McCullough: Is this finally the economic collapse?
McCullough of Hedgeeye writes Is this finally the economic collapse?:
FORTUNE — The Great Depression. Wall Street in 1987. Japan in 1997. Points of economic collapse are generally crystal clear in the rear-view mirror. Professional politicians in Japan have been telling stories for 20 years as to why they can prevent economic stagnation. In the US, the storytelling started in 2007. All the while, stock market and real-estate prices have repeatedly rallied to lower-highs, then collapsed again, to lower-lows.
Despite the many differences between Japan and the US, there is one similarity that continues to matter most in the risk management model my colleagues and I use at Hedgeye, our research firm — debt as a percentage of GDP. Now that the US can’t cut interest rates any lower, the only option left on the table is what the Fed just announced it would start doing — buying Treasury debt. And that could lead the country to the brink of collapse: According to economists Carmen Reinhart & Ken Rogoff, whose views we share, crossing the 90% debt/GDP threshold is the equivalent of crossing the proverbial Rubicon of economic growth. It’s a point from which it’s almost impossible to return.
On July 2nd, we cut both our third quarter 2010 and full year 2011 GDP estimates for the US to 1.7%. At the time, the consensus around US economic growth estimates was about 3%. Now we’re starting to see both big brokerage analysts and the Federal Reserve gradually cut their GDP estimates, but not by enough. Even our estimate for 2011 is still too high.
Slowing growth, both domestically and in China, is core to our bearish views on both the strength of the US dollar and US equities. There will be a downward bias to our US growth estimates as long as debt-financed-deficit-spending continues to be the solution politicians and central bankers turn to as a fix to our financial crisis.
Markets trade on expectations. Yesterday’s zig-zag in the S&P 500 was unlike most sleepy August trading days in America. That’s because the ‘government is good’ crowd leaked word that this second round of “quantitative easing,” known as QE2, was coming, and that Ben Bernanke was going to respond to our buy-and-hope begging. (The first round of quantitative easing was the Fed’s unprecedented purchase of agency debt to prop up the housing market, along with credit facilities for big banks, which began in 2008 and ended earlier this year.)
To think that we have institutionalized market expectations to this degree is downright frightening. It seems impossible but true that all rallies start and end with rumors about what Fed Chairman Ben Bernanke, a humble looking man of government, had to say at 2:15 PM EST yesterday afternoon, or any other day he makes a statement.
So now what?
With 40.8 million Americans on food stamps (record high) and 45% of the unemployed having been seeking employment for 27 weeks or more (record high), what’s left if (or when) QE2 doesn’t kick start GDP growth? Should we start begging for QE3? Should we cancel the bomb of the National Association of Realtors’ existing home sales report, scheduled for public release on August 24th? Or should we bite the bullet and accept that current economic policy dictates 0% returns-on-savings, even as Washington continues to lever-up our future to the point of economic collapse?
Before the Fiat Fools — Hedgeye’s name for political actors and bankers who have placed their hopes of economic recovery in printing endless supplies of new cash — run out campaigning for QE3, maybe they should analyze some real time market results to yesterday’s announcement of QE2:
1)The US dollar is battling for resuscitation after 9 consecutive down weeks — down 9% since June.
2) US Treasury yields are making record lows on the short end of the curve, with 2-year yields striking 0.49%.
3) The yield spread (in this case the difference in return between 10-year and 2-year Treasury bills, which shows a long-term confidence when high) continues to collapse, down another 4 basis point day-over-day to 223 basis points.
4) The S&P 500 is down below its 200-day moving average (a common signpost for the health of a market or stock) of 1115.
5) US Volatility (VIX) is spiking from its recent stability.
6) In Japan, long time quantitative easing specialists found their markets closing down overnight by 2.7%, which makes them down 11.9% for the year to date.
Lest our doom and gloom seem built entirely on technical measurements, what they boil down to is actually quite simple — an idea about our country which dates back to 1835. Alexis De Tocqueville, author of Democracy in America, which was published that year, seemed to warn of this day when he wrote: “The American Republic will endure until the day Congress discovers that it can bribe the public with the public’s money.”
What I have seen mentioned on several occasions now is the 90% debt threshold as the “ok-now-we’re-definitely-screwed”-indicator. I think it’s based on historical research but then it seems a little arbitrary in the big picture because the true public US debt is of course already waaaay past that, more like 385% of it.
I agree on most of the market outlook, and in particular I have been following and predicting ongoing strength in Treasurys, alongside consistently falling mortgage rates and interest rates in general.
