Over the last few weeks, a massive shift has begun within the financial markets: Investors are moving out of safe haven assets and into riskier securities. This comes as the economy revs up again, pushing inflation expectations higher.
This is forcing investors to up the scale of risk from U.S. Treasury bonds to investment-grade corporate bonds to junk bonds to large-cap stocks and eventually to small-cap stocks. Even gold, which is considered an inflation hedge, is coming under pressure as investors seek assets with both inflation protection and exposure to the economic recovery. Stocks offer that. Gold and bonds don’t.
Credit Suisse strategist Andrew Garthwaite sums up the following comment in a note to clients today:
“Bonds outflows are negative for the first time since 2009, while equity inflows are at their highest since 2006 and money market inflows have turned positive again. This pattern of funds flow suggest that investors want to be cautious (hence money market inflows), but realize that bonds carry a risk that, at the margin, some types of equities are safer than bonds (with a lot of names having a lower CDS spreads and implicitly offering a hedge against inflation).”
All of this has created an opportunity to profit from the decline of the bond bubble which saw people shoving money into fixed-income assets offering paltry yields despite signs of economic rebirth and inflationary pressure.
What’s driving this? A combination of overly eager monetary policy from the Federal Reserve (see my column on the subject here) and strengthening economic fundamentals.
After all, the rise in inflation expectations started in late August, which just so happens to have coincided with Fed chairman Ben Bernanke’s first mentioning of his preference for another round of quantitative easing to follow the first round of $1.7 trillion that ended earlier this year.
The stated aim of this policy was to lower long-term interest rates to encourage borrowing by businesses and consumers and get the economy moving forward. But with the action being seen as increasingly inflationary, the opposite has happened: Long-term interest rates have increased as bond prices have fallen. The interest rate on the 30-year Treasury bond, which underpins mortgage rates, has jumped from a low of 3.5% in late August to 4.4% now.
And the selling pressure isn’t limited to just U.S. government debt. It’s happening in Japan where the 10-year bond yield has jumped to 1.3% from a low of 0.8% in October. It’s happening in Germany where the 10-year bond yield has moved over 3% after trading at 2% back in August. And it’s happening to investment-grade corporate bonds as well with the iShares Investment Grade Corporate Bond Fund (NYSE: LQD) now in a free fall after dropping through support.
Money is now rushing out of bonds and into the smallest, riskiest stocks. Since August, the Russell 2000 small-cap index has nearly doubled the performance of the large stocks in the Dow Jones Industrial Average.
The best way to play this trend is through the ProShares UltraShort Lehman 20+ Year Treasury Bond (NYSE: TBT). TBT returns twice the inverse daily return of the Barclays Capital 20+ Year U.S. Treasury Index. The fund looks ready to move over its November high as investors move assets out of boring bonds and into stocks. On balance volume also suggests the TBT is under accumulation.
Disclosure: Anthony has recommended TBT to his newsletter subscribers. Be sure to check out Anthony’s new investment advisory service, The Edge. The author can be contacted at anthony.mirhaydari@live.com.
