Peter Boockvar says bond bull market is over, central banks have reached their limit

Published Tue, Oct 18 201611:35 AM EDT

Peter Boockvar , chief market analyst at The Lindsey Group, said the Federal Reserve and other central banks have reached their "logistical" and "political" limit, which will have broad implications for financial markets for years to come. His comments came in an exclusive conversation with Mike Santoli on the economy, rates and stocks for CNBC PRO subscribers. "I'm very confident in saying that the bond yields in mid-July we may never see again ... that this 35-year bond bull market [is over]," he said. Since the yield on the 30-year Treasury reached an all-time low of 2.10 percent in July, the yield has rebounded by 44 basis points, according to data from FactSet. In this exclusive interview, the analyst also discusses: Hidden inflation risks. Market valuations. How to kick-start the economy. PRO subscribers can also read the entire transcript of the exclusive interview below. (Editor's note: The content below is from a third-party service and there may be some minor transcription errors. Watch the video for the exact quotes.) MIKE SANTOLI: Peter Boockvar is the chief market analyst with the Lindsey Group, a macroeconomic and market research firm. He's also the co-chief investment officer for Bookmark Advisors, an asset management firm. Prior to joining Lindsey, Peter spent a brief time at Omega Advisors, a New York based hedge fund, as a macro analyst and portfolio manager. And before this he was a partner at Miller Tabak and Company where he was an equity strategist and a portfolio manager for 18 years. Peter's a familiar face on CNBC as a regular contributor. And he joins us now to share his investment outlook. And, Peter, thanks a lot for being here. PETER BOOCKVAR: Thanks for having me, Mike. MIKE SANTOLI: A big picture. You've been in real time chronicling this whole period we've had in markets where it's been largely, at least by broad perception, about central banks, what they were going to do, what they have done, what they've been attempting in terms of refreshing the world economies after the great recession. And that's worked largely for a while to assume that central banks were there as the friend of investors to one degree or another. Is there a reason to think that that's going to change? PETER BOOCKVAR: So by everything the central bankers have done they've pulled forward activity. They've pulled forward economic activity through wanting you to behave today, buy the house today instead of tomorrow, and buy the car today instead of tomorrow. And they've also pulled forward investment returns by almost front loading a rally in markets. Now we're reaching a point where it seems that central banks, and I include the Fed, the BOE, the ECB, the Bank of Japan, are reaching logistical limits in how much more they can do, and also now political limits particularly in Japan and in Europe, because of the damage being done to the banking systems. So there is now pushback, and maybe a hitting of a wall in a sense to what they've done. This is also at the same time that global growth is also slowing. So there's no more activity left to pull forward economically speaking. And now we have to question what's the investment returns now that central bankers now have to actually take a step back from inflating asset prices. MIKE SANTOLI: First let's talk about the logistical limits that you see the central banks bumping up against right now. Is this because they're running out of bonds to buy after doing quantitative easing, they're having a harder time pegging interest rates where they want? What are these actual limits? PETER BOOCKVAR: I always thought that higher inflation would eventually limit central banks. What has happened instead is the damage profitability of banks in Japan and Europe are actually doing it. So from the mid 2015 peak the Japanese bank stock index fell 50%. And in between that the Japanese went negative interest rates. So here's the transmission mechanism for monetary policy. Here is a main striver of economic growth, and you see the equity- MIKE SANTOLI: The banking (UNINTEL). Yeah. PETER BOOCKVAR: Deteriorate by 50%. The same thing happened in Europe. Draghi went negative back in June 2014. And by the early part of this year their bank stocks fell 50%. So I think the negative interest rate experiment, the flattening of the yield curve has damaged bank profitability to such an extent that they're not getting pushback in addition to Mario Draghi running out of bonds to buy unless he expands the criteria of his purchases. The BOJ that has their balance sheet at 90% of GDP, and they're owning a third of the JGB's, they're running into logistical limits. And at the same time the Fed now is looking to raise interest rates. And the Bank of England that doesn't want to go negative, they're at 25%. So there's not