Just a quick note due to the negative reaction in the capital markets.
Today's economic data was not much different than consensus expectations. Case Shiller was a bit better (thanks to government stimulus) and consumer confidence was worse than expected (due to a persistently-poor job market). Growth in China may be slowing (I have previously mentioned that China is dealing with its own asset bubble. However, today's data should not have resulted in such a selloff in equities and long-term interest sinking back to lows not seen since crisis days (or just thereafter.
The problem is that equity market participants believed their own propaganda that tremendous government stimulus and easing would prime the pump ad consumers will begin spending and fuel job creation and the economy would boom once again. What seems to have been forgotten is that such measures implemented by the government had worked before because it enabled consumers to lever up further and spend anew. Consumers cannot get credit as they had before. Many have more debt than they can deal with already. Business have little reason to expand payrolls. Forthcoming tax policy changes are not conducive to consumer spending.
No folks, the recovery will not be as sharp was to what we have become accustomed, but that is because the contexts of the recent asset bubble and current global economic situation is far different than in the past. Growth is likely to continue on its modest march upward, but if consumer confidence continues to fall and the job situation does not improve (it could worsen if financially-stressed municipalities and states have to layoff workers) and double-dip recession cannot be ruled out.
If I have time tomorrow I will discuss the mess that is Freddie and Fannie (they own thousands of foreclosed homes).
Tuesday, June 29, 2010
Monday, June 28, 2010
Everything In Moderation
Today's economic data is further evidence that the economic recovery is a modest recovery. The Chicago Fed report (which includes the Detroit automakers) was somewhat disappointing (along with a downward revision of the previous report), but the remaining data was very close to the street consensus (itself only mildly optimistic). Equity market bulls continue to point to corporate profits as evidence that the economy is about to take off. The problem with that assessment is that corporate profits are string precisely because companies can to more with fewer workers. It is going to take economic activity last seen during the overstimulated bubble just to get to acceptable levels of unemployment (around 6.00%). Housing is the key.
Why is housing the key when the sector itself is responsible for a relatively small part of the U.S. economy? It is because a strong housing market makes consumers feel more confident and, more importantly, it gives consumers the home equity necessary to spend to fuel the economy. Wage growth has been lack luster during the past decade, yet consumers were able to spend on cars, TVs, home remodeling and new homes all due to leverage. That game is over.
The new game will be centered around income and not just wages, but the amount of money people take home. The fixed income markets are keenly aware of the economic policies which are coming down the pike. The are not conducive to greater disposable income. Taxes on wages, dividends and capital gains are all going to rise. The estate tax will return.
Credit will not make a comeback anytime soon either. First: Banks cannot lend as they had in the past because they cannot easily lay off the risk via securitization as they had during the last expansion. Secondly: Banks have little incentive to lend and keep loans on their books. By doing so they take risk, could be held liable should the government look unfavorably upon lending practices or loan provisions. Lastly: Banks can make more money via the carry trade in riskless treasuries.
Some economic apologists now exclaim: "If not for Greece" or "If not for Europe the economy would be rebounding strongly." The miss two points. First: The crisis overseas is actually helping U.S. credit and borrowing by keep interest rates low. Secondly: There is no U.S. credit market or European credit market. There is one global market for credit. This is more evidence that there is no such thing as decoupling in this era of globalization. The G20 meeting proved that. Those decoupling proponents were either shortsighted or disingenuous about there true economic views hoping to jawbone the markets higher. The only other option is that they are not all that bright.
Where do we go from here? Get the idea of significantly higher interest rates out of your head, at least for another year, probably two. Floaters will continue to disappoint investors, but step-ups and higher coupon debt instruments should do well. Equity markets should trade mostly sideways, but companies will need to continue to post healthy profits just to maintain current equity price levels.
Many readers ask me what should they look for as a sign the economic outlook is improving. I would be looking at the yield of the 10-year treasury. As the global economic outlook, investors who can leave the safety of U.S. treasuries and invest in riskier asset classes. Please manage your expectations however. The global economy is not likely to recover sufficiently to result in a wholesale exodus from U.S. treasuries, but today's closing yield of 3.02% is far too low to persist in a healthy global economy. Current long-term interest rates indicate that the bond market knows there is at best a persisting economic malaise or at worst a double-dip recession. I believe that it will be the former. In the end it comes down to fundamentals.
