Friday, March 16, 2012

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.
Chart forCBOE Interest Rate 10-Year T-No (^TNX)
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.

Chart forManulife Financial Corporation (MFC.TO)

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.

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