10 Year Treasury
Thursday, August 9th, 2012
by Don Vialoux, EquityClock.com
Upcoming US Events for Today:
- Weekly Jobless Claims will be released at 8:30am. The market expects Initial Claims to show 375K versus 365K previous. Continuing Claims are expected to reveal 3290K versus 3272K previous.
- Trade Balance for June will be released at 8:30am. The market expects -$47.5B versus -$48.7B previous.
- Wholesale Inventories for June will be released at 10:00am. The market expects an increase of 0.3%, consistent with the increase reported previous.
Upcoming International Events for Today:
- The ECB Publishes the August Monthly Report at 4:00am EST.
- Great Britain Merchandise Trade for June will be released at 4:30am EST. The market expects –9.0B versus –8.4B previous.
- Canadian Housing Starts for July will be released at 8:15am EST. The market expects 210K versus 222.7K previous
- Canadian Trade Balance for June will be released at 8:30am EST. The market expects -$0.9B versus -$0.79B previous.
Equity markets traded flat on Wednesday with little to move the tape one way or the other. Volume was once again light as conviction appeared lacking. The two consumer sectors bookended the days activity with Consumer Staples showing the best sector performance with a gain of seven-tenths of a percent, while Consumer Discretionary showed the worst performance, succumbing to a loss of half a percent.
Investors continue to remain hopeful for further monetary stimulus from any one of the major central banks, a fact which is clearly showing up in inflation expectations. The ratio of the Treasury Inflation Protected ETF (TIP) over the 7-10 Year Treasury ETF (IEF) continues to trend higher following an almost five month decline. Even the 5 Year Breakeven Rate has pushed higher since ECB President Mario Draghi hinted of further central bank intervention. Increased inflation expectations are bullish for stocks and commodities, both of which are at multi-month highs.
Inflation is particularly conducive to strength in the price of Gold, which has shown moderate improvement over recent weeks. Seasonal investors are well aware that we are within the period of seasonal strength for the yellow metal, but thus far the price action of bullion has been rather subdued, at least compared to years past. The metal is hinting of a breakout above a descending triangle pattern, a pattern that has bearish implications should the price of Gold fall below $1525. Further evidence is required to confirm the breakout. Hesitation from investors to believe in the stimulus hype is suspected to be culprit for the shallow returns.
The framework for a strong move higher in Gold has become established. In addition to increased inflation expectations, the US Dollar index has also come under pressure over the course of the past month and a minor head-and-shoulders top can be spotted on the charts. The target of this topping pattern points down to 81, also the point at which the price action would intersect with the rising intermediate trendline. The long-term trend for the US Dollar continues to look positive as the upside target derived from a head-and-shoulder bottoming pattern is fulfilled. The US Dollar Index seasonally declines, on average, between now and September, supporting commodity prices, such as Gold.
Another positive for the Gold trade is the fact that the miners have recently shown outperformance compared to bullion, a typical precursor to a positive move in the commodity. The relative performance chart for Gold Miners versus Gold bullion has shown a declining trend for over a year and a half, just recently charting the lowest level since the 2008 low. However, a double bottom has become apparent on the chart, hinting of positive things to come as investors become content with equity valuations at current gold prices. A positive trend still needs to be established, which may not be able to be confirmed until the ratio breaks above the 200-day moving average (0.29 on the chart below). The seasonal trade in gold currently looks appealing given the positive backdrop, but keep in mind that the trade could easily break if stimulus expectations are not confirmed.
Sentiment on Wednesday, as gauged by the put-call ratio, ended bullish at 0.80. The ratio continues to hold within a declining range as bullish expectations flourish.
Chart Courtesy of StockCharts.com
Chart Courtesy of StockCharts.com
- Closing Market Value: $12.40 (up 0.40%)
- Closing NAV/Unit: $12.36 (down 0.02%)
Click Here to learn more about the proprietary, seasonal rotation investment strategy developed by research analysts Don Vialoux, Brooke Thackray, and Jon Vialoux.
Tags: 10 Year Treasury, 9b, Bullion, Central Bank Intervention, Central Banks, Consumer Sectors, Consumer Staples, Don Vialoux, Ecb President, ETF, ETFs, Half A Percent, Inflation Expectations, Initial Claims, Merchandise Trade, Seasonality, Sector Performance, Seven Tenths, Stocks And Commodities, Trade Balance, Weekly Jobless Claims, Wholesale Inventories
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Wednesday, August 8th, 2012
Every now and then we prefer to sit back and let some of the smartest money speak, especially when said smart money agrees with us. In this case, we hand the podium over to none other than Paul Singer’s Elliott Management, which after starting with $1.3 million in 1977 was at $19.8 billion most recently. No expert networks, no high frequency trading, no “information arbitrage”, no crony capitalism and pseudo monopolies of scale, and most certainly no bailouts: Singer did it all the old fashioned way: by picking undervalued assets and watching them appreciate. The timing is opportune because while Elliott has much to say about virtually everything in their latest 20 pages Q2 letter, it is the billionaire’s sentiment vis-a-vis US Treasury debt that may be most critical, and may be the catalyst that resulted in today’s abysmal 10 Year bond auction. To wit: “long-term government debt of the U.S., U.K., Europe and Japan probably will be the worst-performing asset class over the next ten to twenty years. We make this recommendation to our friends: if you own such debt, sell it now. You’ve had a great ride, don’t press your luck. From here it is basically all risk, with very little reward.” There is little that can be misinterpreted in the bolded statement. And while many have taken the other side of the Fed over the past 3 years, few have dared to stand against Paul Singer because if there is one person whose opinion matters above most, certainly above that of the Chairsatan, it is his.