This should be a relatively slow week in the capital markets. The forthcoming Independence Day weekend has many market participants at the beach, in the mountains or on the golf course. Next week will be no better. Thin markets usually result in heightened volatility. The market is focused on this week's employment data. The street consensus is calling of a loss of 115,000 jobs an an unemployment rate of 9.8%. Not exactly the stuff of economic expansion.
Why is housing the key when the sector itself is responsible for a relatively small part of the U.S. economy? It is because a strong housing market makes consumers feel more confident and, more importantly, it gives consumers the home equity necessary to spend to fuel the economy. Wage growth has been lack luster during the past decade, yet consumers were able to spend on cars, TVs, home remodeling and new homes all due to leverage. That game is over.
The new game will be centered around income and not just wages, but the amount of money people take home. The fixed income markets are keenly aware of the economic policies which are coming down the pike. The are not conducive to greater disposable income. Taxes on wages, dividends and capital gains are all going to rise. The estate tax will return.
Credit will not make a comeback anytime soon either. First: Banks cannot lend as they had in the past because they cannot easily lay off the risk via securitization as they had during the last expansion. Secondly: Banks have little incentive to lend and keep loans on their books. By doing so they take risk, could be held liable should the government look unfavorably upon lending practices or loan provisions. Lastly: Banks can make more money via the carry trade in riskless treasuries.
Some economic apologists now exclaim: "If not for Greece" or "If not for Europe the economy would be rebounding strongly." The miss two points. First: The crisis overseas is actually helping U.S. credit and borrowing by keep interest rates low. Secondly: There is no U.S. credit market or European credit market. There is one global market for credit. This is more evidence that there is no such thing as decoupling in this era of globalization. The G20 meeting proved that. Those decoupling proponents were either shortsighted or disingenuous about there true economic views hoping to jawbone the markets higher. The only other option is that they are not all that bright.
Where do we go from here? Get the idea of significantly higher interest rates out of your head, at least for another year, probably two. Floaters will continue to disappoint investors, but step-ups and higher coupon debt instruments should do well. Equity markets should trade mostly sideways, but companies will need to continue to post healthy profits just to maintain current equity price levels.
Many readers ask me what should they look for as a sign the economic outlook is improving. I would be looking at the yield of the 10-year treasury. As the global economic outlook, investors who can leave the safety of U.S. treasuries and invest in riskier asset classes. Please manage your expectations however. The global economy is not likely to recover sufficiently to result in a wholesale exodus from U.S. treasuries, but today's closing yield of 3.02% is far too low to persist in a healthy global economy. Current long-term interest rates indicate that the bond market knows there is at best a persisting economic malaise or at worst a double-dip recession. I believe that it will be the former. In the end it comes down to fundamentals.
This should be a relatively slow week in the capital markets. The forthcoming Independence Day weekend has many market participants at the beach, in the mountains or on the golf course. Next week will be no better. Thin markets usually result in heightened volatility. The market is focused on this week's employment data. The street consensus is calling of a loss of 115,000 jobs an an unemployment rate of 9.8%. Not exactly the stuff of economic expansion.
Thursday, June 24, 2010
Frozen In Time
Just checking in from vacation. Yesterday's Fed statement was not surprising, unfortunately. The Fed's language was decidedly more cautious than prior meetings. Thomas Hoenig was the only dissenter to keeping rates ow for an extended period of time. Some day he will be correct, but not now. Not as long as the rest of the world is more dysfunctional than us. Not as long as housing (and the rest of the economy) is stimulus driven. No folks, the malaise continues. I think we will be fortunate to see a Fed Funds rate hike as soon as early 2011.
What about the positive reaction to the Fed statement by the equity markets? The equity markets were happy to hear the Fed will keep rates low which should keep corporate profits respectable, even though employment will be disappointing. Also, today's jobless claims data was nothing to write home about.
What about the positive reaction to the Fed statement by the equity markets? The equity markets were happy to hear the Fed will keep rates low which should keep corporate profits respectable, even though employment will be disappointing. Also, today's jobless claims data was nothing to write home about.
Monday, June 21, 2010
All Summer Long
I am on vacation this week so I probably won't be writing much. Some of you probably thought I was on vacation as my post from last week did not go out (although it was on the blog website). Don't be confused when you see the June 15th post today, sorry. That being said there are a few things to which I would like to call your attention.