It seems like the author is suggesting some weakness in the dollar when actually the Dollar has just been taking a little break for a few weeks from a fundamental rally. A rally that I expect to resume against other major currencies (including the Yuan, but probably excluding the Yen), when the market begins to tank seriously again.
And here’s Mish, as always an avid watcher of the Yield curve, noting that 2 Yr Yields are below 0.5% for the first time ever:
Yield Curve as of 2010-08-06
Curve Watchers Anonymous is once again watching the yield curve. Here are a couple of charts.
The above chart shows today’s reaction to the monthly jobs report: Jobs Decrease by 131,000, Rise by 12,000 Excluding Census; Unemployment Steady at 9.5%; June Revised from -125,000 to -221,000
The following chart shows the yield curve over time.
click on chart for sharper image
The chart depicts weekly closes. 10-year yields did slightly exceed 4% in April but those highs do not show in the above chart. Thus, the decrease in yields is even more dramatic than shown.
Note the huge rally on 5 and 10 year treasuries as compared to the 30-year long bond. It appears as if someone is putting on a long-10 short-30 spread.
If the economic data continues to be poor (and I believe it will be), the low in 10-year yields may not even be in even if the low in the 30-year long bond is in.
So much for the idea that an end in the Treasury rally is near … expect the Dollar to catch that wind again soon.
Mish on Tech Ticker on Stimulus & Markets
There’s no hotter debate right now than stimulus vs. austerity, as folks like Paul Krugman and even Barack Obama call for more spending to fix the economy.
Michael “MISH” Shedlock is not having any of it, arguing that the financial pump has failed, and that the only way to get the economy back on track is to pursue a policy of less government, and less spending, with a special focus on reforming pensions, public sector unions, and other institutions that drain the government of its resources.
As evidence: Japan. The country has now seen multiple decades of recession despite massive pumping on both the fiscal and the monetary side.
But at least Japan hasn’t had a debt crisis yet, right? The key word there, says Mish is “YET.” The fiscal situation in Japan is getting more and more tenuous, and it’s no sure thing that the market will retain its confidence in the Japanese government’s ability to finance its debt. And of course the same thing could happen here.
But for now in the US the big risk is deflation, which you can see in housing and other economic categories. Spending won’t solve this problem; actual economic adjustment is what’s needed to start growing again.
The bulls have pushed aside the bears on Wall Street — for now. Signs of optimism following three consecutive winning days in the stock market have replaced the doom and gloom mood so prevalent in the two prior weeks.
Having already heard the bullish case from Doug Kass and James Paulsen earlier this week, Tech Ticker decided to invite Mike “Mish” Shedlock, author of Mish’s Global Economic Trend Analysis, back on the show to hear the other side of the argument.
Is he bearish? You bet!
“The optimism out there is rather insane,” he says. There’s only a 15-20% chance of the market rallying, Mish tells guest host and Business Insider deputy editor Joseph Weisenthal. “It’s more likely we go down there and test the March lows, and there’s a decent chance actually that we break those lows,” he says.
Mish says “it is nuts to be net long” stocks right now in the face of all these headwinds:
– Slowdown in Europe as austerity measures take hold.
– Slowdown in U.S. as stimulus fades, housing remains weak, state and local governments cutback
– China looks to cool its economy in the face of growing housing bubble
Until Mish sees signs of sustainable job growth, he’ll be firm in his bearish stance. “Without a driver for jobs I don’t know how someone could be bullish on the stock market.”
If not stocks, then what?
Mish is sticking with what’s worked this year: Treasuries and gold. Treasury yields are still near record lows, but he think with the macroeconomy the way it is, it’s very possible, “the bull market in Treasuries is not over.” As for gold, he’d buy on the dips.
On Thursday, a slew of retailers posted monthly same-store sales. They were described best as a “mixed bag.” There was no obvious trend in terms of up or down, even within specific categories of retailers. But bulls on the economy should be disappointed.
For one thing, notes Mike “MISH” Shedlock author of Mish’s Global Economic Trend Analysis, the same-store sales gainers benefited by the general reduction in store locations. Essentially, survivorship bias is skewing the numbers. If somehow you could take into account all the locations that had been shuttered, you’d see that things were much worse.
And there’s evidence for this, notes Mish. State sales tax collections remain depressed, with no indication of a rebound. That, more than the corporate numbers, is the key thing to pay attention to.
And with states thirsting for cash, this is a crucial problem that will play out in terms of further budget cuts, and a further drag on the economy.
Ultimately it’s all about jobs. Without a jobs recovery, there will be no consumer recovery, and without a consumer recovery, there’s little reason to be excited about the market or the economy.
