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Bond Conundrum

A conundrum. 

Google says it means a confusing and difficult problem or question. Or it can be a question that is asked for amusement, typically one with a pun in its answer. 

Investing seems to always provide us with a conundrum. Questions that don’t get answered till it’s too late. 

I love those people that take a firm stance one way or another with regards to an investment… call it those perma-bears who are always bearish. 

They continuously preach their position and eventually they are right. Once this happens they gloat and try to get deemed a Master of the Market. But really these people are just persistent rather than people that are actually solving the continuous market conundrum. 

I digress. 

The Newest Market Conundrum 

Recently another conundrum arose. 

Question: if you had $1,000 to invest in any economy which one would you choose: US or Spain? 

For me this isn’t where the conundrum occurs, because to me it’s a simple answer… the US. 

Call me a homer or whatever, it doesn’t matter. The US, to me, is a better economy when compared to Spain… hands down. 

But that’s not what the bond markets are telling us. The bond markets are telling us the opposite… that Spain is better than the US. 

Yes, Spain has the ECB and other strong countries (Germany) supporting it’s economy (some), but this shouldn’t mean a yield that say’s Spain is stronger than the US.

Remember the PIIGS? Portugal, Italy, Ireland, Greece and SPAIN. Yes, we can’t live in the past, but do we truly believe that the Spanish economy has made enough strides over the past 3-4 years to put its economy ahead of the US? 

Quenching That Yield Thirst 

Currently yields on Spanish 10-year bonds are at 2.07%… while those on the US 10 year bonds are at 2.44%. Just back in 2012 yields on Spanish debt was near 8%. 

The thirst for yield over the past years likely led to a flooding of investors into Spanish debt. But this statement brings up another question. Has the thirst for yield subsided? 

I don’t believe so. This is a possible reason that we (US investors) may not see yields within the middle of the curve (7-10 year bonds) rise too quickly.

Because now the US treasury is yielding more than some of those juicy yield countries from a few years back (Italy and Spain). Those investors that flooded Spanish and Italian debt are likely still searching for yield. Given that US debt is providing better yields means we may see those new dollars come back inside the boarders. 

If that is the case, buying pressure will keep yields from rising too quickly. 

A ReCap of Conundrums 

So, as the ECB begins to institute its most recent actions to avoid deflation, the conundrum is still whether the Spanish economy is truly better than that of the US. 

This doesn’t seem like much of a difficult question to me (and likely to others), but the how the bond markets are reacting makes it much more difficult. Because the bond markets don’t usually lie. 

Are the bond markets trying to tell us something different? Maybe something about the US markets? 

Possibly, but I don’t think so. It seems like what has occurred is more of a short term dislocation than a telling signal. But it is definitely something that we all need to keep a close eye on. 

 

(All data used within The Capital Course was provided by Ned Davis Research) 


 

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