much more they can go there. And there's not much more QE they can do. Because now you have their prime minister clawing them out. So. MIKE SANTOLI: Which gets to the idea of political pushback. So political-- PETER BOOCKVAR: Correct. MIKE SANTOLI: limits to what central banks might want to do otherwise. So you mentioned in the UK the new prime minister is essentially questioning the Bank of England, and its policies. Where else are we seeing something like that? PETER BOOCKVAR: I think that's really Japan to me was the epicenter of this, because of the size of their QE relative to their economy. So it was really in September when they started buying less long term JGB. So we start to see a little bit of a steepening. So in July the 40 year JGB yield was seven basis points. MIKE SANTOLI: Japanese Government Bonds here? PETER BOOCKVAR: The Japanese Government Bond. Two months later that seven basis points all of a sudden became 67 basis points. So I said, "Something is afoot here." And US bonds, European Sovereign bonds have been very well correlated to each other. So we started to see a backup in long term yields in these countries, in these regions as well irrespective of the economic data. So to me it seems like we're reaching inflection points here with the influence, and the manhandling of interest rates that central bankers have done. And because all other asset prices are priced off the level of interest rates I think we have to pay attention to all asset prices, not just fixed income. MIKE SANTOLI: I wonder if somebody would counter with the idea that if you look at the Federal Reserve specifically just in the United States, what it has done, it has only incrementally in the last two or three years gone in a less easy direction. In other words it's kind of raised interest rates once, but before that it ended its quantitative easing, and before that signaled it was going to end. And so in other words it's been attempting for a while to pull itself back out of these policies. And yet we haven't seen anything really get damaged in a lasting way in terms of markets. Is that hopeful, or is that an exception to the rule? PETER BOOCKVAR: I think the Bank of Japan and the ECB bought them time, because of all the ramp up of QE that those two central banks have done. So the Fed was able to take a step back. But if you look at central bank balance sheets in the aggregate they still exploded higher. The Bank of Japan and the ECB alone are buying an extraordinary amount of monthly bonds that makes what the Fed did somewhat tame. So I shouldn't say tame. It's still the equivalent. But it'll offset the pullback that the Fed initiated. MIKE SANTOLI: Got it. So let's get to market implications. So you pointed out that globally bond yields have lifted even though it hasn't seemingly been as a response to faster growth, or pickups in inflation as you might expect. What does that tell you? And I guess how much more of that might we have to brace for? PETER BOOCKVAR: It's going be tough to say where the reset goes from here. I'm very confident in saying that the bond yields in mid-July we may never see again. That this 35 year bond bull market, the bottom in yields is here I believe. MIKE SANTOLI: So for the ten year US Treasury that was around 1.35 or so? PETER BOOCKVAR: Exactly. And in Japan we know it was deeply negative, and certainly in Europe with the German ten year bund yield going to minus 15 basis points. Now how this progresses from here none of us really know. I just know yields should go higher if people start to question against central banks. Now I'm going to throw in some fundamentals. Because I'd rather talk about fundamentals, but central banks have dominated. So you have now oil at $50. If you look at the rate of change for gasoline, for natural gas, for crude oil, it's now positive. So in the US-- MIKE SANTOLI: On an annual basis? PETER BOOCKVAR: On a year of year basis. So just on rate of change base effect basis headline inflation in the US is going to start to rise closer to 2%. Because you already have services inflation, x-energy running at 3%. So let's throw that into the fixed income mix. In the US foreign central banks are net sellers of US treasuries. And in the aggregate they've sold about $160 billion of US treasuries. So we have less of a bid in US treasuries. So to me this rise in interest rates possibly has longer to go. And unfortunately it's not happening because the economy is improving. It's happening because of all these other dynamics. And if you look at it in the US the two main interest rate sensitive sectors, autos and housing, autos peaked last year. And now you have record incentives just to get people to go buy a car now. And housing, while it continues to improve, it's been very lumpy. The first time household has been priced out of the market. They're renting instead. So here you have potential a rise in longer term