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Hot Summer, Hotter Bond Markets

|Includes: EMB, ENY, GLD, iShares 7-10 Year Treasury Bond ETF (IEF), JNK, TBF, TBT

Unrelenting summer heat has broiled most of the U.S. into a stupor.  Russia had extremes of heat and drought not seen in hundreds of years.  Global warming theories are again on the front burner.

The SP500 has wandered aimlessly all summer and now is about where it was in early June.  The U.S. dollar has mostly fallen, though firming recently.  Commodities, as show by the CRB Spot All Commodities Index, are strong and rising.  Equity volume is light, cash positions high.

Many "went away in May" and are sitting out this hot summer in cash or treasuries.  Is this a smart thing to do?  Well, the stash under your mattress may be safe as long as ex-spouses, burglars, mice and the federal government stay away.  I would be most worried about that last one.

But, wow!  Look at the bond markets!  In case you haven't noticed, everything is on a tear.  Treasury, corporate, sovereign, and municipal bonds, all are trending (in some cases rocketing) up.  U.S. 10 year treasuries as shown by IEF recently topped 98 with the yield dipping below 2.6%.

Even traditionally risky bonds are in a strong upswing.  Consider junk (aka hi-yield) issues.  JNK has risen signifigantly over the last 3 months -- no recession predicted here.

Emerging market bonds also continue to out-perform.

As an (perhaps unrelated) aside note: Obama's economic advisers are jumping ship.   Peter Orszag, director of the Office and Management and Budget resigned in late June while the ebullient Christina Romer, chair of the White House Council of Economic Advisers, plans on stepping down in September.  Both Orszag and Romer say they are leaving for personal reasons, not job frustrations.  Well . . . draw your own conclusions.

So what to make of it all?  Do record low 10-yr yield indicate a flight to safety ahead of a coming crash?  Or, do steadily rising hi-yield (junk) bonds, strong commodities and emerging market indexes indicate a recovering world economy and strengthening inflationary trends? 

It may be a mistake to fight the upward trending 10 year treasury but I would watch this very carefully.  U.S. treasury upside potential is limited while downside risk is very high --  if bonds crash.  It may not be too early to take a position in TBF or TBT (short and ultra-short 20+ year U.S. treasuries ETFs). At the very least, keep a close eye on this market.   Also, you may wish to consider ENY, the Canadian Energy Income Index, which has both yield (3.6%) and real assets of  Canadian oil and gas.  Gold (GLD) will be strong with disruptions in currency markets.

With the U.S. government facing northward of $100 trillion dollar in debt obligations eventual massive money printing seems inevitable.  It just isn't here yet.  Things could end badly with high inflation or possible currency (U.S. dollar) devaluation.

The hot summer of 2010 will soon be a memory.  If bonds go south, however, a lot of other unpleasant things will heat up fast, making us long for the days when just the weather was hot.

Disclosure: Long IEF, TBT