Buy High, Sell Low

Bonds have been getting a lot of attention lately. With more inflows to fixed income funds, and yields on treasuries that only seem to go in one direction, discussion of whether a bubble exists has taken center stage. I, myself, used the term bubble in my last post - in retrospect, I was being too cavalier with the written word. To clarify, I continue to believe that bonds (especially, US treasuries) are a bad investment. Eventually, they will have their day of reckoning. But, while use of the term "bubble" conjures up certain images of investor behavior, it was not quite what I was driving at. Simply, I was trying to draw a bad parallel to real estate, where euphoria trumped reason. In the case of bonds, it is fear that's driving the investment, and the mistaken calculation that deflation is the likely outcome. But, unlike real estate. and as David Rosenberg pointed out today in his missive, it is not a levered trade and sentiment is not at irrationaly exuberant levels. Nevertheless, bubble or probably not, I hold fast to my position that bonds stink.

There is a Trend Developing...

I recently came across an article on Seeking Alpha entitled "U.S. Dollar and Long Bonds: Gotta Own Them". The author, eloquently I might add, renders the same talking points that we hear about a lot these days -- deflation is the trend. Debt destruction will continue on, rendering the Fed's attempts at generating inflation moot (at least for a while), and the U.S. is turning into Japan.

Let's cut through it and get to the point. While I could agree that the day of reckoning for bonds may not be imminent, and the game could go on for a while, why bother trying to time it so right? For 3% dividends? I am hard-pressed to see how the cost of living in the United States has gone down. And certainly not enough to suggest that the coupon you're getting with Treasuries (unless it's off of a whole lot of money) will foot the bill. At the same time, there is competitive devaluation going on globally right now, allowing you to look at an increasing U.S. Dollar Index and to draw the totally wrong conclusion about what it means with respect to the actual value of dollars in your pocket.

In the U.S., Europe, and Japan, growth is stagnating. But I also believe that there are countries in this world that played the game much smarter than we did, that have banking systems and economies that were not totally built on paper promises since proven worthless. They will grow, their currencies will prove more reliable, and they will end up pricing out their counterparts in the more "staid" and "mature" regions of the world. It won't be an easy process, but it will happen.

So, when I look at the investment universe right now, I think you own bonds for the capital appreciation component more than for the yield. And, that's why I think the bubble is forming. And even if it doesn't burst tomorrow, I don't want to be left holding the bag when it does.

The "Measure" of Inflation

I'll make this post a quick one, but I wanted to add a little color to my last installment. Specifically, my criticisms of CPI as a methodology for measuring inflation.

The most oft-stated rebuke is that it excludes food and energy prices from its calculation, due to their volatility. For a host of reasons, I think it's ludicrous. But, it is what it is.

The part that warrants some explanation is the hedonic model, which from my view receives less attention and is probably not as well understood. The gist is as follows: product XYZ costs $100 today. A year from now it costs $103. Intuitively, one would think that the price increase was 3%. In fact, according to CPI, that's not necessarily the case. Rather, the BLS, through the use of some sort of voodoo, err, regression analysis, makes a determination about how much of that $3 increase can be attributed to an improvement/change in product quality - oh, I don't know, say $2. Therefore, on a CPI basis, the rate of inflation would be something more like 1% - even though it still cost the consumer 3 more bucks.

In the end, I think it's clear that the hedonic model could potentially be manipulated or simply wrong, rendering CPI a fiction. And ultimately making the debate about inflation v. deflation, premised on CPI, a fool's game.