More deep thoughts from Elliott:
On QE and the nanny state:
- Printing money and overstaffing government offices may look like growth for a period of time, but it is actually the road to poverty, corruption and, ultimately, political upheaval.
- Opaque, overleveraged and vulnerable Financial Institutions which need to be propped up by the implicit or explicit guarantee of sovereigns does not make for a solid financial plumbing system for the global economy…this is a formula for power entrenchment, favoritism and shady deals behind closed doors.
- Not only will it fail to make the system safer, but we believe it will likely be an actual accelerant of the next financial crisis
- Dodd-Frank was supposed to “fix” the American financial system and end “too big to fail.” Unfortunately, the law, born in a political steamroller, does the exact opposite: it will be the accelerant of the next crisis.
- The 2008 crisis was episodic and took a while to get rolling. The next one could well be a black hole, and Dodd-Frank will bear responsibility for that.
On why Americans are angry:
- The government, lacking deep understanding of these firms, wants to pretend that their gigantic efforts (most notably Dodd-Frank) actually fixed the situation. But we believe that citizens are angry at what their guts tell them (correctly, basically) about the special treatment and riskiness of Financial Institutions.
On public data reporting:
- Decades ago, the balance sheets of the Financial Institutions contained most of the information you needed to know to understand their risks. Today the picture is profoundly different, predominantly due to the growth of leverage through derivatives….As a result, there is no major Financial Institution today whose financial statements provide a meaningful clue about the risks of the firm’s entire panoply of assets and liabilities including derivatives, nor how the firm’s performance, or even survival, will be affected by market movements in the future.
- Including derivatives, nearly all the world’s largest Financial Institutions are levered 50-100 times (not 10-20 as reflected on their balance sheets), so the exact composition of their derivatives books is essential to an understanding of their risks and stability….no hedge fund is remotely as leveraged as the Financial Institutions, and no hedge fund actually had to be rescued during the crisis.
On European banks:
- European institutions are in worse shape than before. Not only is their leverage (including derivatives) still at pre-crash levels, but they are choking on vast holdings of questionable sovereign debt which regulators more or less forced on them with lenient risk-weightings.
- These banks are stuffed with paper that private investors would not buy, as part of the “three-card Monte” shuffle that characterizes the European banking/sovereign system today.
On “peak fragility” in the bond and stock market:
- People are still buying bonds despite pitifully low yields because, well, they continue to go up in price, albeit in a self-reinforcing process goosed by central bank and momentum buying. When these forces exhaust themselves, the reversal could and should be swift and large.
- A decade ago, stocks were overpriced, but institutions who owned them were generally happy… Stocks looked predictable and safe at the very moment that they were maximally unsafe. That is where long-term bonds of these four currency blocs (euro, U.S., U.K. and Japan) now stand.
- “Safe haven” could be the two most expensive and painful words for investors in the financial lexicon this year.
On market sentiment:
- Global financial markets currently feel like they are in a period of calm before a storm, possibly centered on the European situation. The problem is that no one can foresee when the storm will make landfall, or how severe it will be.
On why Europe is making one wrong decision after another:
- Raising taxes to confiscatory levels (75% top rates are absurd and self-defeating), lowering already-too-low retirement ages, making it hard or impossible to fire people (which obviously discourages hiring them in the first place), increasing the scope of regulation and making it more complicated and subject to greater discretion by hostile, inadequately informed regulators, and making threatening noises at every turn about “the rich”, are the precise opposite of the actions and statements that policymakers should make to attract businesses and encourage expansions of existing businesses.
- Nobody is forced to locate a business in Europe, and in fact capital flight today from several countries is already large and relentless.
On the future of Europe:
- Since all of the euro bloc surprises in the last couple of years have been negative, and since the answer to every question about the ultimate cost of preserving the euro is “more than you thought yesterday,” the metaphor of a slow-motion train wreck seems quite appropriate.
- The overall situation is not going sideways or up. It is drifting down.
On Socialists – in this case in France, but applicable everywhere:
- The Socialists are unlikely to be terribly successful at preventing the destruction of jobs, but they may be all too effective, however unintentionally, at stifling job creation.
On tax policy:
- Dramatic increases in taxes and regulation, together with a repeatedly punitive tone, are understandably extrapolated by capitalists and investors as indicators of hostility toward business and profits. The societal loss from the business decisions occasioned by such signals is self-reinforcing. Businesspeople sitting on their hands leads to lower growth and more angry rhetoric and hostile actions by government.
On the lack of job creation:
- Since the top 20% of taxpayers (which includes a great number of people making less than billions and even millions) pay the overwhelming bulk of taxes, this promise to raise taxes has not exactly generated enthusiasm or jobs.
On US (small) business uncertainty:
- Under ACA and the scheduled rise in overall federal income tax rates, one of the largest aggregate tax increases in American history is scheduled for five months from now. This is occurring at the same time that several strapped large states are also raising their top tax brackets.
On shifts in paradigms:
- Businessmen are inherently optimistic, typically always looking for reasons to do business, expand and innovate.
- Historical experience shows that when established perceptions are wrong, it can take a long time for contradictory data points to accumulate before such perceptions start to adjust and to cause alterations of behavior. However, at a certain moment, shifts in perceptions and trends could be abrupt, especially given modern tools of instant communication.
- Today the hostility of the American and European governments to private enterprise, wealth and profits is used by those governments as vote-buying tactics. The impact on growth and jobs is already visible, and capital flight (already seemingly underway in France) may accelerate unless the policies, and tone, change.
On the US welfare state:
- If [Social Security, Medicare, Medicaid and government pensions] are not reformed, such entitlements simply cannot be paid as promised, regardless of the levels of future growth or taxes on “the rich” or anyone else.