First: This week is Fed week. I don't think we will see any surprises. The Fed is in no position to tighten, or even jawbone rates higher.
Second: Markets should continue to trade sideways, albeit with considerable volatility as many market participants are, like myself, on vacation. Expect these conditions to persist throughout the summer.
Third: Look for the 10-year note to remain range bound between .00% to 4.00% for the balance of the summer, or perhaps 2010 (and beyond). As Meredith Whitney pointed out on CNBC, the 10-year is the only place to safely stash cash. Why the 10-year. No yield inside the 10, too much potential volatility farther out, too much risk and uncertainty overseas.
Ms. Whitney made other astute observations. First: during the past decade short-term rates have been all over the place (they move with Fed policy), but long-term rates (10-year) have been range bound. This is due to modest inflation pressures and the U.S. dollar's reserve currency status. Secondly: Banks' earnings could be more modest as their fee revenue should be lower. Much of the fees they earned prior to this year (going back several years) were from underwriting their own deal, especially ABS deals. Thirdly: there is little impetus for companies to hire workers.
Many investors who have come of age during the past 20 years may view all of this being negative. I view this as being realistic. There was no way to perpetually sustain the kind of economic activity we experienced since Paul Volcker and Ronald Reagan repaired the economic damage caused by the great society. The problem is that the 25 year rebound from nearly two decades of malaise was considered to be "normal" The 25 year bull market was no more real than the prior 15 years of economic malaise. At best we are now settling in to a more fundamentally-based economy or, at worst, heading into another great-society-like malaise thanks to government over reach.
This promises to be a nerve-wracking time for equity investors, but for retiring baby boomers this could lead to a stable bond market with attractive credit spreads (corporate bond yields) just when they are needed. Some may wish for higher yields for even higher return. However, investors should keep in mind that higher yields usually mean higher inflation. That means what ever you gain from higher yields, you lose in the way of higher prices.
Happy Summer!
First: This week is Fed week. I don't think we will see any surprises. The Fed is in no position to tighten, or even jawbone rates higher.
Second: Markets should continue to trade sideways, albeit with considerable volatility as many market participants are, like myself, on vacation. Expect these conditions to persist throughout the summer.
Third: Look for the 10-year note to remain range bound between .00% to 4.00% for the balance of the summer, or perhaps 2010 (and beyond). As Meredith Whitney pointed out on CNBC, the 10-year is the only place to safely stash cash. Why the 10-year. No yield inside the 10, too much potential volatility farther out, too much risk and uncertainty overseas.
Ms. Whitney made other astute observations. First: during the past decade short-term rates have been all over the place (they move with Fed policy), but long-term rates (10-year) have been range bound. This is due to modest inflation pressures and the U.S. dollar's reserve currency status. Secondly: Banks' earnings could be more modest as their fee revenue should be lower. Much of the fees they earned prior to this year (going back several years) were from underwriting their own deal, especially ABS deals. Thirdly: there is little impetus for companies to hire workers.
Many investors who have come of age during the past 20 years may view all of this being negative. I view this as being realistic. There was no way to perpetually sustain the kind of economic activity we experienced since Paul Volcker and Ronald Reagan repaired the economic damage caused by the great society. The problem is that the 25 year rebound from nearly two decades of malaise was considered to be "normal" The 25 year bull market was no more real than the prior 15 years of economic malaise. At best we are now settling in to a more fundamentally-based economy or, at worst, heading into another great-society-like malaise thanks to government over reach.
This promises to be a nerve-wracking time for equity investors, but for retiring baby boomers this could lead to a stable bond market with attractive credit spreads (corporate bond yields) just when they are needed. Some may wish for higher yields for even higher return. However, investors should keep in mind that higher yields usually mean higher inflation. That means what ever you gain from higher yields, you lose in the way of higher prices.
Happy Summer!
Tuesday, June 15, 2010
Tech or Wreck
Today was a good day in the markets. The price of the benchmark 10-year note was down a about half of a point. The Dow Jones Industrial Average was up over 200 points. These are signs of strong economic data. There is one problem. There was no such data released today. Oh sure, the Empire Manufacturing data was better than the prior report, but it missed street expectations to the down side. Besides, is manufacturing data from the New York region (not exactly a manufacturing hotbed) a good overall economic indicator? No, today's rally was not based on fundamentals. It was due to (I hate this) technical levels.