Coprorate vs Treasury Spread
Since the beginning of April, the price of Treasury Bonds has risen while that of corporate bonds has dropped. The action has, once again, been a good predictor of the recent weakness in equities.
As I noted in September last year: Keep an eye on the bond market.
Click on image to enlarge.The question is where are corporate yields headed and where are Treasury yields headed. So long as the spreads remain flat or continue to narrow, stocks will probably move sideways or spike up a little more.
The time of flattening spreads seems to be over for now … what this means for equities is obvious.
The Unstoppable Dollar Rally; Gold & Treasury Snapshot; The Great Depression 2.0 in Full Swing
The Dollar Rally
I will be focusing on the Euro/Dollar, but what I will be saying is not necessarily limited to the Euro, but applies many other currencies (except maybe the Yen).
The Dollar has now reached a 4 year high against the Euro:
Those who kept on talking about a Dollar crash from 2008 on where a bit late in the game. The Dollar crash, that was a result of expansive and inflationary government induced credit and monetary expansion with the naturally ensuing business cycle, has already happened through the 2000s. The Dollar has essentially bottomed out in April 2008.
Since then it has moved up and down, but up on the net. A trading range seems to be emerging that I expect we will continue to stay within for years to come.
Thus, my (and other people’s) predictions of a coming Dollar rally were essentially nothing but an expectation that the fundamental long term trend that began in 2008 will continue:
3% Bullish Sentiment on Dollar – Indication of a Coming Dollar Rally
Here is another thing from January this year that I dug up from my Campaign for Liberty inbox, it’s a response I gave to John Dennis who asked me why I expect the Dollar to go up (, and who by the way is running for Congress against Nancy Pelosi in San Francisco this year):
John,
I am sorry I haven’t been checking my C4L inbox regularly. I will follow it more closely now. Keep me posted about upcoming meetings if possible.
Reasons why I think the Dollar won’t collapse (against the other major currencies, that is):
- The debt load in the US is rather crushing, the general direction of credit is currently a net contraction with upticks from time to time which by no means are changing the general trend
- The major Dollar crash HAS ALREADY happened from 2001 through 2008, years of massive credit and money expansion, but now we are on the other side of peak credit
- The true money supply growth rate is now coming down in spite of massive and futile attempts to reflate and to destroy the Dollar
- The global debt pyramid is one that builds on the dollar, that means that in an environment of global delevaraging, people divest from foreign currencies and need to get back in the dollar before doing anything else
- China is inflating to the tune of 30% money supply growth, I believe that were China to depeg the Yuan might crash
- Bullish sentiment on the Dollar is at an all time low, I believe a few months ago it was at 3%! Everyone and their mother are predicting a Dollar collapse; this is a strong indicator for a massively oversold asset …
- On a side note: All paper currencies move toward zero in the long run when measured against gold, but they fluctuate amongst each other on their way down, the US currency is a bad one, but that doesn’t mean all other currencies are being printed by saints
Time will tell what to expect.
I think is far as politics and this matter are concerned, Libertarians are opening themselves up to attack when they continue to predict a Dollar crash that may not happen anytime soon. On top of that, People can’t relate to the argument that says “what they are doing is destroying the Dollar”. Most people don’t get all the intricacies that are involved and tune out I believe.
We have so many better things to talk about that visibly affect everyone in their day to day lives.
Thanks for the interest.
Regards,
Nima
EconomicsJunkie.com
By the way: Good luck, John! Even though political action is futile, it would sure be nice not to have to see this pompous and terribly arrogant witch in the news anymore. :)
The Gold Rally
Those who predicted a dollar crash, thought it would coincide with a gold and soft commodity rally. And then there were those who said that a strengthening Dollar would make the gold price fall.
I have been saying again and again that I think strength in the Dollar may actually coincide with strength in gold and silver, while soft commodities and stocks will tank. Thus I responded to an article on Minyanville whose author predicted the Dollar rally but also expected gold to fall at the same time:
I agree with his bullishness on the dollar. I don’t necessarily agree with his conclusions on gold. I think gold may actually do OK during a dollar rally. Maybe it will drop a little, maybe rise a little, but it will most definitely outstrip other commodities. In fact, I think a smarter play when betting on a dollar rally would be to short any other commodity BUT gold.
Gold is a money commodity. A dollar rally would be a sign of further delevaraging and deflation. During deflation cash is king. And gold is the king of all cash.
Here’s gold over the past year:
And here is gold VS oil (an example for a soft commodity) since the Dollar rally resumed:
This is important to understand: All fiat currencies move down against gold in the long run. This is completely inevitable. However, they fall at differing rates.
The Treasury Rally
What about Treasury yields?