- The numbers are just too big, the result of a form of corruption: politicians made big promises in exchange for votes, not worrying about whether the promises could be fulfilled.
On the US “recovery”
- Three and a half years after the bust, the massive spending, guarantees and money printing have left America with 8.2% unemployment (which vastly understates the actual level, since millions of people have simply left the workforce, while others have migrated from receiving unemployment benefits to getting long-term disability payments), sluggish growth, $5 trillion in additional federal debt, and $3 trillion of freshly-printed dollars on the Fed’s balance sheet. This is not a success. This is a national tragedy, in a society in which the world’s greatest engine of prosperity has historically been fueled by innovation, optimism, entrepreneurship, flexibility and opportunity.
On Congress handing over the decisionmaking process to the Fed:
- We believe that relying on monetary authorities to pick up the considerable slack in growth by printing money by the boatload is completely wrongheaded. It distorts both the price of money and the risks of holding long-term claims denominated in paper money, builds a future risk of large inflation, supports economic activity only in an oblique and unfair way, and creates something that is going to be very hard to unwind.
On the consequences of the printing money “alchemy”:
- Somehow many policymakers and citizens have come to believe that money printing is some kind of magical process, that good things can be produced literally out of thin air, and that if leaders don’t create growth from obviously-needed changes in wrongheaded policies, then poof!… printing more money will solve it. This is pathetic.
- The range of inevitable costs to societies practicing such alchemy is somewhere between “a lot” and “utterly catastrophic.” The damage is already becoming evident, particularly in the distortion between the rise in financial asset prices and the sluggishness of the real economy. When consumer prices soar across the board or there are other painful consequences, we wonder what excuses the blameworthy policymakers will make to deny their responsibility.
Finally, on what nobody wants to discuss, but could very easily be the final outcome:
- A loss of confidence in paper money could result in searing and startling inflation, evaporating life savings and turning every stolid worker into a frantic speculator.
- If that were to occur, nobody could possibly say in hindsight that the conditions for such a sorry state of affairs were not in place.
- The people who are telling us now that inflation is impossible because there is slack in the global economy, and that central banks can print trillions of dollars more without a significant risk of inflation, are the same folks who not only failed to predict the financial crisis, they did not even have a clue that a crisis of such kind was possible.
Indeed the “smartest money” is just that because it calls it how it is.
Tags: 10 Year Treasury, Arbitrage, asset class, Billionaire, Bond Auction, Crony Capitalism, Deep Thoughts, Expert Networks, Financial Institutions, Government Debt, Government Offices, Monopolies, Nanny State, Paul Singer, Political Upheaval, Printing Money, Qe, Smart Money, Sovereigns, State Printing
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Thursday, August 2nd, 2012
The S&P 500 has made little headway for two years running and as Gluskin Sheff’s David Rosenberg points out, it first crossed 1380 on July 1, 1999 and since then has run around like a headless chicken (while other asset classes have not). Meanwhile, Europe’s bottomless pit of debt deleveraging (which is as much a problem for the US and China but less ion focus for now) makes the entire discourse of some new and aggressive intervention by the ECB even more ridiculous (and all so deja vu); and the US is facing up to an entirely topless earnings season as revenues are coming in at only 1.2% above last year as it appears Q2 EPS is on track for a 0.2% YoY dip – with guidance falling fast. But apart from all that, Rosie sees the only source of real buying support for the stock market is the stranded short-seller forced to cover in the face of CB-jawboning as there is little sign of long-term believers stepping into the void.
Headless Chicken Markets: BULL OR BEAR?
The cup is half full camp would lay claim that the S&P 500 is not only still up on the year in what has been a challenging 2012 but it is more than twice the lows posted in March 2009.
A discerning bear, however, would point to the fact that the index has made little headway for two years running and keep in mind that it first crossed the 1,380 mark on July 1, 1999 and since then:
- It has crossed 59 times above and below the 1,380 level on a closing daily basis
- Gold is up 515%
- The producer price index is up 45%
- The consumer price index is up 37%
- The 10-year Treasury total return index is up 160%
- The 30-year Treasury total return index is up 215%
So bench-marked against gold prices, producer prices, consumer prices, or bond prices, the secular bear market in equities remains an ongoing phenomenon.
Bottomless Europe: UNRESOLVED DEBT ISSUES
Quote of the day:
What can they do and what would bring about a sustained turnaround in market confidence? There I struggle to find something that would really be convincing.
From Jacques Cailloux, chief European economist for Nomura, in yesterday’s NYT (page B3).
Indeed, this entire discourse on some new and aggressive intervention by the ECB is all so ridiculous, and all so déjà vu. The ECB has already done two LTROs and bought bonds outright before. Draghi is still throwing spaghetti against the wall to see what sticks. The bottom line is that monetary policy is a blunt tool to deal with structural insolvency issues as they pertain to bank and government balance sheets. The ECB has only a temporary effect and then bond yields go back up in the periphery. Until there is a move to solve the issue of too much debt relative to the economy’s capacity to service the debt, the problem will re-emerge.
Meanwhile, the credit crunch in the euro area continues unabated, exacerbating recessionary pressures. Cross-border lending by German banks to the periphery has declined nearly 20% in the past seven months to stand at the lowest level since 2005. Overall bank loan books in Spain. Greece and Portugal have contracted 2% as deposits shift to the northern regions. At the same time, the entire regional banking sector is beset by a trillion euros worth of impaired loans, which have expanded 9% from a year ago (2.5 trillion euros are non-performing) with Spain, Ireland and Italy suffering with the largest increases.
