Ben Bernanke’s term as Fed Chairman does not end until February 2014 and so it is reasonably safe to say that this student of the 1930s is not going to be tightening monetary policy between now and then; ...the normal spread between the overnight rate and the 30-year Treasury bond yield is 200bps. That gap is now north of 400bps and so it stands to reason, as per Bob Farrell’s Rule 1 ...that in the mean-reversion process, bringing this Treasury curve back to its typical shape will inevitably require much lower yields out the curve.
It will never be a straight line down, but the primary trends in long-dated yields is still down. Recall that the 2% low in the long bond in the U.S.A. in the early 1940s and to sub-1% levels in the JGB yield in the 1990s occurred a decade after the initial credit and asset shock — despite years of massive government reflationary efforts. Those calling for an end to the secular bull market in bonds — the vast majority of pundits — are clearly in need of a history lesson.
It is the equity market that is most overbought at the current time. Portfolio managers are all the way down to just 3.5% cash ratios. According to the latest Investors Intelligence survey, there are now 56.2% bulls and a mere 23.6% in the bear camp — we have not seen such a gap since early May and within the next two months the S&P 500 was down more than 12%. The buying has exhausted itself.
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