Flat since Dollar rally resumed. I expect the support to give way sooner or later. The way down is pretty much wide open then. On December 18th 2008 they dropped as low as 2.04% as the reality of Deflation was all to visible to everyone. Since then we have seen numerous efforts to bailout businesses and all the wildly unimaginative interventionist measures that already caused the Great Depression in the 30s.
People have been outdoing each other in calling an end to the recession and bureaucrats and central bankers have been lauding themselves about successfully preventing another depression. The funny irony is that they have in fact beautifully set the stage for The Great Depression 2.0 with all its unsurprising and predictable side effects …
Once existing stimulus programs and credit expansion attempts subside, there won’t be much left to pick up the slack. The consumer won’t be able to go back to business as usual unless he goes through a long period of reduced consumption, deleveraging, and savings, a period during which the majority of production and spending inside the US will have to be focused on capital goods, so as to restore a balanced ratio between the production of consumer goods and the production of capital goods.
At the point when these government stimuli wind down, Keynesian clowns will be jumping out of the bushes left and right, and demand that the government take on more debt and spend more money. But at some point their mindless tirades will no longer appeal to an overtaxed and overleveraged populace. Their ivory tower nonsense will be way too far detached from simple realities.
Any temporary recovery we witness now, is likely to be remembered as just that, a temporary phenomenon. All actions taken so far have set the perfect stage for a double dip recession of enormous proportions, the worst possible prolongation of the necessary correction.
If it was our dear government’s objective to repeat the playbook from the Great Depression one by one, then they have indeed succeeded phenomenally.
And here is Chief Clown Krugman, once again doing his duty in filling the role:
A similar argument is used to justify fiscal austerity. Both textbook economics and experience say that slashing spending when you’re still suffering from high unemployment is a really bad idea — not only does it deepen the slump, but it does little to improve the budget outlook, because much of what governments save by spending less they lose as a weaker economy depresses tax receipts. And the O.E.C.D. predicts that high unemployment will persist for years. Nonetheless, the organization demands both that governments cancel any further plans for economic stimulus and that they begin “fiscal consolidation” next year.
Hmmm, I thought the government has solved the crisis with its heroic spending intervention? Why don’t we all just lean back and let that magic Keynesian multiplier do its work in getting us back on track? Why spend even more when the crisis has been solved, when Big Government has saved us, as Krugman himself proudly pronounced not too long ago?
So it seems that we aren’t going to have a second Great Depression after all. What saved us? The answer, basically, is Big Government.
One might object that this all makes perfect sense since Krugman is actually not an economist, but rather a propagandistic, dishonest, and filthy mouthpiece for any Democratic agenda you throw at him. But that’s not a very nice thing to say about this poor fellow so I would never go down that path … oh wait, I just did it, damn, sorry Paul! It’s just … could you maybe try to be a bit less predictable??
And yes I know I know, he goes on in there talking about how the situation remains terrible and how we must remain careful and bla bla bla, but that nonsense just doesn’t matter. He did lead his readers to believe that “big government saved the day”! He did say that we’re NOT going to have another Great Depression. That’s the essence of his message.
Here is a good discussion about it on yahoo:
The truth is, we’re seeing precisely the expected scenario in action, the Japanese model:
From 1989 on, the Japanese government has launched one stimulus after another to no avail, leaving Japanese taxpayers with the largest public debt per capita of all industrialized nations.
A burden that the US government seems to be more than willing to have its taxpayers shoulder over the years to come unless someone picks up a history book and tries not to feverishly repeat mistakes others made in the past.
Thus the long term outlook for the US economy is the fate Japan took: A long lasting correction supercycle with one failing “stimulus” program after another, and with on and off periods where the economy slips out of and back into recessions from time to time.
Reality is kicking in again. We’re slipping out of a small break we took from recession, and back onto the inevitable path. As a result of foolish government intervention we are now, once again, in worse shape than we were at them time the real correction was supposed to occur. And this is rather likely to be reflected in consumer behavior, and by extension also in Treasury yields.
China
An interesting side effect of the Dollar rally is what’s happening to Chinese exports. Since its currency is pegged to the US Dollar, the Yuan is strengthening against the Euro which is hurting the powerful Chinese export lobbyists.
This is yet another case for a coming Yuan devaluation against the Dollar, that I already talked about almost 1 year ago:
The stabilization of the Dollar against the Yuan has almost coincided the reversal of the Dollar’s fall against other major currencies. It thus appears as if, since mid 2008, the Yuan/Dollar peg has been reinstated and continues to be in place as these lines are written. What is also noteworthy is that the US current account deficit has been declining sharply since then.