Europe for some reason continues to believe that a debt crisis can be fought with more debt. Maybe because they think this strategy has worked in the United States. But it hasn’t and the U.S. is either recession-bound or at best left with a listless economy, and also will likely soon face its own existential moment from a fiscal crisis perspective if it doesn’t get its act together. If left unchecked, the day will come when the entire revenue base will be absorbed by interest expense, defense, health care and social security.
TOPLESS EARNINGS SEASON
The numbers vary by the hour and the data source. but it looks like Q2 operating EPS of S&P 500 companies is on track for a 0.5% YoY dip — by far the weakest since the recovery began three years ago (and well below consensus views of +3% a month ago) . The big problem !s revenues which are coming in just 1.2% ahead of year-ago levels and only 43% are beating their sales targets the lowest since the first quarter of 2009 (only the fourth time in the past 10 years that the beat-rate was under 50%).
The other problem is guidance. The WSJ cites research that finds that 40 companies have already warned about Q3 versus only eight who have raised guidance. We have not seen a gap like this since the onset of the tech wreck in the second quarter of 2001. The bottom-up consensus is now looking for just +3.3% for YoY EPS growth for Q3 — last October, the analysts collectively were calling for 14.5% for the quarter. Talk about a mea-culpa.
Summing It All Up
All that said, the key for all of us is to understand that we are still in the throes of a debt deleveraging cycle that first engulfed the housing and consumer sectors and is now attacking the government sector in country after country. It is not only Europe. China and the U.S.A. too. There is still far too much debt at all levels of society relative to the world’s capacity to service it. This is a critical reason why government and central bank policies aimed at fighting traditional recessions in the past have so far been ineffective and now we have monetary authorities dipping into the toolbox of unconventional balance sheet expansions and contortions.
We have governments battling a debt deleveraging cycle of epic proportions, and by definition, these phases involve debt paydowns, defaults, and rising savings rates — a highly deflationary brew. And it also means that we now reside in a world of fat-tail distribution risks, where the range of outcomes is unusually wide, as opposed to the comfort zone of a classic post-WWII cycle, where we understood what caused recessions and we knew exactly what it took to get out of them, and where there was a much thinner tail to the probability curve.
May those days rest in peace. But once we can acknowledge that we are in a fat-tail world, it is akin to moving into the acceptance phase of the classic five Kubler-Ross stages of grief. This is no time for denial.
Tags: 10 Year Treasury, 30 Year Treasury, Aggressive Intervention, Asset Classes, Basis Gold, Bond Prices, Bottomless Pit, Chicken Markets, Consumer Price Index, Daily Basis, David Rosenberg, Debt Issues, Earnings Season, Gluskin Sheff, Gold Prices, Headless Chicken, Headless Chickens, Producer Price Index, Producer Prices, Secular Bear Market
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Sunday, July 29th, 2012
Energy and Natural Resources Market Radar (July 30, 2012)
- The yield on 10-year Treasury notes closed the week at 1.534 percent, still below the June Consumer Price Index of 1.7 percent. The dividend yield of the stocks in the Global Resources Fund’s portfolio increased from last week to an average of 3.68 percent.
- Eagle Ford oil production more than tripled in May year-over-year, according to the Texas Railroad Commission, and this may be an underestimate. Experts believe that production here in Texas may reach one million barrels a day in the next couple of years.
- Speculation of Europe’s plan to spur economic growth by purchasing government bonds caused oil to increase 2.2 percent this week. Copper also climbed 2.1 percent from Tuesday this week on the New York Mercantile Exchange. Mario Draghi said that the ECB will do whatever it takes to “preserve the euro.”
- Peru’s mining ministry reported that from January to May, production of copper increased 2.5 percent. It was also noted that production in May was up 8.04 percent year-over-year.
- The same report from the mining ministry of Peru also showed a decline in zinc and iron ore production. Zinc declined about 4.5 percent during the January-to-May time period and iron ore declined further at 16.02 percent.
- The Western Australian Mines Minister has banned coal mining in the Margaret River region based on the “potential ground water impacts.” All applications to mine in this area will be denied and companies have already started to withdraw their requests. Mineral titles already granted, however, will remain intact but any coal mining project proposals will be rejected.
- Tenova Mining and Minerals was awarded a contract to design a copper ore handling and processing system as well as a solvent extraction and electro-winning plant, which could potentially produce 80,000 metric tons per year of copper cathodes. This will support Minera Antucoya’s copper oxide deposit in Chile.
- Aluminum Bahrain BSC (Alba) has hired BNP Paribas to assist the company in a $2.5 billion dollar expansion plan to add 400,000 metric tons of capacity annually (currently 881,000 metric tons) to its operations. According to Reuters, this could be completed by 2015. Alba is currently the fourth largest aluminum smelter.
- In China, the capital of Hunan Province has announced plans of a 195 project undertaking for 2012. It will involve airport, urban transit, and residential infrastructure development.
- Iron ore prices are now at $116.20 per metric ton, the lowest since December 2009. Small traders in China are now selling their stockpile for a loss, and this would have a very negative impact on the commodity if larger traders were to follow.
- Lakshmi Mittal, CEO of ArcelorMittal, the world’s largest steel and mining company, said that the steel market would remain week going into the second half of the year, especially in Europe. The company lowered expectations of European consumption to between 3 percent and 5 percent for 2012.