Technical analysis has become very popular during the past decade. When fundamentals do not provide reasons to buy or sell securities, technical analysis is used to provide those reasons. Technicians will look for trends and repeated phenomena to predict market behavior. Although technicians can be and have been correct, technical analysis can lead to trouble down the road.
Trading or investing using technical analysis may lead to self fulfilling prophecies. In other words, if technical analysis says market levels should rise further in dramatic fashion if a certain market level is reached and people enter that market to buy because of said analysis then the analysis appears valid. The prophecy was self fulfilled.
The problem with this is fundamentals eventually come into play. At some point, real life, actual data, matters. Ask the modelers who created asset backed deals using historical data and trends or economists who have been warning of a return to double-digit interest rates for years because of some trend found by cherry picking a historical time period. Peter Sorrentino told Bloomberg News:
“No one disregards technical analysis now. If they do so, they do so at their own peril."
I counter, those who rely too much on technical analysis while ignoring fundamentals do so at their own peril. Reality always wins out in the end.
Technical analysis has become very popular during the past decade. When fundamentals do not provide reasons to buy or sell securities, technical analysis is used to provide those reasons. Technicians will look for trends and repeated phenomena to predict market behavior. Although technicians can be and have been correct, technical analysis can lead to trouble down the road.
Trading or investing using technical analysis may lead to self fulfilling prophecies. In other words, if technical analysis says market levels should rise further in dramatic fashion if a certain market level is reached and people enter that market to buy because of said analysis then the analysis appears valid. The prophecy was self fulfilled.
The problem with this is fundamentals eventually come into play. At some point, real life, actual data, matters. Ask the modelers who created asset backed deals using historical data and trends or economists who have been warning of a return to double-digit interest rates for years because of some trend found by cherry picking a historical time period. Peter Sorrentino told Bloomberg News:
“No one disregards technical analysis now. If they do so, they do so at their own peril."
I counter, those who rely too much on technical analysis while ignoring fundamentals do so at their own peril. Reality always wins out in the end.
Thursday, June 10, 2010
Get A Job
The U.S. trade deficit was little changed and not as wide as forecast as continued economic headwinds (high unemployment, higher energy priced, credit standards, etc.) are restraining spending and therefore, imports. The Jobless Claims data offered little encouragement that consumer spending is poised to take off. Initial claims came in at 456K. The was higher than the street consensus of 450K and although it was lower than the prior revised 459K, the prior number was revised to 459K from 453K. Net / net, initial claims were more than expected for the past two weeks. Continuing claims fell to 4,462K from a prior revised 4.717K (which was revised higher from 4,666K). The street consensus called for 4,640K continuing jobless claims. I have not seen data stating how much of the drop was due to workers finding employment and how many dropped off the regular jobless claims rolls and onto extended benefit rolls.
There are some who believe that the paring of jobs is good for the markets as the increased productivity. In a consumer driven economy, relying purely on productivity gains for economic growth is like a pilot dumping fuel to go faster by reducing weight by dumping fuel. He may go faster, but not very far.
Today we had another strong treasury auction. The auction yield was lower than the 4.206 percent street consensus. The bid/cover ratio, came in
at 2.87, indicating stronger demand. The ratio was 2.60 when this treasury was first auctioned last month The yield on the bonds sold today was the lowest since the 4.009 percent at the October auction. At the
previous auction, the bonds yielded 4.49 percent.
Indirect bidders, a group that includes foreign central
banks, bought 36 percent of the amount sold, compared with 32.5
percent in the prior auction.
In spite of the strong auction, prices of long-dates treasuries headed lower (about one point lower for the 10-year and two points lower for the 30-year) due to stronger economic data from China and Australia.
Market pundits are become tedious. With every down day they are all gloom and doom. After today's up day pundits were extolling the virtues of owning equities. Nothing has changed folks. I believe that Mr. Bernanke is correct and the recovery, although sustainable, will moderately paced. To all those who believe that then economy is ready to roar, if not for the pessimists, answer this: Why are corporations holding on to huge cash positions?
According to a Fed report companies are now holding $18.4 trillion in cash. That is up 26% from last year. Cash now makes up 7% of all corporate assets, the most since 1963.