A first look at the above chart leads one to believe that Chinese and US authorities aimed at putting an end to the fall of the Dollar, and thus intervened accordingly. However, another possibility which I would like to propose is that the Dollar had fundamentally and truly begun to stabilize at the level of RMB 6.83 at that point and was actually in for a major revaluation upwards. Thus the current intervention by Chinese authorities could actually be aiming at a stabilization of its own currency at a higher level than the market would mandate.
Some points fundamentally support the thesis that the dollar should gain in value against the major currencies:
- Global deleveraging is driving investors from other currencies back to the Dollar
- Deflation hitting the US first, and other countries only later
- Imports into the US are falling rapidly
- Significant domestic spending sprees by the Chinese governmentAll this may indicate that if the Chinese government were to let the Yuan float freely at some point, it may actually drop significantly against the US Dollar. Such an event could possibly be the ignition for a significant Dollar rally in the years to come.
Bottom line: The supposed Yuan devaluation everyone seems to be expecting, were the Yuan to be freely floated, is simply not gonna happen!
That’s all I have to say for now. Have a good weekend everyone!
Prechter: “We Are On Schedule for a Very, Very Long Bear Market”
Prechter on yahoo finance today:
The global selloff in stocks accelerated Thursday, sending the Dow down 3.6% to 10,068 while the S&P 500 lost 3.9% to 1,071.59 and the Nasdaq shed 4.1% to 2,204.
All major U.S. averages are now down for the year and at least 10% below their 2010 highs, meaning the downturn has officially entered “correction” territory.
Unfortunately (for bulls), there’s much more selling ahead, according to Robert Prechter, president of Elliott Wave International and author of Conquer the Crash.
“We should be in for [another] week or two of pretty serious selling,” Prechter says. “They’ll be bounces along the way…but I think this should last a long time. We should be on schedule for a very, very long bear market period.”
In the near-term, the veteran market watcher predicts a “dramatic increase in volatility,” beyond what’s already occurred. The CBOE Volatility Index (VIX) rose another 30% today and is now up about 180% from its late April lows.
Notably, today’s selling occurred despite a rally in the euro amid reports of central bank intervention. Joe Brusuelas of Brusuelas Analytics says, “The capitulation in today’s market has more to do with the unwinding of the easy money [carry] trade on commodities,” which fell again today, with notable weakness in energy and palladium.
Meanwhile, Treasury prices continued to benefit from the “risk aversion” trade with the yield on the benchmark 10-year note falling to 3.21%.
Broken Record or Market Sage?
Other than to say “a long way down,” Prechter wouldn’t say how much further he thinks the market will fall, suggesting a repeat of the 1930-32 scenario when “extremely sharp rallies” kept investors interested and “feeling like a bottom [was] forming.”
Anyone familiar with Prechter knows he’s been predicting doom for a long time so it’s tempting to dismiss his latest warning – a veritable repeat of what he said here in February. But he’s not a perma-bear and did turn bullish ahead of the bottom in March 2009.
More dramatically, in 1978 he co-authored Elliott Wave Principle – Key To Market Behavior, which predicted a great bull market similar to the 1942-1966 rally. By his own admission, Prechter underestimated the extent of that historic rally, which ran from 1982-2000 and saw the Dow rise 1,500% from 777 to 11,723.
Prechter says the market has spent the past 10 years building a “major head and shoulders” top from those 2000 highs, even though they were exceeded in 2007. Ultimately, he expects a “corrective mode that’s going to retrace virtually the entire” 1982-2000 bull market.
“The best place for most people to be is in cash” and equivalents, he says. “You want maximum liquidity until this thing blows over.”
A long term outlook I posted a while back:
I have often compared the current situation in the US to Japan in the 90s. Indeed, a lot of the characteristics of the current contraction match what went on in Japan back then.
Since 1989, the Nikkei index has dropped from just below 40000 to now around 9000. It is conceivable that US stocks will see similar declines over the next decades, along with spectacular counter trend rallies from time to time.
Below I put together a chart that shows how the Nikkei has fared since the bust of the Japanese credit bubble in 89 vs. the development of equities in the US (S&P 500) since the bust of the US credit bubble in 2007:
As you can see, since the crash, both charts have behaved rather similar. Immediately after the crash, the Nikkei, too, staged a phenomenal 35% rally from around 20000 to around 27000. If US equities continue mimic the events two decades ago in Japan, it is indeed conceivable that we may see an S&P 500 in the 200s or 300s in ten years or so.
Obviously that bear rally went on for a lot longer than I expected in my chart above. But such differences won’t matter in the long run. What is important to grasp is that the days of long term rising stocks with the occasional and severe dips are over. We are now on the other side of the peak: A long term declining stock market, with the occasional and severe rallies in-between from time to time.