Tags: 10 Year Treasury, Coal Mining, Consumer Price Index, Copper Cathodes, Copper Ore, Dividend Yield, Eagle Ford, Government Bonds, Handling And Processing, Margaret River Region, Mario Draghi, Market Radar, Mineral Titles, New York Mercantile Exchange, Ore Production, Project Proposals, Resources Fund, Texas Railroad Commission, York Mercantile Exchange
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Sunday, July 22nd, 2012
by John Hussman, Hussman Funds
Just weeks after the enthusiasm over Europe’s plan to plan for the possibility of using the European Stability Mechanism to bail out Spanish banks, the subtle technicality – that direct bailouts would make all of Europe’s citizens subordinate to even the unsecured bondholders of Spain’s banks – has predictably deflated that enthusiasm. On the growing recognition that addressing Spain’s banking problem will mean taking those banks into receivership, wiping out unsecured debt (much of which unfortunately was sold to unknowing Spanish savers as secure “savings” vehicles), and having the Spanish government sort out the damage, Spanish 10-year debt plunged to new lows last week (see chart below), and Spanish yields hit fresh Euro-crisis highs. At the same time, interest rates in Germany, Finland, Holland, Denmark and Switzerland all moved to negative levels looking 2-5 years out. The world is paying these governments to lend money to them, because the only way to acquire other default-free, non-commodity assets is to hire armored trucks and secure vaults to take delivery of physical currency. This set of conditions is not normal or sustainable, and indicates extreme credit market strains in Europe.
The Euro also hit a fresh 2-year low last week at 1.21, just a shade above its 2010 crisis low of 1.20. Likewise, the yield on 10-year U.S. Treasury bonds dropped to 1.45%, matching the historic low it reached a few weeks ago. Yields were higher even in the depths of the Great Depression, when the S&P 500 was trading at less than 2 times the pre-Depression level of earnings, the Shiller P/E on 10-year normalized earnings was less than 5, and the S&P 500 was yielding 16%. As a side note, many analysts seem almost woozy at the “incredible value” that supposedly exists in stocks because the 2.3% yield on the S&P 500 exceeds the 1.45% yield on 10-year Treasuries. It’s worth pointing out that prior to the point that inflation took off after 1960, the yield on the S&P 500 exceeded the yield on Treasury bonds in fully 93% of the data.
Keep in mind that once you subtract out the necessary compensation for default risk (which is rapidly increasing in Spain, for example), interest rates represent the value that the economy places on time. Long-term interest rates have plunged to record lows, and real interest rates are negative after inflation. What interest rates are telling you; what the Federal Reserve is telling you; what the equilibrium created by lenders and borrowers is telling you – is that time is economically worthless and that economic malaise will extend for years.
This does not reflect a well-functioning economy. To the contrary, if you look across history and across nations, strong prospects for sustained economic growth are typically accompanied by high real interest rates, because the demand for capital is robust and good ideas have to compete for funding. Interest rates are an indication of both the demand for loans and the incentive to save. It is not “stimulative” to depress interest rates in an environment where households, businesses and governments are desperately trying to reduce debt. That policy may insult the value of time enough to deter people from saving, and to reduce the immediate penalty for assuming even larger amounts of debt (as the U.S. government continues to do), but it should be clear that these actions move the economy further from a sustainable equilibrium, not closer to it.
I do expect that it will be possible to navigate the coming years well, but it will not be by locking in negligible yields and depressed risk premiums in the futile hope that one plus one will end up being something other than two. Prospective returns vary a great deal over the course of the market cycle, and the strategy of varying risk exposure in proportion to the prospective compensation for that risk will be essential.
On the economic front, as we expected based on leading economic evidence, new orders and order backlogs have dropped abruptly in recent reports. These indices are short-leading indicators of production, which is likely to show a striking decline beginning in the July data. Note carefully whether any positive surprises are in May and June data, because these reports will still be mixed. I continue to expect negative employment changes in the coming months, though as I’ve noted before, we may only find this out later on revisions rather than the initial prints in real-time. In any event, I am convinced that we will ultimately learn that the U.S. economy, slightly trailing the global economy, entered a new recession in June.
While July components are still coming in, the chart below shows the most recent condition of coincident U.S. economic data, reflecting a variety of Fed surveys and Purchasing Managers surveys.
The key question – in view of extreme credit market strains in Europe, and accelerating economic deterioration in the U.S. – is why the S&P 500 continues to trade within a few percent of its April bull market high. The answer is simple: investors are scared to death of missing the widely anticipated market advance that they expect to follow a widely anticipated third round of quantitative easing. Good economic news may be a relief for investors, but bad economic news in this context is just as much of a relief because it brings forward the anticipated delivery date of the sugar. The follow-up question, however, is that if more QE is widely anticipated, and a market advance is widely anticipated to result, isn’t that the precise definition of an event that is already priced into the market?
If you look at the Federal Reserve’s own research on quantitative easing – large scale asset purchases (LSAPs) – nearly every paper emphasizes the “portfolio balance” effect. Put simply, as the Fed removes longer-term Treasury securities from the menu of portfolio choices available to investors, it forces investors to consider alternative securities, raising their prices and lowering their yields – with a particular impact in driving down the risk premiums of risky securities. Indeed, as we’ve noted, QE has generally been effective in helping stocks to recover the peak-to-trough loss that they have suffered in the prior 6-month period (though the most recent LSAPs in the UK and Europe have been failures in that regard).
Still, once risk premiums are already deeply depressed (we estimate the likely 10-year prospective total nominal return for the S&P 500 to be only 4.8% annually), once stocks are trading near their bull market highs, and once Treasury debt already sports the lowest yield in history, should investors really expect much of a portfolio-balance effect from further attempts at QE? Frankly, I doubt it, but in the eventuality of a third round of QE, we’ll focus on our own measures of market action – not on any blind faith in the Fed.
