Why the Markets Will Fall in October

Why the Markets Will Fall in October

Gold took a tumble three weeks ago.

Diving from US$1,550 to as low as US$1,485 in a little over a week.

That’s a 4.9% slide.

While the fall was unexpected, I don’t expect it to last.

As Jim has written over the past couple of weeks, China and the US have once again come to a ‘truce’ on the trade wars.

However today, Jim points out that the ‘truce’ could be more about President Xi Jinping saving face as the 70th anniversary of the Chinese Communist Party draws near.

Once October is over, chances are the markets will see through the truce.

And the price of gold will rally again.

Now, it’s over to Jim.

Until next time,

Shae Russell Signature

Shae Russell,
Editor, The Daily Reckoning Australia

Why the Markets Will Fall in October

Jim Rickards, Strategist

Jim Rickards

I was around when the greatest ever bull market in bonds began in 1982.

The US economy was in the midst of the then-worst recession since the Great Depression.

It was the second of two ‘back-to-back’ recessions in 1980 and 1981–82.

The US was also just emerging from a period of sky-high inflation (over 15% annually) and equally high interest rates (over 20%).

Suddenly, the bottom was in and long-term interest rates started to come down.

As you know, bond prices move inversely to bond yields.

As the yields came down, bond prices went up. The bull market had begun and it has continued to this day, albeit with dips and rallies along the way.

The US 10-year Treasury note just traded near a 1.550% yield to maturity, not far from its all-time low of 1.367% on 5 July 2016.

Slowing growth and the Fed’s new rate-cut cycle offer is good reason to believe a new low yield below 1.35% will be hit in the months ahead.

Bond kings wrong?

So why are the bond kings yelling ‘Bear market ahead!’ at the top of their lungs?

Three of the greatest bond traders on the scene today — Jeff Gundlach of DoubleLine, Dan Ivascyn of PIMCO and Scott Minerd of Guggenheim — are all warning of a coming bear market in bonds. As noted by Reuters:

All three investors – Gundlach, the chief executive of DoubleLine Capital; Ivascyn, group chief investment officer of Pacific Investment Management Co, known as Pimco; and Minerd, global chief investment officer of Guggenheim Partners – have been underweight corporate credit relative to their benchmarks.

But all three told Reuters they can live with the underperformance because of the greater damage that they see coming for corporate bonds.

“We have never owned a single corporate bond in the Total Return Strategy dating back to 1993. Look it up,” Gundlach said. “When corporate bonds become very overvalued, especially when rates fall due to recession prospects increasing — well?” he added of why he has avoided the asset class.’

There’s no denying the past success of these ‘bond kings’.

And in fairness their warnings apply as much to corporate bonds as government bonds (it’s possible for credit spreads to widen, producing gains on government bonds and losses on corporate bonds at the same time).

Yet they explicitly see a bear market in government bonds as well.

I’ve seen this pattern repeated many times in the past 10 years.

Yields hit a new low, some bond maven yells, ‘The bear market has begun’ and then they suffer huge losses when the next leg down in yields commences.

This time their reasoning is that yields are so low they can’t go much lower, so they have to go up (and prices down). That’s fallacious.

The would-be bears are not distinguishing between nominal yields (the ones you hear quoted) and real yields (nominal rates minus inflation).

Its true nominal yields are low, but real yields are not.

That’s because inflation is also low and falling lower.

Central bankers have told me privately that nominal yields have to come down a lot to get real yields into negative territory to provide stimulus.

They’re right.

This bull market in bonds has much further to run.

Don’t fall for the Chinese fake truce

Last week, China and the US announced they were resuming trade talks in early October.

Right on cue, the stock market rallied, bonds and gold fell and the euro came roaring back from interim lows.

It was as if they were playing ‘Happy Days Are Here Again’ on CNBC.

By the way, the early October date was not random.

It follows the 1 October 2019 celebration in Beijing of the 70th anniversary of the Communist victory over the Nationalists for control of China, and the beginning of the regime of the Communist Party of China that continues until this day.

President Xi did not want messy trade talks let alone failed talks to muddy the waters on this big celebration.

That aside, the question is whether the stock market rally was justified and whether anything really changed in the China–US trade wars as a result of these new talks.

The short answer is no.

Talking is certainly better than not talking and much better than fighting. But the issues are still irresolvable.

China cannot give up its theft of US intellectual property because it depends on that theft to propel growth.

China cannot amend its internal laws to provide enforceability of any agreement because that involves a major loss of face and erodes Xi’s power.

Trump cannot let the Chinese trade surplus with the US persist because it’s a major drag on US growth and it steals US jobs.

None of the big issues are any closer to a solution and that state of affairs may last for years.

Despite the temporary euphoria, the market will realise sooner than later that the resumption of trade talks is just part of China’s strategy of delay and Trump’s strategy of propping up the stock market.

When that realisation sinks in, probably in late October, I say stocks will reverse course and bond and gold prices will resume their long-term climb.

All the best,

Jim Rickards Signature

Jim Rickards,
Strategist, The Daily Reckoning Australia