An "Interesting"
Picture of the US Bond Markets
Pinank Mehta
Métier Capital Management Pvt. Ltd.
Oct 12, 2006
THIS IS THE MOST ALARMING
PICTURE I HAVE SEEN IN THE FINANCIAL MARKETS SINCE SOME TIME.
The points to note are:
- The current Long "Open"
Interest in 10-year US treasury bond is greater than SIX Standard
Deviations (12 SIGMA)! (The
odds of a 6-Sigma event are one in 500 million or 1.37 million
years, so it will be exponentially higher for a 12 Sigma event.)
- This level is unprecedented.
Why Should We Be Worried:
- What information has led to
the professionals building up this unprecedented position in
such an accelerated fashion?
- What are the consequences
of the unwinding of this position?
a. If it is an orderly unwinding the
bond yields should be at the current levels or lower for some
time from the beginning of the unwinding.
b. If it is an unorderly unwinding
the bond yields start rising fast from the beginning of the unwinding.
- Either way, the important
consideration is the consequences of this unwinding on the other
asset classes (please note that the bond markets are 4 times
the size of the equity markets!!) and the dominoes effect on
other asset classes and participants.
Why I Could Be Wrong:
- Notwithstanding the odds of
a 6-sigma event, we have seen a level of 6-sigma three times
in the past two years and there have been no major dislocations
in the markets!
- The market size has grown
and the liquidity is very much higher with bigger and "sophisticated"
participants. The game is probably just being escalated to a
higher level.
Some of the defensive steps:
- Unwind leverage in the portfolio.
- Get out of long-dated debt
preferably into the highest quality / sovereign short-term debt.
Do not hold paper you do not intend to hold to maturity.
- Pare down exposure to aggressive
equities.
- Hold investments that you
intend to hold for the long term (at least 2 years) only.
- Temporarily move out of synthetic
instruments (structured paper, hedge funds, OTC derivatives,
Fund of Funds, etc)
October 2006
Pinank Mehta
email: métier@mtnl.net.in
Pinank Mehta is a director with
Métier Capital Management Pvt. Ltd. He can be contacted
at:
métier@mtnl.net.in
Métier
Capital Management Pvt. Ltd. is not a registered advisory
service and does not give investment advice. Our comments are
an expression of opinion only and should not be construed in
any manner whatsoever as recommendations to buy or sell a stock,
option, future, bond, commodity or any other financial instrument
at any time. While we believe our statements to be true, they
always depend on the reliability of our own credible sources.
We recommend that you consult with a qualified investment advisor,
one licensed by appropriate regulatory agencies in your legal
jurisdiction, before making any investment decisions, and barring
that, we encourage you to confirm the facts on your own before
making important investment commitments. This report does not
provide individually tailored investment advice. It has been
prepared without regard to the individual financial circumstances
and objectives of persons who receive it. The securities discussed
in this report may not be suitable for all investors. Métier
Capital Management Pvt. Ltd. recommends that investors independently
evaluate particular investments and strategies. The appropriateness
of a particular investment or strategy will depend on an investor's
individual circumstances and objectives.
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