The more troubling issue is that Fed papers on the effectiveness of QE focus almost singularly on the effect of QE on interest rates and risk premiums in the financial markets, with the notable absence of any analysis of the resulting effect on the real economy. This is like showing that squirting gas into an engine will make the engine run faster, without any concern for the fact that there is no transmission that connects the engine to the wheels. In a nutshell, the problem with QE is the lack of any material transmission mechanism from monetary interventions to real economic activity. This is a problem that the Fed should have recognized years ago, because there is strong and consistent historical evidence that real economic activity has very weak “elasticity” with respect to financial market fluctuations, particularly in equity values. Invariably, a 1% change in the value of the stock market is associated with a change of just 0.03-0.05% in GDP, and even that change is transitory. What the Fed has been doing is little but bubble-blowing, while at the same time driving the global financial system further from equilibrium rather than toward it.
Unfortunately, I expect these efforts to continue, but I also expect that it will be useless in averting an unfolding global recession. If the Fed was to initiate a third round of QE near present levels, it would likely be disappointing in the sense that it would fail to reverse economic weakness and at the same time would fail to drive equity prices higher than they already are, or interest rates materially lower than they already are. This would damage confidence in the Federal Reserve and force it to resort to language about monetary policy working with “long and variable lags.” Moreover, at a 1.45% yield and an 8-year duration on a 10-year bond, any interest rate increase of more than about 18 basis points a year will now produce a negative total return for the Federal Reserve over the period that the bonds are held, which comes at public expense (reducing the amount of interest that the Fed would otherwise turn over to the Treasury). As a result, talk is presently much cheaper than action. It seems likely that another round of QE will await obvious economic weakness and a significant spike in risk premiums – probably best measured by the depth of the drawdown in the S&P 500 from its most recent 6-month peak. Still, given that the rationale for much higher risk premiums is very real, it’s not clear that QE will have durable effects on stocks even in that event.
In short, a broad array of observable evidence suggests extraordinary strains in Europe, and abrupt though expected deterioration in U.S. economic activity. The Federal Reserve certainly has policy options, but those options have no material transmission mechanism to the real economy. We’ve always viewed the Federal Reserve as having an important and legitimate role in providing liquidity to the banking system in the event of heavy withdrawals; creating new reserves in return for high-quality, default-free securities backed by the full faith and credit of the U.S. government. This remains an important role, but the Fed’s actions have gone far beyond this role into areas that distort financial markets without transmission to economic activity. That’s just a reality we have to accept, and we’ll respond to further interventions with particular attention to trend-following measures of market action.
Here and now, we remain defensive in the face of accelerating strains the global economy – new highs in Spanish yields, negative interest rates across more stable European countries, new lows in the Euro and U.S. Treasury yields, collapsing new orders and backlogs, a sudden plunge in the employment component of the Philly Fed index, collapsing M2 velocity, and other factors. Due to some modest interest-rate considerations, our estimates of prospective return/risk have improved negligibly from the most negative 0.5% of historical observations, and are now among the most negative 0.8% of historical data. This rare extreme keeps us on red alert for now.
As noted above, accelerating strains are evident both in the global economy – particularly Europe – and in the U.S. economy. Stock valuations remain stretched on the basis of normalized earnings. Profit margins are nearly 70% above their historical norms at present, but these margins reflect very high deficit spending and very weak savings rates – something that can be related to corporate profit margins through accounting identities. Unless one anticipates continued deficits indefinitely, either revenues will revert closer to the level of labor compensation, or less likely, labor compensation will increase toward the level of revenues, but in any event the gap will tend to narrow. This may not be an immediate outcome, but stocks are instruments with an effective duration of over 40 years (mathematically, the duration of stocks is essentially equal to the price-dividend ratio, regardless of growth rates or repurchases). The very long-term stream of cash flows matters enormously in asset valuation.
One of the immediate issues I have with stocks here is the “exhaustion syndrome” (see Goat Rodeo) that has re-emerged in recent weeks. Examining the rare past instances of this syndrome, in 1961, 1987, 2000, and early-2008 among others, the key feature is a breakdown in measures of market action from an overvalued, overbought extreme, followed by a recovery rally toward the prior high and accompanied by earnings yields below their level of 6-months earlier. Normally, the recovery carries the market back to the prior “line” of support that surrounds the peak. The emergence of this exhaustion syndrome may seem benign or unimportant, but it has historically been an important precursor of major market declines. Given what are already significant challenges for both the economy and for the prospective return/risk tradeoff in stocks, my concerns about the potential for deep market losses remain elevated.
Investors often have the impression that the market simply collapses once a bull market peak is set, but this isn’t typical. What is typical is exactly the sort of exhaustion pattern we’ve observed since April. To illustrate this, the chart below presents market behavior around several market peaks that were also followed by an exhaustion syndrome as we observe today. The bull market peaks are aligned at 1.0. The remaining scale is set as a fraction of that peak. Time is measured in trading days before and after the bull market peak. Note that after a quick initial decline from the bull market peak, it’s typical for the market to recover much of the lost ground before the downside progress continues, in some cases producing the “exhaustion syndrome” that we presently observe. Exhaustion syndromes can go on for several weeks, but have historically been very dangerous advances to trade, because more often than not, there is a bear market just behind them. This was not the case in three instances: the July 1998 instance – followed by a decline of only 18%, the July 1999 instance – down only 12% over the next several months, and of course the instance in late January of this year, which occurred at about 1326 on the S&P 500 and still hasn’t yet resolved into losses beyond the weakness we saw in May. It’s possible that the market outcome will be benign in this case, and that the market will go on to set further bull market highs. We have no intention of taking that improbable gamble in the face of present headwinds.