What I appreciate a lot about Prechter is his unusually long term look back and outlook on the market, and his in depth incorporation of social moods and their swings when it comes to understanding economic phenomena.
Market Meltdown – Deflation Trade is Back
Many things are being said about today’s market plunge by over 1000 points at some point. I won’t delve into that, just how today’s action beautifully shows the general idea behind my long term view.
Dollar
I have been writing for a while now about my expectation of mid to long term strength in the Dollar:
August 2nd 2009 – US Dollar Looks Bullish Fundamentally & Technically
August 13th 2009 – 3% Bullish Sentiment on Dollar – Indication of a Coming Dollar Rally
December 9th 2009 – Has The Dollar Rally Started?
Here is the Dollar over the past months through today:
This Dollar rally is best explicable as a symptom of global de-leveraging alongside deflation in the US. As investments the world over are being unwound, a flight into the world’s reserve currency is inevitable.
Today’s gains in the Dollar index were around 1% overall. In particular the Euro took a significant beating over the ongoing monetary insanities perpetrated by the ECB. A Dollar rally is at the same time usually a very bearish sign for stocks. Today’s moves beautifully accentuated this correlation, in particular during the intraday spikes and corrections. The fact that the Dollar has been moving up together with stocks over the past months is to me just a sign of how severe a correction stocks are going to be in for sooner or later.
Gold
Global delevaraging is also bullish for gold. As I have said many times: During deflation cash is king. And gold is the king of all cash. This is counter-intuitive to many people because they throw gold in one bucket with all other soft commodities. But gold is a categorically different commodity. It serves virtually no industrial production, except for some negligible applications. It is a money commodity. Silver has some money characters, but also has quite a lot of industrial uses.
Thus I explained in August of last year when commenting on an article by James Kostohryz at Minianville:
I agree with his bullishness on the dollar. I don’t necessarily agree with his conclusions on gold. I think gold may actually do OK during a dollar rally. Maybe it will drop a little, maybe rise a little, but it will most definitely outstrip other commodities. In fact, I think a smarter play when betting on a dollar rally would be to short any other commodity BUT gold.
And how has gold done throughout the dollar rally? Here it is:
You see? The Dollar has risen to a new 12 months high over the past 6 months, during that time gold dropped for a little while, but has gained back all those losses and is now actually up on the net as flight to safety continues. Meanwhile most other commodities are actually down on the net over that time. That’s what I meant when I said what I said above in my comment.
Today in particular gold was up around 2% while all other commodities got clobbered.
Treasurys
As a corollary of Dollar strength one can expect the prices of Treasury notes, pretty safe claims to Dollars at interest, and bonds to rise and thus their rates to fall. I have been arguing for a while that over time treasury rates will fall, but with quite some noise inbetween, sparked by false inflation fears:
I think Treasurys will continue to act well. There maybe some upward pushes here and there so long as inflation expectations pop up once in a while, but the mid-term trend remains unchanged: It is likely that yields are headed for new lows.
Treasury rates have been moving pretty much up and down and are actually still a bit up from when the rally started, but one thing I just wanted to point out is the strong move today in long term treasury instruments, alongside a strengthening Dollar and strong gold, see Mish:
Yield Curve as of 2010-05-06 3:15PM EST
Bullish Flattening of Yield Curve
That chart shows a bullish flattening of the yield curve as I expected. Those expecting a bearish flattening (yields rising) got their clocks cleaned today as treasury bears were slaughtered.
What’s next?
… we shall see. I certainly expect this global sovereign debt contagion to spread rapidly and exert its effects, among other things. I would be rather surprised if US equities could somehow decouple from this avalanche. Personally I still think that a healthy mix of gold, Dollars, and Treasurys is the right recipe to protect one’s wealth in these turbulent times.
One should not think that I am suggesting that the US is immune against sovereign debt problems. The public debt in this country is crushing as well, I just think that before the US defaults outright on its Treasury bonds many much more serious things would need to happen. One thing you can be sure of: The US government will continue to raise taxes should there ever be doubts about its ability in servicing the public debt, and it will probably do so quite a few more times before the people would be ready and willing to do more than hang a few teabags on their ears, grab signs, and protest before Congress to express their inconsequential anger.
Has The Dollar Rally Started?
The rally of the US Dollar vs. other major currencies is something that I have been expecting for a while now. The dollar made some bold moves recently. It is conceivable that this may be the kick off to that said rally. Just as an example, below see the Euro/Dollar chart:
The upward trend in the Euro since March seems to have begun reversing. Dollar perma-bears will look at this as just another temporary counter trend move. I believe that it is possible that a longer term Dollar rally is quite conceivable, for all the reasons I stated again and again and that I will not delve into here again. You can read the “Related Posts” below if you like.
