Is This Really the End of the Bond Bubble?

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I don’t know what’s happening in the rest of the country, but spring has been reluctant to show its face in Melbourne lately. The mornings are cold and the days are average.

And when we do get some heat, it comes with gale force winds full of dust and pollen. Don’t get me wrong, I’ll take Melbourne’s weather over Sydney’s humidity any day, but spring isn’t delivering so far.

Perhaps this week’s Cox Plate, the highlight of the spring racing carnival in Melbourne, might bring a change in fortunes. I was on the winner Winx last year, but this year will be tougher for the champion mare. Still, she’ll be worth a little wager again.

Spring carnival is always an interesting time in Melbourne. When I see blokes all suited up with the latest fashions, I’m never really sure if they’re headed to the track or off to conduct an auction.

It’s funny, in banking’s heyday it was the bankers leading the fashion charge. But now it’s the real estate agents taking over. The theatre of an auction demands a well-dressed gent (and yes, they’re mostly gents). If only to dazzle the eyes and remove the focus from the numerous questionable claims that come from the mouth…

Speaking of property, I wonder how the folks at the RBA are feeling after watching the property market continue to bubble away over the past few weekends? Clearance rates in Sydney and Melbourne have been around 80%, indicating upward pressure on prices.

A few months back, in trying to justify another few needless interest rate cuts, the RBA said the housing market was cooling, thanks to their regulatory crackdown. What nonsense.

The market is heating back up again precisely because of the RBA’s recent cuts. And their warnings about apartment oversupply seem overly cautious, or just plain wrong, given the weekend’s action. As the Financial Review reports:

New apartment sales in Sydney soared on the weekend despite the Reserve Bank warning on Friday about the risk of a glut in Sydney, Brisbane and Melbourne.

There was no cooling in sight for established homes either, as Sydney and Melbourne auction markets hit the 80 per cent clearance mark. 

The long queues for new apartments — a regular occurrence at the peak of the boom in 2014 and 2015 — returned to developer Golden Age’s launch of its 408-unit Park One project in Macquarie Park, 18 kilometres north of the Sydney CBD. 

Eighty per cent were sold to local buyers — mostly Chinese Australians and residents — and 20 per cent to overseas buyers in China, Singapore, Canada and Malaysia. 

“People were snatching, not buying … the display suite is going to close soon at this rate,” Golden Age founder Jeff Xu said.

Who would’ve thought that interest rate cuts would lead to rising house prices? Everyone, it seems, but the RBA. We’re in good hands, aren’t we?

Well, we’ll see whether new Governor Philip Lowe has anything to say on this tomorrow. He’s delivering a speech on ‘Inflation and Monetary Policy’. I’ll take a stab and guess that he won’t have much to say about asset or house price inflation. Rather, he’ll keep his comments on the apparent lack of inflation in household goods and services.

Here’s a tip, Phil: As people pay more for housing, they have less to spend on good and services…

Anyway, before I go off on some dark tangent, let’s have a look at the markets.

US stocks were flat on Friday. The S&P 500 started off strong, but sold off as the day wore on, finishing up just 0.02%.

The most notable move came in the bond market. US yields continue to rise. The 10-year Treasury yield is now up to 1.8%. That’s hardly a worrying level, but it’s well off the 1.34% low reached during the Brexit panic.

The move higher on Friday was probably in response to Janet Yellen’s speech in which she stated that, in the aftermath of a slump, policymakers should tolerate a higher growth economy before raising interest rates too aggressively.

In other words, the Fed would be happy to see inflation increase in the short term because, well, it’s the latest ‘solution’.

Removing the obscure academic jargon from her speech, it seems she’s saying that if the Fed can’t juice real growth out of the economy, it’s happy to settle for nominal growth. Nominal growth is real growth plus inflation, so if the Fed can generate a bit of inflation, it will be happy to sit back and let it run for a while.

That sounds like desperate thinking. Or maybe it’s simply an attempt by Yellen to prop stock prices up prior to the election.

As I’ve pointed out previously, stock markets are delicately poised around here. If US stocks were to fall sharply prior to the election, it would be a real boost to Donald Trump. Trump has all but told Yellen she’ll be out of a job if he gets in, so it’s clearly in her interest to try and hold markets up for the next few weeks.

But the rise in bond yields hasn’t gone unnoticed by fund manager Kerr Neilson. And he is someone you should listen to.

Commenting on the latest back-up in bond yields, Neilson thinks it’s the start of a major change in trend. From The Australian:

Mr Neilson said bonds and bond-like investments might not violently snap back, but the tectonic plates were certainly shifting — and not in the favour of bonds.

“I think that game is getting very long in the tooth. To say it’s over is always premature, but we’ve had an usual period of bond market profitability,” he said.

“It’s not the place I particularly want to be. I don’t particularly want certainty now. It may feel comfortable, but intellectually I think that’s what you want to avoid now.”

Is this the beginning of the end of the great bond bubble? And if it is, what does it mean for stocks?

More on that tomorrow…

Cheers,

Greg Canavan,
For The Daily Reckoning

Greg Canavan
Greg Canavan is the Managing Editor of The Daily Reckoning and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to The Daily Reckoning for free here. If you’re already a Daily Reckoning subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Daily Reckoning emails. For more on Greg go here.
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