The Prettiest Mare at the Glue Factory

The worst bond market since 1788... The Mesopotamians would be heckling us... The flight of the bumblebee... Doing 'whatever it takes'... The prettiest mare at the glue factory... The most important price in the world is broken...

Bonds have never sucked this much in U.S. history...

As Deutsche Bank reported this week, during the first half of 2022, the 10-year U.S. Treasury note logged its worst six-month performance since 1788.

That's around the time when George Washington, Ben Franklin, and their buddies ratified the U.S. Constitution. Who knew they kept records that far back?

And the thing is, the 10-year Treasury has been merely the worst of a rotten bunch so far this year. CBS News reported some key details of the recent bond rout...

High-quality, investment-grade bonds were down 11.3% for the first six months of 2022, as of Monday. Any down year is a notable thing for bonds. The Bloomberg U.S. Aggregate index, which many bond funds use as their benchmark, has had just four losing years on records going back to 1976.

Treasurys did even worse, with Deutsche Bank's 10-year Treasury index having the worst six months on record, going back to 1788.

The 10-year Treasury yield finished 2021 at 1.52%. It rose steadily after New Year's Day as the Federal Reserve hiked interest rates (meaning prices fell, since prices and yields move in opposite directions). And it closed as high as 3.49% on June 14. (The three yield-curve inversions that my colleague Corey McLaughlin wrote about yesterday added to the drama.)

It's a far cry from the halcyon moment of August 6, 2020. That's when the 10-year Treasury yield hit an all-time intraday low of 0.504% in the wake of massive global central bank rate cuts meant to soften the economic blow of COVID-19 pandemic lockdowns.

And it wasn't just the U.S. bond market making all-time-low yields back then...

The entire global bond market hit 5,000-year-low yields – and 5,000-year-high prices – in 2020...

I've used the "5,000 years" reference in the Digest before. It's based on Sidney Homer's classic book, A History of Interest Rates (widely referred to as "The Yield Book").

The first data table or chart in the book summarizes Mesopotamian interest rates from 3000 B.C. to 400 B.C. Back then, rates on grain and silver lending ranged from 20% to 50%.

So from 3000 B.C. through A.D. 2022 – roughly 5,000 years – interest rates were never lower than they were in the summer of 2020. If the Mesopotamians could see what has happened to rates over the past five millennia, they would probably say something like...

50? You mean 50%? Oh yes, the Assyrians were getting 50% for grain lending once upon a time. Well done. You must be very fine businesspeople.

What's that you say – not 50%? But I thought you said 50? 50 what then?

50 basis points? What's a basis point?

Oh, I see. Bwahahahahahaha.

You're all idiots. And you'll all be broke soon, when your entire system collapses.

Perhaps you remember when all this bond market craziness began...

It started in the summer of 2012, during the eurozone crisis that followed the 2008 financial crisis.

Mario Draghi, then-president of the European Central Bank ("ECB"), gave a famous speech on July 26, 2012. He said he would do "whatever it takes" to keep the euro alive.

Draghi started the speech by saying the euro was "like a bumblebee"...

It's a mystery of nature, Draghi said, because the bumblebee shouldn't be able to fly – and yet, it does. Then, he said the crisis meant the bumblebee would need to graduate to become a real bee – no longer a mystery of nature, but a strong currency that could be trusted.

Um, bumblebees are real. But I get it. Here's the famous quote from Draghi...

[T]he ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.

There are some short-term challenges... The interbank market is not functioning. It is only functioning very little within each country, by the way, but it is certainly not functioning across countries.

And I think the key strategy point here is that if we want to get out of this crisis, we have to repair this financial fragmentation.

The ECB cut its benchmark deposit facility rate for the euro area to 0% after the speech. Then, two years later, with nowhere else to go, the ECB embarked on its negative interest rate policy, cutting the rate to -0.1%.

After that, the ECB made four more cuts in 10-basis-point increments. Today, the benchmark rate stands at -0.5%, the level of the last cut made in October 2019.

The current chatter is that the ECB will end its negative-rate policy later this year. We'll see.

The 5,000-year top in the global bond market came five months after Draghi's 2012 speech...

That's when the total amount of negative-yielding debt in the world hit $18.4 trillion, according to the Bloomberg Global Aggregate Negative Yielding Debt Index.

That was the top. You could've sold bonds short at that time and fallen asleep for two years.

With interest rates rising and bonds getting trashed, around $2.2 trillion of negative-yielding debt now exists on planet Earth. Most of it is European and Japanese government debt.

Let me make that point clearer... Despite the worst bond market in centuries, more than $2 trillion of allegedly safe, sovereign bonds still remain in the world that are guaranteed to lose you money if you hold them to maturity.