Daily FX writes US Dollar Closer to Beginning, Rather than End, of Bull Move:
This is the same chart that was published yesterday. I wrote then that “the clearest portion of the decline is the initial decline that ends at 14670. Since then, price has stair stepped lower in what could be the beginning of a 3rd wave. Staying below 14785 keeps this extremely bearish count on track. A loose target is 14000, which is the 161.8% extension of wave 1.” This analysis remains on track. Risk can be moved to 14600 and resistance is 14420-50.
Sometimes Mish tends to have the amazing tendency to call certain trend reversals almost exactly on the day of the peak/low. This is him on Nov 27: New Record Low Yield On Two Year Treasuries; Is This The Start Of A Dollar Rally?
Given the US markets were closed yesterday, I have the same question floating in my mind as a day ago, wondering if this is another one day wonder rally in the dollar (and another one day wonder selloff in equities) or if this is the start of a long awaited correction in both the dollar and equities.
A significant Dollar rally is, at the same time, very bullish for Treasurys and and very bearish for stocks. Gold may continue to do fine. Time will tell …
Confusion Over Gold and Treasury Yields
The following article from Marketwatch is a perfect example of how confused market participants are about the recent and current action in gold and Treasury yields:
Gold and bonds do not usually go up or down together.
But try telling that to the markets over the last two months.
Since early August, in fact, gold bullion has risen by around 10% and the Treasury’s 10-year yield, which moves inversely with Treasury prices, has fallen by nearly 15%.
These moves are substantial, in other words, and more than just day-to-day noise in the data.
What’s going on?
Consider first why gold is so strong, reaching a new all-time high this week. One explanation is that this has been caused by a weaker U.S. dollar on the foreign exchange markets. This is certainly plausible, since the dollar has been very weak lately.
Another plausible explanation for gold’s strength is that it is discounting higher inflation in coming months and years. And it is indeed hard to imagine that the trillions of dollars that the world’s central banks have injected into the financial system won’t eventually have an impact on the inflation rate.
Credible as these explanations are, however, they are hard to square with strength in U.S. Treasury securities. A weaker dollar, of course, puts more pressure on the Federal Reserve to raise rates, which would in turn cause Treasury prices to fall, not rise. The same outcome would presumably result from higher inflation, too.
We reach a similar impasse when we consider why Treasury prices have been so strong. The standard explanation is that they are discounting a weaker-than-expected economy and/or deflation, which will cause rates to stay low. But those are hardly the preconditions of a gold bull market.
Either way you look at it, then, we come to the same conclusion: Recent trends are unsustainable. Something’s got to give.
Which will it be?
Several factors are pointing to the bond market as being the more vulnerable right now:
- The stock market has also performed well of late, and equities would not thrive if the economy were weaker than expected or if deflation were a bigger-than-expected threat. So, in essence, the stock market is betting that gold is right and bonds are wrong.
- Bond market sentiment is at near-record levels of bullishness right now, and (according to contrarians) the consensus is rarely right. ( Read my September 15 column on bond market sentiment.)
- Sentiment among gold timers is remarkably restrained, if not outright gloomy, suggesting that there is a strong “wall of worry” for a bull market in gold to continue climbing. ( Read my October 6 column on gold market sentiment.)
The bottom line?
Don’t be surprised if the bond market over the next several months is markedly weaker than gold.
All this confusion regarding gold stems from one false pretense: that gold is an inflation hedge. It is not. Gold and Treasury Notes/Bonds are, as opposed to almost all other assets, up from October 07 levels for the exact opposite reason, deflation.
Read what I have written before, for example in Gold, Silver, Treasurys – A Snapshot.
Monetary commodities, such as gold and silver should act well during a deflation. Why? Because during deflation cash is king. And gold is the king of all cash.
…Treasury Notes and Bonds are the ultimate deflation investment. Why? Because during deflation cash is king. And Treasury securities are the safest possible claim to cash at interest. Why? Because the government can always (and will) tax and loot the people to the hill to pay off its debts if it needs to.
Read the whole article, look at the predictions I made in there and look where we are today in terms of gold, silver, and Treasury yields. Market data can only be interpreted, understood, and predicted, when you have a sound economic footing to stand on.
I would like to ask the author: What if in addition to falling yields and rising gold prices, the dollar were to start rallying? How confused would he be then?
Corporate Bond Yields – Where to From Here?