interest rates at the same time that two very interest rate sensitive parts of the economy are not moderating in the context of asset prices that are still very extended. MIKE SANTOLI: Sure. I guess the question is when you say this is all happening at a time when the economies of the world are slowing, are they slowing in a noticeable way, or is it just more of the same? In other words the US economy's been around 2% for years. But it's had periods of 1% or worse, sometimes closer to 3%. The stock market's suggesting maybe we're reentering one of those periods that's closer to 3%. I mean, does that all matter in how this goes? PETER BOOCKVAR: I guess because of the expansion after the recession was somewhat modest you're getting sort of a modest slow down. US growth now running at about 1.5% if you average the last four quarters it's the slowest rate of growth in a few years. We know Europe is growing no more than 1% to 1.5%. And China is certainly leading a slowdown in Asia. So I don't expect unless rates dramatically go higher, and expect a sharp decline in the economy, but you're sort of getting this slow bleed. And now you're having an issue with corporate profits, with profit margins slowing. And what does that mean for capital spending, which is already weak to begin with? What does that mean for hiring if cash flows start to slow? So there are just a lot of things coming together. Now fundamentals in my opinion didn't really matter last couple years. It was what our rates are, what central banks are doing, let's inflate (UNINTEL) multiples. But now that that game is beginning to end I think fundamentals are going to begin to matter again. And they're going to be shown for what they are. If they improve, well, then that's great. We can maybe deal with what's going on with central banks. But if they don't improve at the same time central banks are less relevant, well, then all of a sudden that begins to matter in terms of price, and stocks, and among other assets. MIKE SANTOLI: So I guess just to knit it back to what it might mean for an investor it seems as if this is dangerous potentially for bond holdings if in fact we are on a longer term trajectory of higher yields. On the other hand slowish (SIC) growth usually is friendly for bonds. We're kind of in this unusual spot. And then of course equities as you say, pretty close to all-time highs. And now there's a hope that you'll have a rebound in corporate profits that baked into that. PETER BOOCKVAR: Right. The corporate profit story is going to be determined by labor costs. It's the largest portion of a company's P & L, profit and loss statement. And I expect what's good for the employees may not be good for profit margins and employers as they get a greater share of company profits. So stock prices are on a variety of metrics, historically very overvalued. And again that only matters when it does. The question is what caused it to matter. And unfortunately that's a rise in rates. That's why when people go to sleep at night they should be looking at JGB yields. When they wake up in the morning they should see what's happening in Europe and US yields. Because I think that the sensitivity to the stock market, to this rise in interest rates will become more pronounced. And the mediocre US economy, the mediocre earnings picture I think becomes more of a focus in that context. MIKE SANTOLI: So that again suggests some hazards no matter what you might own, or for a balanced portfolio, which is kind of interesting. Because we've had a multiyear period now where both stocks and bonds have performed extremely well in tandem. Right. They haven't really been offsetting very much. So does that mean just run away, reduce risk, or how do you handle that? PETER BOOCKVAR: When you're in the eighth year of an economic expansion, you're in the second longest bull market of all time, I just think from a prudence standpoint you should just watch your back. Because you don't know what's out there to hit you. And my old boss always said, "Bear markets don't die of old age." I said, "Well, they may not. But they may start to have a sore back. And they may-- MIKE SANTOLI: Bull markets you mean? PETER BOOCKVAR: Bull markets don't die of old age. Sorry. MIKE SANTOLI: Maybe do bear markets. But. (LAUGHTER) PETER BOOCKVAR: They may move slower. They need a cane to walk. They start to get impacted by just general cycles. So I think that people should start to pay attention to multiples. If you're paying 24 times earnings for a consumer non-durable, well, maybe say, "You know what? I bought it at 15 times. It's now 24 times. Maybe I should take some off the table." Cash has been this neglected asset class, because there is no alternative. In bull markets there's never an alternative to stocks. You never want to hold cash in a bull market. But if the market's beginning to change, then cash becomes an attractive asset class. Because