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After the Bond Bubble, Cash Will Be King

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It's not likely that money will head into stocks. Instead there will be an unprecedented rush for cash -- T-Bills, physical cash, you name it. Pure unadulterated, street-cred liquidity.

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Yesterday, Todd Harrison raised the literally $64 trillion question, "When the money comes out of the bond bubble, where will it go?"

Todd raised the possibility of it heading into stocks, but I seriously doubt that, for a few reasons.

First, please consider that the credit markets dwarf the stock market in size, so any mass migration out of bonds is likely to be associated with a blowing out of credit spreads and absolute rates.

Those aren't normally conducive to fund flows into stocks. Not to be flip, but if they were, wouldn't we have seen stocks rally during the credit crisis of 2008?

I believe that tumultuous credit markets are likely to be associated with volatile stock and commodity markets as widening spreads and higher rates are "translated" into perceptions that liquidity is rapidly leaving the credit markets.

And as we've all seen, perceptions of liquidity are a key factor in the market's determination of asset prices.

As we saw in the dot-com bubble aftermath, few will grasp the nuance that prices got too high, until prices go far, far lower. And as the prices most likely to first move far, far lower are bond prices, any bursting of the credit bubble will almost certainly take other markets with it.

Second, and compounding the consequences, will be the fact that it's not just a credit bubble that's bursting, but, as I offered earlier this week (subscription required for link), a risk-aversion bubble that is bursting.

I suspect that what's ahead will demonstrate that even on a sinking ship the price for life jackets can in fact go too high.

So where will funds go?

I believe there will be an unprecedented rush for cash -- T-Bills, physical cash, you name it. Pure unadulterated, street-cred liquidity.

I know it sounds extreme, particularly as this view suggests that extreme liquidity can unintentionally create extreme illiquidity, but that's what I see ahead.

History suggests that bubbles are bubbles are bubbles, whether it's technology stocks, Cabbage Patch Kids, residential real estate, or bonds.

And when they burst, human nature suggests that we move to further risk aversion, not further risk taking.

And as a result, cash will be king.


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Position in SPY options, SH and JPM
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