Mish points out accurately that corporate bond yield spreads from Treasury yields are a good indicator where stocks are headed:
Keep an Eye on Bonds!
As long as corporate bonds fetch a good bid, which in turn allows companies to raise cash at decreasing costs, the stock market is likely to be reasonably firm. Note that the pullback in junk bonds began 3 days ago on that last red candle.
I am skeptical the rally in bonds can last much longer, but until the corporate bond market starts showing increased signs of stress, equity bears expecting huge pullbacks are likely to be disappointed.
Either way, it will pay to keep one eye on the credit markets to help ascertain long-term equity direction. In August of 2007 the corporate bond market cracked wide open. Although the S&P 500 made a new high in November, the corporate bond market didn’t. It was the mother of all warning calls that most missed.
I prepared a chart that compares Treasury note prices (IEF, blue), corporate bond prices (HYG, red), and the S&P 500 (green), since October 2007:
Click on image to enlarge.
The question is where are corporate yields headed and where are Treasury yields headed. So long as the spreads remain flat or continue to narrow, stocks will probably move sideways or spike up a little more. But as we can see in the chart above, it looks like they are very slowly beginning to widen again. It’s too early though to identify a clear direction at the moment.
News like this certainly won’t bode well for the bond market and will continue to apply downward pressure to corporate bonds, and thus upward pressure on spreads:
The number of U.S. companies that have defaulted on their debt this year rose to 12.2% in August, matching a peak last touched in 1991, Moody’s Investors Service said in a report Wednesday. The default rate is expected to rise to 13.2% in the fourth quarter, then drop to 4.1% a year from now, analysts said. A key part of that forecast is that U.S. unemployment will peak at 10% in 2010, said Moody’s Kenneth Emery. On Friday, the Labor Department said the jobless rate reached 9.7% in August. “If the U.S. unemployment rate were to increase substantially above 10% in the coming year, then default rates would likely be significantly higher than indicated under the model’s baseline scenario,” Emery said.
Here is a nice straight resistance line that corporate bonds are testing right now:
HYG Chart:
The downward trend since October 2007 continues to hold up.
Meanwhile, the exact opposite holds true for Treasurys:
IEF Chart:
… bottom line: keep an eye on corporate vs. Treasury yields.
Gold Breaking Out – Ready to Reach for New Highs?
Action in Gold
There was some noticeable action in gold today. Some say it is just another irrelevant noise, others are calling for new highs.
I have been saying for quite a while that I think gold will do well as soon as people return to the world of reality, and deflation, deleveraging, and credit contraction show their impacts on the markets once again. Whether we are headed that way now or later is still open, but I happen to believe that we are approaching a turnaround.
The action in GLD today makes a breakout a possibility:
Click on image to enlarge.
The HUI index continues to hold the line, the upward move I expected in July did occur, and it also happens to have initiated a breakout out of a triangle now:
Click on image to enlarge.
If the stock market rally is over, and stocks and other commodities are headed for new lows, I expect gold and gold mining to do well. If it is not that time yet, then today’s action may indeed just have been irrelevant noise.
Treasurys
… and what is a well thought out deflation trade without considering Treasury Notes/Bonds. I have been following the trading range in Treasurys for quite a while now and everything has played out as expected so far.
Back in November 08 I called for significantly lower Treasury Yields between 2% amd 2.5%. They then fell from 3.09% to just below 2.5% in January 09. I then expected for technical reasons that they will move higher to the upper end of the range which would be around 3.3%. They actually overshot and went as high as 3.99%. I then said that Treasurys are a good call again. Yields have since then fallen to around 3.30%:
Click on image to enlarge.
I think Treasurys will continue to act well. There maybe some upward pushes here and there so long as inflation expectations pop up once in a while, but the mid-term trend remains unchanged: It is likely that yields are headed for new lows.
Today’s action in gold was beautifully complemented by corresponding action in Treasury yields which dropped by 8 basis points to close at 3.29%, a recent July low. If it breaks, the way down is more or less open:
Click on image to enlarge.
Again, all this ultimately depends on fundamentals. Just as gold, Treasurys will only continue to rally when stocks fall. In addition to that, the dollar rally I am expecting would need to start playing out in order to complete the deflation trade.
Community Activity- Roberto Lloyd wrote a new blog post: Earth, Wind & Fire The Speed of Love tekst September 9, 2010
- Cecil Moore became a registered member September 9, 2010
- Felix Cole wrote a new blog post: News from the Yoga mat September 9, 2010
- Milton Johns became a registered member September 9, 2010
- Vincent Sharpe wrote a new blog post: Accutane Lawsuit Lawyer Information September 9, 2010
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