Strategists Warn On Bonds

Way back in 1981, I was SVP and chief investment officer for NYC based and since long
gone Irving Trust (1 Wall St.). Relative to our size, the trust unit was among the biggest
bond buyers in the US. Sentiment was so bearish, I used to get the occasional phone
call from an economist on Fed Chairman Volcker's personal staff inquiring about my
job standing and whether I still liked the bond market. My stock answer was that I was on
tenuous ground but still a buyer as bonds were 1) yielding more than most companies
earned on their equity and 2) with a blended bond portfolio, we could earn out our clients'
capital inside of five years (There were call protected corporates available for 18%). It
was not the last time I faced career risk in buying bonds, but it was the most memorable.

The bull market in bonds was one of the greatest and most durable in history and also one
of the easiest to trade ever known -- far easier to trade than stocks or currencies or just
about anytrhing else. It was simply like shooting fish in a barrel.

looking at the very, very long term for bonds, it is easy to note that yields are at or near
historically low levels, and it is hardly difficult to wisely surmise that yields will not
stay so low forever. So,what to watch for.

From a finance perspective, bond yields have had two anchors: 1) a long term decline in
short term Treasury yields, and 2), a long term deceleration of inflation. A lengthy bull
market in bonds has  instilled such investor confidence that the "spread" between the 30 yr.
Treasury yield and the consumer price index measured yr/yr has shrunk dramatically.

The US 91 day T-bill now yields 0.07%. Even with economic recovery, the 36 month
centered CPI is but 2.3%. With low inflation and the Fed's ZIRP policy on the Fed Funds
Rate (FFR%), it makes perfect sense for bond yields to be low.

Now, despite an achingly slow path, the US economy is moving toward more normal
bounds and is very gradually recovering the ability to self sustain. It can still certainly
backslide, but within the next year or two, economic expansion may be stable enough
for the Fed to not only have curtailed liquidity infusions but to raise short term interest
rates. Ending ZIRP will send a shudder to the bond market, and yields might be
expected to rise dispropotionately to the initial moves up in the FFR%. as bond players
assume there will be more upside to the FFR% over time. This series of events will be
a strong bear signal for bonds at least on a cyclical basis.

But, rest assured, the near collapse of the financial system and the damage to the economy
that came with the near economic depression of 2008 - 2009 created great caution that is
only slowly dissipating and which can be set back by premature Fed tightening, stepped up
fiscal austerity or the continued punishment of the wage earner.

In the meantime, I will be watching my favorite standbys -- the direction of industrial
commodities prices and the 6 mo. % momentum of industrial production.