it doesn't lose you anything. And it's dry powder to take advantage of an eventual pullback in markets. MIKE SANTOLI: Is there anything you could foresee that might change this whole dynamic at all? In other words are there policy measures, or is there anything that could kick start either fundamental growth, or maybe just keep central banks at this for a while? PETER BOOCKVAR: We hear about fiscal stimulus jumpstarting growth. But fiscal stimulus takes different avenues. Is it spending? Is the money multiplier on government spending above one, or below one? The government will say it's above one. A lot of private sector estimates say it's well below one. Is the fiscal stimulus going to be if Trump wins, tax policy, or regulatory policy? Who knows? Maybe that helps. But if that does maybe you'll get a rise in interest rates that offset that. Unfortunately there's no free lunch. And you don't enter such an extraordinary moment of monetary experiment, and somehow get your way out of it with no pushback. Because again when you pull forward activity there always had to be a hangover of some sort. And the question is, in the US at least, do central bankers try to keep this going as long as they can, and be Japan, or do we take the bitter pill, take the medicine, absorb a recession and a bear market, because we know rates have to normalize, and we're going to get out of this in a much better place? Unfortunately I think that's the only way out. But politically try telling that to a politician, "Sorry. Tell your constituents we're going to have a recession, and a bear market, because that's the only way out." Janet Yellen will not have that conversation. MIKE SANTOLI: Right. And that's the thing, right? So at one point we thought we were on a path toward normalization, not for the purpose of inducing a recession, but we thought we were going there. And now it's become a little more like maybe the definition of what normal rates are has changed. And they're not as high as we thought they were. PETER BOOCKVAR: Right. That's the unfortunate feedback loop that we're on that low rates create the incentive to borrow. Where you reach a point where there's just so much debt your natural growth rate is going to slow. Then the Fed says this R-Squared model of theirs that the natural rate of interest should be lower, because growth is lower. You can argue that their policy caused the slower growth rate. Which then prevents them from raising rates, because there's so much debt. So they're trapped in this loop that they can't get out of. And it gets to the point where you almost need some form of debt destruction, or deleveraging to refresh. But that's a difficult thing to pull off. So I would argue you need to almost Volcker-ize central banking-- MIKE SANTOLI: You're talking about Paul Volcker, and giving it some kind of a shock? Yeah. PETER BOOCKVAR: Yeah, and pull the Band-Aid off. And say, "You know what? We need to sacrifice the economy, and have a recession in order to get us out to a better place." But again the political pushback to that would be so extraordinary that I don't know how they would be able to pull it off without some guts. MIKE SANTOLI: Especially because the conversation politically right now is not so much about, "You know what? We're kind of due for a (LAUGH) recession." It's much more about-- PETER BOOCKVAR: Right. That's never part of the conversation. MIKE SANTOLI: "What happened? We didn't really have a recovery." For a lot of people at least from their perspective. PETER BOOCKVAR: Right. Exactly. That's the difficult situation that we're in right now. You feel for people that have never really recovered, which gets me upset when I hear a central banker say, "You know what? Maybe we'll raise the inflation target." And I always give the analogy of that central banker should go into a Walmart at 11:30 at night with the family that has filled up their cart. Their paycheck rolls in at 12:01, and then they go to the cashier and pay. And the central banker tells them, "You know what? 2% inflation is not enough. We're going to raise the cost of living up to 3% for you." MIKE SANTOLI: Yeah. Sure. Now no easy ways out I guess is the takeaway. PETER BOOCKVAR: No, unfortunately. MIKE SANTOLI: All right. Peter, thank you very much. Appreciate it. PETER BOOCKVAR: Thanks, Mike. MIKE SANTOLI: For CNBC Pro Talks I'm Mike Santoli.

"I'm very confident in saying that the bond yields in mid-July we may never see again ... that this 35-year bond bull market [is over]," he said.

Since the yield on the 30-year Treasury reached an all-time low of 2.10 percent in July, the yield has rebounded by 44 basis points, according to data from FactSet.

In this exclusive interview, the analyst also discusses:

Hidden inflation risks.
Market valuations.
How to kick-start the economy.

PRO subscribers can also read the entire transcript of the exclusive interview below.