The “News” is just starting to come around to the fact that bonds have been a losing trade. As a Sleep Well subscriber this is kind of comical. The “News” is almost always behind the curve. For the last 6 months we have stated bonds were a no go.

We are now shifting our focus to the US Dollar. As we have stated in the past, a strengthening dollar is a strong headwind to emerging markets.

As The news focuses on the Fed today, we will hear mostly the same message from the Fed Chair. They are still buying assets and printing. We are a long way away from targets. Inflation is temporary.

Bond yields continue to rise see (figure 2). It is normal to see this after massive intervention from the central bank. A big buyer will temporarily push prices down but as those new prices are unattractive to other investors the lack of buying makes them float back to the surface, just like the beach ball being pushed underwater.

OECD data

The major bond participants will only buy bonds if the rates of those bonds are better than the alternatives returns, vs the risk.

As Bond yields rise and return to pre covid levels, like in 2009-10 there will be a readjustment in large money management firms to shift assets away from stocks into bonds.

As Stocks rise and bond yields rise, it increases the chance of stocks correcting or reducing return. One reason for this is because new money coming in will favor the safety of bonds if the probable return is similar to stocks.

The true question is, will we have a life preserver from the fed if stocks correct?

The answer to this question is profoundly serious. As yields rise and if stocks correct, and it starts to pull the economy with it, the central bank and politicians will have to act.

What will that look like? With the information I have drummed up, it looks as if the fed would have to up the long-term yielding products like mortgage backed securities and purchase more assets in general where there is liquidity. As this happens investors will be forced yet again to buy other alternatives like stocks. Remember the “Powell Put”?

So, Awesome! We can print the stock market out of a correction. Well wait a sec we are playing a very complex game. If the FED prints more, we risk drying up the bond market as inflation expectations will drastically increase in the event of even more printing.

As the bond market dries up the only buyer is the FED. The Beach ball would be so underwater that we will be on a runaway printing train that the FED can’t jump off of.

If anyone remembers volmageddon when the volatility ETFs kept buying more VIX futures and as the pressure of those purchases pushed the VIX futures higher it had to buy more. This went round and round until it blew up and the ETF had to liquidate (Bankrupt). This is the situation we are talking about for the FED.

OK so all this doom talk. Is it really that bad? Right now, we have an accommodative FED and a rising stock market. No alternatives that I pay attention too are signally an issue yet. As reality sets in and the world gets back to work, we are faced with an unemployment near recession levels.

If employment continues to strengthen, we will get some real economic growth. It sounds strange but stocks might suffer a little in the short run as bonds get more attractive, but this would be a good thing long term for the Dollar and the global economy. This will lessen the need for further FED intervention and reduced systemic risk. If we see things get worse and fiscal policy does not find a way to get GDP lifted, the train might take off. In this scenario inflation avoidance will be the driver of investing.

As a citizen of the US, I hope we can pull in the reigns of the bifurcated inflation; Consumable goods staying the same price and assets inflating making the wealth gap larger every year. As an investor I enjoy the assets rising and leverage strong return to risk strategies like the Sleep Well Portfolio to provide a quality life for my family.

Wrap Up

So far, a small pullback in small caps and emerging markets have kept us from reaching new highs. Fortunately, we have still avoided the meltdown in bonds. We retain an extraordinarily strong return over a stock/bond portfolio and an even better return over a “risk parity” portfolio. Maybe it is time for the S&P to catch up a little. We invest for what the markets “are” doing and not for what they “should” do. Markets are still telling us we are in an upward trending stock market with bonds losing favor. The strengthening dollar might throw us a small wrench for a bit. Just as in 2010 we are likely to get a slowing of return and a less one-sided market until some larger macro events transpire.

May your assets grow and you Sleep Well,

Wayne Klump

Sleep Well Portfolio equity chart versus SPY
Sleep Well Portfolio performance
Sleep Well portfolio performance
since 29 sep 2020

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