The Bond Market Knows Best

There's an old saying in the markets that the bond market "knows" more and has more wisdom then the stock market. Well, something amazing occurred this week in the bond market - a run in bond yields. Say what? If you have a hobby more exciting than mine - than you might find this as boring as watching paint dry. But here we go... The yield on the U.S. 10 year Treasury Note ( 10yr Bond ) jumped over 15% from around 2.00% to 2.30% (so bond prices fell).  While that might not seem like much, in the big/deep world of bonds (32 trillion worth, in the US alone), that's a big move. It's clear that bond investors are finally anticipating growth ( and inflation ) and don't want to hold longer dated bonds. It's unclear whether this is the end of the 30 bond bull market, but I think it might be.

So what does this means for a bottom-up stock picker? Well, it means three things:
1) the bond market is telling us that the world is not coming to an end - the economy is getting better and inflation in coming. Inflation doesn't always have to be bad - owning stocks can protect you from inflation.
2) the bottom might be in on depressed life insurance stocks. You'll see in the chart below how the insurers (the chart shows Manulife, Sunlife and Great-West Life)  ran-up this week, as much as 15%, as 10 year bond yields soared. The insurers, invest the premiums you pay them in bonds, so they can generate income to pay-out claims and turn a profit. With yields so low over the last few years, the insurers have been suffering. With the pick-up in yields, the insurers will roll over capital into higher yielding bonds which means better earnings going forward. Just a 1% increase in yields can generate an additional $1 billion a year for Manulife. There is a positive correlation between bond yields and the stock market indices. So, markets could continue higher if yields continue higher. Yikes!!!
3) stay away from longer dated bonds. If you have to own bonds then you'll want to stay with maturities of less then 5 years - and hold them to maturity.



With all this talk of cheap insurers, I did sell some ( just a little) MFC this week. Say what??? It should be noted, that this transaction was a portfolio decision to raise some cash. It is not a call on the valuation or quality of MFC. I will continue to hold my remaining position. MFC is probably worth around $20/share.

If you are a Manulife customer - thanks for your business. If you aren't a customer - you should be become one.

Raising Cash

The market has been on quite a tear since the November 2011. The market has cycled from pessimism to optimism. While there is good reason for the markets to trade higher, like an improving economy and declining unemployment, I'll proceed with caution. Overall, the prices for most common stocks are no longer dirt cheap. Remember, the markets have more than doubled off the march 9th, 2009 bottom of 676 on the S&P500. Interest rates are at all-time low's and we (North American consumers and businesses) are still chugging (when we should be sipping)  from the low-interest-rate punch bowl. Who would of thought we'd see 5 year fixed money at 2.99%? I'm firmly in the camp that says it's time to raise rates ( I can hear the collective - gasp!!!). So I'm raising cash - selling into the strength. In the meantime, I'll continue to look for value opportunities that may arise. On that note, I have started a position in a large oil company, that's currently way out of favour (read cheap), but still has good prospects going forward, and plenty of oil/gas in the ground.

On another note, this week 19 major U.S. banks were stress tested by the Federal Reserve. I fully expect most of the super-majors ( C, BAC, WFC, USB, JPM, GS) to pass. Some, may come closer to the line that I'd like, but remember, these are tests based on hypothetical severe economic conditions. All eyes will be on BAC, as it's my largest U.S. bank holding and >10% position in my portfolios. With these tests complete, that will likely pave the way for increased dividends and share buy-backs. The uncertainty (warranted and unwarranted) around many of these banks has started to lift and their stock prices will react accordingly over time. Several of these majors are still cheap. But if your adding new money to the banks, then wait for a pull back.

 

In case you missed it: I'm long BAC, C, WFC