The Best of Kass

Doug Kass of Seabreeze Partners is known for his accurate market calls and keen insights into the economy, which he shares with RealMoney Silver readers in "The Edge," his daily trading diary.

This week, he discussed why it's the right time to short bonds, and why investors' current distrust of stocks is misplaced.

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Bonds Will Become Certificates of Confiscation
Originally published on Sept. 3 at 8:27 a.m. EDT.

At current yields, bonds represent certificates of confiscation, and bond holders face the likelihood of large capital losses.

I believe that, on a risk/reward basis, shorting fixed income is among the most attractive investment strategies in the year(s) ahead.

Bearish economic concerns are overblown. There will be no double-dip. Most indicators point toward a domestic economic growth rate that is moderating but also likely to be sustained.

The 2.60% yield on the 10-year U.S. note is discounting a double-dip. Over the course of the past 60 years, the 10-year note has yielded 365 basis points more than GDP growth. In other words, the fixed-income market is now discounting an unlikely 1% drop in GDP (2.60% less 3.65%).

Over the same time frame, the yield on the 10-year U.S. note has averaged about 300 basis points more than the inflation rate. While zero-interest-rate policy argues for a somewhat lower relationship, since the implied inflation rate in TIPS is about 1.6% now, this would imply that the yield on the 10-year U.S. note should be closer to 4.60%, or 200 basis points above the current reading.

10-Year TIPS (Since 2008) Source: Bloomberg

Numerous cyclical components of the economy (inventories, autos, housing) are at very low levels relative to GDP and substantially below their long-term trendline relative to GDP. This limits the likelihood of a double-dip, and in the fullness of time, a mean-reversion could add several trillion dollars against a $15.0 trillion GDP.

Housing, in particular, stands ready for a gradual expansion that could be sustained for many years. Affordability is at a multi-decade high, mortgage rates are at generational lows, the value of home ownership vs. renting is back to mid 1990s levels, payroll growth should soon expand, and new-home production has fallen well below household formations for over two years. (Supportive of a positive forward-looking view was the 5.2% increase in pending-home sales in July reported yesterday.)