So first, global bond yields hit 5,000-year lows on the back of the ECB's negative-interest-rate policy. Now, two years later, negative yields are still a thing, and the 10-year Treasury just logged its worst six months since 1788.

It feels like the two things are related. It's like how the housing bubble went way up and a bunch of people without jobs borrowed a bunch of money right before it all blew up.

One of the many weird takeaways about Draghi's speech – which I've never heard anyone point out before – is that, when a central banker says he'll do whatever it takes to defend the value of a currency... it doesn't usually mean lowering interest rates.

Lower rates make the currency less attractive. Higher rates tend to make it more attractive for return-seeking investors. That's why central bankers raise rates to defend the currency.

So Draghi was really defending the banks... the system... the status quo...

Draghi was trying to make it easy for people to borrow money to keep asset prices supported.

That's what central bankers mostly do. They keep the system propped up, then earn millions in speaking fees and board appointments when they leave government service.

I'll rant about that another time (and trust me, there's plenty of ranting to do). Today, I'm more concerned with the idea of central bankers doing "whatever it takes"...

At some point, central bankers and their governments wind up creating so much inflation that they really do have to start defending the currency.

After all, you can't get a cushy gig at a big bank if people don't even trust the currency enough to use it. And if you're the central banker and nobody in the world wants to own your country's currency or bonds, it kind of looks like it's your fault.

So... you try to avoid that.

And guess what Jerome Powell, Grand Poobah of the Federal Reserve and likely soon-to-be Pimco, BlackRock, or Citadel director said recently...

OK, to be fair, Powell didn't actually say the Fed will do "whatever it takes" to defend the U.S. dollar. But he did say this, from the latest Fed meeting minutes, published Wednesday...

Participants concurred that the economic outlook warranted moving to a restrictive stance of policy, and they recognized the possibility that an even more restrictive stance could be appropriate if elevated inflation pressures were to persist.

Powell didn't say "whatever it takes," but that didn't stop everyone on the planet from hearing it that way. If you don't believe me, I'll just sit here and finish my drink while you search for "Jerome Powell whatever it takes" on Google (or maybe you use Bing).

See what I mean?

When what you didn't say is 10 times louder than what you did say, you're not fooling anybody...

And just so we're clear, stopping inflation – which the Fed claims is its current priority – is synonymous with defending the U.S. dollar. They're the exact same thing...

Every time the Fed raises interest rates to stave off inflation, it's defending the U.S. dollar.

Most of the time, it's light work consisting of a few rate hikes. It's the equivalent of running your wipers and washers to get a few dead bugs off your windshield on a family summer road trip. No big deal.

But at other times, it's more serious. It's like grabbing a gun off your nightstand to defend your family from an intruder.

And finally, there are times when central bankers must feel like they're stuck in the 1996 film, Independence Day, as the planet is invaded by a powerful alien race set on wiping us out so it can use our resources. In those cases, if Will Smith and Jeff Goldblum can't fly into outer space and save the day... it was nice knowing you.

Most folks – including Powell and his clueless Ph.D. economist horde – probably think the Fed is in bug-washing mode. But I believe we've already left homeowner-versus-intruder mode and the Fed is doing a terrible job of hiding the fact that it's in Smith-and-Goldblum-save-the-planet mode.

It probably sounds ridiculous, of course. Maybe you're saying, "It was a horrible six months for bonds. So what, Dan? Stuff happens and markets don't stay down forever."

But the more folks say that last bit about markets not staying down forever, the more ominously I feel they're tempting fate. They seem to be forgetting something important about the currency behind the worst 10-year Treasury returns in 234 years...

The U.S. dollar is less like a thoroughbred and more like the prettiest mare at the glue factory...

And it will probably take a lot less financial and economic trouble than you would guess to strip off the thoroughbred costume and reveal the soon-to-become-glue, equine corpse beneath it.

The bond market is supposed to be where the safe money goes. That's mostly because the interest is paid in a currency whose value you can trust – the U.S. dollar.

It's where your rich uncle puts a lot of his financial assets. Retired people are supposed to own a lot of bonds because they're safe. And the bond market is supposed to "signal" the general state of the economy.

But with the Fed fiddling around in the bond market and playing games with interest rates, the signal is drowned out. Billionaire Stanley Druckenmiller nailed it during an interview at the recent Sohn Investment Conference when he said...

Unfortunately, the last 10 [or] 11 years, the bond market has not signaled anything because the central banks took it upon themselves to manipulate bond prices...

The 10-year Treasury is the most important price in the world and they took that price out of the equation as a signal. I remember last summer, when certain forecasters who had a different forecast than my own, kept talking about, "Well the bond market is saying this, the bond market is saying that," when the 10-year [yield] dropped all the way from [1.7%] to [1.15%]...