Strategic Growth and Strategic International continue to be fully hedged, with a staggered-strike option position in Strategic Growth (which raises the strike prices of the put side of our hedge). We presently estimate the time-decay or “theta” of the staggered-strike position at about 0.25% of assets monthly – which we are willing to accept based on the extremely negative outcomes that are typical of the current climate, and the expectation that we will not remain in this position for a long time. Strategic Dividend Value is hedged at about 50% of the value of its stock holdings, and Strategic Total Return continues to carry a duration of just over one year, with about 10% of assets in precious metals shares and a few percent of assets in utility shares and foreign currencies.
Copyright © Hussman Funds
Tags: 10 Year Treasury, Armored Trucks, Bondholders, Commodity, European Stability, Great Depression, Hussman, Hussman Funds, John Hussman, Lows, Receivership, Shiller, Spanish Banks, Spanish Government, Strains, Technicality, Time Interest, U S Treasury, U S Treasury Bonds, Unsecured Debt, Vaults
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Sunday, July 8th, 2012
The Economy and Bond Market Radar (July 9, 2012)
Treasury yields headed lower this week on disappointing economic reports and global central bank easing. Two key economic data points bookended the week, with a very weak reading from the ISM Manufacturing Index on Monday, followed by a subpar employment report on Friday. On Thursday we had what appeared to be coordinated global central bank policy easing with the ECB and the Bank of China cutting interest rates by 25 basis points, along with the Bank of England adding ?50 billion to their quantitative easing program. As can be seen in the chart below, the yield on the 10-year treasury fell to the lowest level in more than a month.
- Economic data is weak globally, forcing central banks to act which is sparking a bond rally and pushing down yields.
- Domestic auto sales remain a bright spot for the economy with GM, Ford and Chrysler all posting strong sales growth in June.
- Factory orders for May rose 0.7 percent, beating expectations.
- June nonfarm payrolls were weaker than expected, rising by a meager 80,000, little changed over the past few months.
- The ISM Manufacturing Index fell to the lowest level since July 2009 and indicated contracting manufacturing in June.
- European bond yields remain elevated even after central bank intervention and the EU summit the week before.
- The Federal Reserve reaffirmed its commitment to an ultra-low interest rate policy through 2014 and additional monetary easing is possible in the near future.
- Europe remains a wildcard with the markets shifting focus on a weekly basis.
- China has obviously become more concerned about the economy and has eased twice in the past month.
Tags: 10 Year Treasury, Bank Of China, Bank Of England, Basis Points, Bond Market, Bond Yields, Central Bank Intervention, Central Banks, Domestic Auto, Economic Data, Economic Reports, Employment Report, Gm Ford, Interest Rate Policy, Ism Manufacturing Index, Market Radar, Nonfarm Payrolls, Shifting Focus, Strong Sales, Treasury Yields
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Thursday, July 5th, 2012
by Russ Koesterich, Chief Investment Strategist, iShares
Here’s my take: I believe high yield bonds are close to fair value, I hold a neutral viewof the asset class and I advocate that investors generally maintain a benchmark weight.
That said, in the following three instances, I’d advocate investors consider being more aggressive buyers of high yield:
1.) If spreads widen. The spread between high yield bonds and the 10-year Treasury has generally fluctuated between 500 to 600 basis points this year, about where high yield should trade given the sluggish economic environment. However, assuming no further deceleration in the US economy, any further widening of high yield spreads back toward a premium of 650 to 700 basis points over the 10-year Treasury would represent a good buying opportunity, especially considering that many corporate balance sheets generally have been extremely strong and default rates have been low.
2.) If they have portfolios with high income needs. With a yield to maturity a little under 7% and volatility of less than 10%, a fund like the iShares iBoxx $ High Yield Corporate Bond Fund, (NYSEARCA: HYG) is an efficient way to add incremental yield to a portfolio. As such, investors may want to consider adding high yield bonds to their fixed income portfolios as their demand for income rises. For instance, while risk adverse investors may only want to hold around 10% of their fixed income portfolios in high yield, investors willing to take incremental risk to earn additional income may want to consider holding as much as 30% of their fixed income portfolio in high yield.
3.) If they are worried about rising rates. Investors who are worried about rising interest rates may also want to add high yield as a substitute for long-dated Treasuries. High yield bond funds currently have lower durations than Treasury funds, meaning that Treasuries are far more sensitive to interest rates. If interest rates rise even modestly, Treasury funds are likely to suffer larger losses than high yield bond funds.
Source: Bloomberg, iShares.com
The author is long HYG
The performance quoted represents past performance and does not guarantee future results. Investment return and principal value of an investment will fluctuate so that an investor’s shares, when sold or redeemed, may be worth more or less than the original cost. Current performance may be lower or higher than the performance quoted. Performance data current to the most recent month end may be obtained by calling toll-free 1-800-iShares (1-800-474-2737) or by visiting www.iShares.com. For standardized performance for HYG, please click here.
Bonds and bond funds will decrease in value as interest rates rise. High yield securities may be more volatile, be subject to greater levels of credit or default risk, and may be less liquid and more difficult to sell at an advantageous time or price to value than higher-rated securities of similar maturity.
Tags: 10 Year Treasury, Aggressive Buyers, asset class, Basis Points, Bond Fund, Chief Investment Strategist, Corporate Balance Sheets, Corporate Bond, Deceleration, Default Rates, Fixed Income Portfolio, High Yield Bond, High Yield Bond Funds, High Yield Bonds, Hyg, Neutral View, Rising Interest Rates, Treasuries, Treasury Funds, Yield To Maturity
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Wednesday, July 4th, 2012
Whether gold-bug, permabull, or deflationst; BofAML provides a little something for everyone in the most complete picture guide to ‘financial markets since 1800′. A collection of almost 100 charts on asset price returns, correlations, volatility, valuations and many other market and macro factors for the US, UK, Europe, Japan, and Emerging Markets.
