About 2-3 months ago, while I was having lunch with a few friends who are on the investment side of large asset managers, I find myself being the only one who would buy long term T-bonds. Quickly they wedged me to bets against them. I smiled and said that while I am sure I will win the bet, I am not going to bets against you guys. First, the bets placed on lunch table will likely be very small compared to the large sum that I will put where my mouth is. Second, if I made a good amount of money from my investment, I do not feel good to take more money from you guys who would miss the party or even lose money. At the time, the price of the long term T-bond ETF from iShares, TLT, is about $95, and I said that there would be at least 15-20% upside in the next 6 months.
Last Monday, I wrote to my friends again, urging them to join the party, because I think it is still not too late. By then, TLT is already up by about 10%. By the end of last week, TLT was about $106. I mentioned to them that a simple strategy of buying long-term T-bonds or related funds while shorting stocks, be it U.S. or international markets, will easily yield at least another 20% at some point before the end of Q1 2011, and more likely it could be another 30% before the end of this year.
I have predicted that this scenario will happen in the second half of 2010 all along (since the beginning of 2010). Many people with strong financial expertise, including professional investors, can testify for it. I hope that I have made a good impression on them, especially because some of them heard my predictions while they were still holding stocks for more gains to come at the end of Q1 2010. I guess the more curious question is how I made this call? Was it all out of thin air?
Obviously, I would not bet a large sum of my own money on thin air. As an example, let’s take a few simple numbers to which every one has access. After the seemingly phenomenal GDP growth in Q4 2009 and Q1 2010, all that we see is a paltry of about 2% of private demand among the total growth. The rest are from economic stimulus. Even among that 2%, a large portion is inventory restocking. Naturally, we know that economic stimulus and inventory restocking would have zero and then negative impact on GDP growth at some point. (The only exception is when we have another large dose of stimulus, especially fiscal stimulus, which seems infeasible unless we are already in a double dip, given the madness of bond vigilantes who get it all wrong.) For example, if you put in $200 billion stimulus into the economy in Q4 2009, the economy will grow by some percentage from stimulus. If you were to have the same impact on GDP growth from stimulus in Q1 2010, you would have to put in at least $400 billion. By many estimates made even at the end of Q1 2010, the impact on growth from stimulus and inventory restocking will likely be zero in Q3 2010 and be negative in Q4 2010. What that means is that even without too much sophisticated help from economists (who also tend to be quite overly optimistic), you can figure out that we will have a GDP growth of about 2% and 1%, respectively, in Q3 and Q4 2010. That is still the estimate before you taking into consideration the slowing growth in China today, the ongoing sovereign debt crisis in Europe, and the exploding trade deficit of the U.S. with China that will persist and keep exploding (See an explanation why this trade deficit will explode and persist here http://xlpartners.blogspot.com/2010/08/preoccupation-on-nominal-exchange-rates.html). So even if the initial announcement of Q3 2010 GDP is 2.4%, the revised number to be announced this coming Friday will be more likely to be below 2% than above 2%.
Although it may still make some sense to speculate for equity market rallies in Q1 2010, armed with these realistic numbers, one should know that that the party for equities would have been long over and the party for T-bonds would have long started by this time of year. But if you have been absent minded until today, it is still not too late to step away from the rail track of the equity train and join the party for long term T-bonds while shorting equities. Most news that we will get from now on will be negative news, and markets will be down at least until they incorporate these negative surprises. At the same time, the Fed has only turned the doorknob for a certain QE2. Even if they let the door half open eventually in comparison to 2008, say in 2-3 months of time, the upside of TLT is still substantial.
You may want to say that I just get lucky this time. However, I have advised many people to take this same strategy before September 2008. On March 11, 2009, I start to advise many people to take advantage of the bear rally. I have also always stick to my description of the rally since March 2009 as a bear rally. I guess that I have to be really lucky in all these historical occasions.
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