Inflation

Outside of the 10% move in 30-year zeros (premium widened), the bond market in February was a quiet affair. In terms of the bond market, it was a good month to be on vacation. I didn't miss much.

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Much has been made about the CRB Index making a new high on November 27. We are very skeptical. Comparisons herein will demonstrate the warping in this index. I think we are now getting an inflation false alarm, but at this point the signals are mixed.

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After an ominous five-point sell off in the first part of October, the Treasury market turned on a dime and blasted upward, running up 10 points in four days. But not all bond market sectors participated. It was a flight to quality.

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The bond market held its own in the middle two weeks of September, but the first week and the last week of the month were downright nasty.

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The bond market edged tentatively higher in the first half of August, but lost it all in the last two weeks of the month. T-bonds made new lows for the year in the last days of August.

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The bond market held Its own for the first few weeks of July, but prices took a sharp dive on July 21 and drifted lower for the remainder of the month.

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Mid-course corrections to our annual economic and market projections for 1987. Also, some low down dirty pirates from “out east” made a pass at Minnesota’s beloved Dayton Hudson...our Legislature's response and the Greenmail Solution.

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The bond market entered June with a sharp one day sell off and then spent the best part of the month edging higher. However, in the last week or so, bond prices drifted lower in a relatively dull market.

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For the time being, negative pressures seem to have subsided for the bond market. We don’t think the decline in bond prices is over, but June should allow for a little rest and rehabilitation on the part of the players.

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April couldn’t have been much crueler. Even with the rally from near panic lows, long T-bonds lost 6-7 points for the month, as did long municipals. Corporates held up a little better, dropping only three or four points.

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Three questions that seem to be coming up quite frequently these days: Is it time to buy electric utilities? What do we think about the telephone utilities? Inflation sensitive stocks - what do we do now?

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As we enter April, our view of the bond market is increasingly cautious. Very short-term, a snap back is expected after the rocky action in recent sessions, but then what? This issue we are pulling in our horns, reducing long bond exposure.

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The bond market surprised a lot of the players in February. When the T-bond futures broke 98 around mid-month, a number of traders thought it was the beginning of a significant decline. But, as you may recall from last month, this publication did not feel such a breakdown would be significant.

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Inflation sensitive issues are being added to our equity model as a distinct theme, a new tactical play. Although we are not projecting a significant pickup in inflation in 1987, we are coming to believe that Wall Street will mistakenly believe inflation is re-igniting.

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No, we do not expect to see inflation over 3% by the end of 1987 or even in 1988. Actually, deflation seems more probable. But from the bond and stock market investors’ standpoint in coming months, inflation perceptions are expected to become more important than reality.

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In this business, it is often best to conveniently forget what was said in the past. But unfortunately, when the opinions are written down and published, this does not always work. At any rate, this publication has a sometimes embarrassing commitment to full disclosure. So again, we will include our old (1986) crystal ball gazing right along with this year’s predictions.

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Having been a super bull on the bond market since 1981, this publication has turned more cautious. A number of readers have asked for details and elaboration. Today we still view the bond market trend as up, but think a sharp decline might occur sometime in 1987, with T-bond yields rising by as much as 300 basis points.

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Today, many are concerned about the potential negative impact of deflation and the stock market. Our work demonstrates that moderate deflation has typically not been a hostile stock market environment. However, deep deflation (5%-11%) has historically been a bad time for stocks.

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Even considering these deficit related problems, we have to remain cyclically bullish on T-bonds for the next few months. The bond market just has too much going for it. Most of our inflation work remains cool, but this month we present two momentum measures for the PPI and CPI that may appear ominous to some.

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The bond market worked lower in the first half of September but rallied later in the month, cutting losses for the month in half. Short rates were little changed during September.

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