“History does not repeat itself but it does rhyme.”
The Long-run in numbers:
- 1.45%: the yield of US 10 year Treasuries on June 1, 2012; a 220-year low
- 1958: the last time US AAA corporate bond yields were as low as they are today
- 1517: Dutch government bond yields currently at lowest level in almost 500 years
- 320bps: the current spread between European dividend yields and German bund yields, an all-time high
- 63x: the amount EM equities are up since the late 1960s
- $1900/oz: record high gold price reached in September 2011
- 43%: the drop in US real home prices since the 2006 peak, making the current US real estate bear market the greatest since 1921
- 8%: Japan’s share of global equity market cap; close to an all-time low and down from 44% in 1988
- $3,642,000: What $1 invested in US large company stocks in 1824 would be worth today with dividends reinvested
- 1 out of 2: the number of years since 1871 that the S&P 500 has had a negative real price return
- 44%: the share of US Treasuries owned by foreigners; up from just 1% in 1945
- 280mn: the number of people India’s working age population will grow by over the next 25 years; this is more than the current working age population in the US and Germany combined
The Long-run in years:
- 1602: the Dutch East India Company becomes the first company to issue stocks and bonds
on the Amsterdam Stock Exchange
- 1685: Germany establishes the second stock exchange in the world
- 1790: an $80 million U.S. Government bond offering to refinance Revolutionary War debt
becomes the first publicly traded security in the US
- 1792: the NYSE is organized and the Bank of New York becomes the first company listed
- 1810: Russia is the first “emerging market” country to establish a stock market
- 1879: US stocks record their best year ever, returning 57%
- 1891: the first US equity bear market (>20% loss) is caused by the “Baring Brothers Crisis”
- 1918: US Inflation hits an all-time high of 20.4%
- 1931: US stocks record their worst year ever, declining 43%
- 1932: the most volatile year ever for US stocks as volatility hits 68%
- 1981: monthly US 10 year Treasury yields hit an all-time high of 15.8%
- 1982: the best year of total return for long-term Treasuries of 40%
- 1987: on “Black Monday,” October 19th, the Dow falls 23%, the largest daily drop ever
- 2009: the worst year for long-term Treasury returns with losses of 15%
- 2012: a year marked by multi-century lows in many DM government bond yields (including
the Netherlands, France, US)
For your Independence Day enjoyment:
Tags: 10 Year Treasury, Age Population, Amsterdam Stock Exchange, Asset Price, Company Stocks, Corporate Bond Yields, Dividend Yields, Dutch East India, Dutch East India Company, East India Company, German Bund, Gold Bug, Gold Price, Government Bond, Guide To Financial Markets, Macro Factors, Stock Exchange In The World, Stocks And Bonds, War Debt
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Monday, June 4th, 2012
The Economy and Bond Market Radar (June 4, 2012)
Treasuries rallied this week, sending yields sharply lower across the long end of the curve. Europe was the focal point for most of the week. While Greece still makes headlines, Spain was more in focus as the government planned to borrow to pay for bank bailouts. At the same time, economic data is deteriorating very quickly. On Friday there were a slew of negative data points as May purchasing managers’ indices from around the world disappointed and nonfarm payrolls grew a meager 69,000.
- On June 1, the 10-Year Treasury yield fell to 1.45 percent as investors sought perceived safety. This rate is lower than the Near-Term Tax Free Fund (NEARX)’s 30 Day SEC yield on a tax equivalent basis based on a 35 percent tax rate, even though the fund holds bonds that, on average, mature in less than five years. Click here to see returns.
- Retail sales were surprisingly strong in May with same store sales generally beating expectations.
- Brazil cut interest rates by 50 basis points to a record low 8.5 percent.
- European Central Bank president Mario Draghi supported the idea of a bank deposit guarantee. This would likely help prevent a “run” on European banks.
- May nonfarm payrolls expanded by only 69,000, well below estimates of 150,000. The prior two months were also revised lower by 49,000. Overall it was a very weak report.
- Global purchasing managers’ data released late in the week also disappointed. China was a negative surprise relative to expectation, while European data just confirmed the weakness.
- April’s pending home sales unexpectedly fell 5.5 percent which casts a shadow on the recent strength in the housing market.
- Bonds continue to grind higher and appear to be forecasting benign inflation and slow growth.
- The Fed appears willing to increase monetary accommodation if necessary, which would be a boost to the bond market.
- China’s economy is slowing faster than expected and government policy makers appear comfortable with this dynamic.
- Europe remains a wildcard with austerity programs under pressure, creating significant uncertainty.
Tags: 10 Year Treasury, Bank President, Basis Points, Bond Market, Brazil, Deposit Guarantee, Economic Data, Employment Concerns, European Banks, Focal Point, Housing Market, Less Than Five Years, Mario Draghi, Market Opportunity, Market Radar, Nonfarm Payrolls, Purchasing Managers, Retail Sales, Slew, Tax Rate, Treasuries
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Tuesday, May 22nd, 2012
With the 10-Year US Treasury now yielding 1.74%, it is now paying a coupon that is less than the dividend yield of more than half of the stocks in the S&P 500. As of today’s close, there are now 271 stocks in the S&P 500 that have a greater yield than the 10-Year US Treasury. Of the remaining 229 stocks in the index, 126 have a dividend yield that is less than the 10-Year US Treasury, while 103 pay no dividend at all.