But the bond market wasn't saying anything. What was going on is central banks were buying trillions of dollars [worth of bonds] and manipulating the price of bonds, so there was no signal.

In other words... the "most important price in the world" is broken. And therefore, it can no longer be used as a reliable signal by capital allocators.

What Druckenmiller didn't say is arguably more important...

Maybe the currency is in bigger trouble than anyone realizes. Maybe that's why the 10-year Treasury had its worst six months in its 234-year existence.

People don't want bonds because they don't trust the currency behind them.

Why worry about all this?

Many Digest readers are older, like me. They worry about their finances as they approach the day when they'll be too old to work for their income.

I'm 60. My parents lived into their 90s. So maybe, if I'm lucky and take care of myself, I have another 30 decent years left before the big sleep. And maybe I can work another 20?

As I pointed out last Friday, a bond bear market took hold in 1946 and lasted until 1981. That's a span of 35 years. Then, a bond bull market took hold and lasted until the latter half of 2020 – a nearly 40-year stretch.

If history rhymes, I'll be approaching 100 years old before bond prices bottom. So when you put it that way... maybe I've seen my last bond bull market.

Now, maybe you're thinking it's OK because the S&P 500 Index was a 10-bagger during the bond bear market from 1946 to 1981. So... who needs bonds when you have stocks?

Well, that's not a real question. It's something Robinhood users say when their government stimulus checks hit their accounts, as they ignore their rich uncle's warning to be careful.

Meanwhile, their rich uncles are thinking, "How could you expect to make money buying the riskiest part of the capital structure (equity) when the allegedly safer upper reaches (bonds) are still paying diddly squat pretax yields and falling in value every day?"

He's got a point...

The stock market might've returned 10 times during the bond bear market from 1946 to 1981.

But to collect those gains, you had to endure five drawdowns of more than 20%. That included a 36% drop during the 18-month bear market in the late 1960s and the brutal 48% decline during the roughly 22-month bear market of 1973 and 1974. Take a look...

These days, folks would likely look in the rearview mirror and see a delightful series of substantial dips to buy. But the reality back then was much worse...

Inflation took hold in the mid-1960s and grew worse until peaking in 1980.

You would've cried "uncle" and sold out with losses multiple times. They weren't dips. They were earthquakes punching holes to China through your front lawn.

Imagine having to retire in the mid-1970s after a few decades of that. No thanks.

My point is, you want your retirement money in something you don't have to worry about...

That used to be stocks and bonds – or maybe just bonds.

But stocks and bonds have fallen apart this year. And yet, they're still horribly unattractive, scraping all-time high valuations as the Fed tells us all it'll either pursue "restrictive" or "more restrictive" monetary policy.

And maybe Druckenmiller is only half right about bond market signals...

Maybe the epic suckiness is the signal. Maybe the worst bond market in decades and the worst 10-year Treasury performance in 234 years of recorded history are saying...

You're not in Kansas anymore, Dorothy. And there aren't any Munchkins around here to help you. Watch out for the Wicked Witch, the flying monkeys, and the poppy fields. They'll kill you if you're not careful.

Following the pandemic, the financial markets were picked up by a tornado, conked on the head, and then awakened in a state of confusion totally off the map. Now, they're trekking along the yellow brick road toward the Emerald City, trying to figure out how to get home.

And yes, I encourage you to follow the yellow brick road and buy gold...

I don't care what anybody says about gold not soaring since inflation started rising. It has crushed stocks, bonds, bitcoin, and most financial assets since the bear market started.

People complaining about the precious metal have lost a ton holding tech garbage. And they're trying to take it out on gold.

Gold is a 50-bagger since the U.S. dollar went off the gold standard. It has outperformed stocks in the 21st century. And it has a 5,000-year history of preserving wealth.

Maybe both gold and interest rates have a 5,000-year history for a specific reason...

Maybe the ancient Mesopotamians knew something we've forgotten. Maybe when interest rates go bananas, you better own gold. After all, only real money like gold can save you when paper money is melting down in a bubbling cauldron at the glue factory.

Maybe that's the real signal coming out of the suckiest bond market in U.S. history.

New 52-week highs (as of 7/7/22): None.

In today's mailbag, one subscriber has a succinct response to yesterday's Digest and the markets in general. Do you have a comment or question? As always, e-mail us at feedback@stansberryresearch.com.

"The markets are down and that's normal in cycles. [In other words], ho-hum." – Paid-up subscriber Lum L.

Good investing,

Dan Ferris
Eagle Point, Oregon
July 8, 2022