of Jan. 31, outperformed every one of the 91 bond funds in the Morningstar intermediate-bond-fund universe in 2010, despite launching only in April.  It notched a total return of 16.6%, compared with returns of 8.36% for the giant Pimco Total Return Fund (PTTAX), run by the redoubtable Bill Gross  . . .

The essay described how Gundlach’s former employer, TCW, feared that Gundlach was planning to leave the firm.  Accordingly, TCW made a pre-emptive strike and fired Gundlach.  From there, the story gets more interesting:

Five weeks after Gundlach’s dismissal, TCW sued the manager, four subordinates and DoubleLine for allegedly stealing trade secrets, including client lists, transaction information and proprietary security-valuation systems.  The suit also charged that a search of Gundlach’s offices had turned up a trove of porn magazines, X-rated DVDs and sexual devices, as well as marijuana.

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He charges TCW with employing “smear tactics … to destroy our business.” As for “the sex tapes and such,” he says, they represented “a closed chapter in my life.”

That’s certainly easy to understand.  Porn just hasn’t been the same since Ginger Lynn retired.

Jeff Gundlach’s December webcast entitled, “Independence Day” can be found here.  Take a good look at the graph on page 16:  “Top 0.1% Income Earners Share of Total Income”.  It’s just one of many reminders that our country is headed in the wrong direction.


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