Cash may be king for businesses, but it is not a viable option for most investors. Fixed income investors should be laddering, or at least barbelling. Ladders should be weighted on the belly of the curve (5 to 7 years) using callable agencies and high grade financial corporate bonds. Investors should keep very long-dated investments to a minimum as the curve is not as steep after 10 years.
Have a great weekend.
There are some who believe that the paring of jobs is good for the markets as the increased productivity. In a consumer driven economy, relying purely on productivity gains for economic growth is like a pilot dumping fuel to go faster by reducing weight by dumping fuel. He may go faster, but not very far.
Today we had another strong treasury auction. The auction yield was lower than the 4.206 percent street consensus. The bid/cover ratio, came in
at 2.87, indicating stronger demand. The ratio was 2.60 when this treasury was first auctioned last month The yield on the bonds sold today was the lowest since the 4.009 percent at the October auction. At the
previous auction, the bonds yielded 4.49 percent.
Indirect bidders, a group that includes foreign central
banks, bought 36 percent of the amount sold, compared with 32.5
percent in the prior auction.
In spite of the strong auction, prices of long-dates treasuries headed lower (about one point lower for the 10-year and two points lower for the 30-year) due to stronger economic data from China and Australia.
Market pundits are become tedious. With every down day they are all gloom and doom. After today's up day pundits were extolling the virtues of owning equities. Nothing has changed folks. I believe that Mr. Bernanke is correct and the recovery, although sustainable, will moderately paced. To all those who believe that then economy is ready to roar, if not for the pessimists, answer this: Why are corporations holding on to huge cash positions?
According to a Fed report companies are now holding $18.4 trillion in cash. That is up 26% from last year. Cash now makes up 7% of all corporate assets, the most since 1963.
Cash may be king for businesses, but it is not a viable option for most investors. Fixed income investors should be laddering, or at least barbelling. Ladders should be weighted on the belly of the curve (5 to 7 years) using callable agencies and high grade financial corporate bonds. Investors should keep very long-dated investments to a minimum as the curve is not as steep after 10 years.
Have a great weekend.
Wednesday, June 9, 2010
All Together Now
Good 10-year auction, especially considering it was a reopening of the existing 10-year note. The bid to cover ratio was 3.24.. This was better than the 2.96 seen on this exact bond when it was originally issued. It was also better than the 2.96 average for the last 10 auctions. Indirect bidders, which included foreign central banks, purchased 40.2% of the deal versus a 41.3 average for the past 10 auctions. This was a good auction.
Economist sentiment, Fed Beige Book data and Fed Chairman Bernanke's testimony before the House Budget Committee all were consistent with the strength of demand at today' 10-year auction.
A survey of economists by Bloomberg News reveals that the consensus opinion calls for the first Fed Funds rate hikes will occur in 2011. Fragility of the recovery, problems in Europe and a lack of inflation should keep the Fed on the sidelines for 2010. There is one Fed official who believes the fed should get into the rate hike game. Kansas City Fed President Thomas Hoenig is once again urging fed Fund rate increases as he believes the economy has sufficient traction to expand on its own. He repeated is call for the Fed to raise the Fed Funds rate to 1.00% by this September. However, he is a lone voice. Unless we see robust consumer spending fueled by strong job growth and balance sheet transparency from European banks (with good news being reported), it is unlikely that the Fed will begin tightening this year.
The Fed's Beige Book reported that all 12 Fed regions reported improved economic activity, but most region described the improvement as being modest. Fed Chairman Bernanke had this to say:
"Our ongoing international cooperation sends an important signal to global financial markets that we will take the actions necessary to ensure stability and continued economic recovery."
"We will have no easy resolution to the challenges we face in restoring jobs and strengthening the economy."
Any lasting recovery will require consumer spending. Increased consumer spending requires robust job growth (or cheap, irresponsible credit). The Fed is just about out of ammo. However, all is not lost. 3% growth is attainable and after all, 3% is approximately the average annual growth rate of the United States since its founding (at least it was when I was in school).
Meanwhile there are some relative bargains in the market. No not TIPS, they are rich, but one large bank issued three-year bonds today which should price in the 5.30% area. Just some food for thought.
Economist sentiment, Fed Beige Book data and Fed Chairman Bernanke's testimony before the House Budget Committee all were consistent with the strength of demand at today' 10-year auction.
A survey of economists by Bloomberg News reveals that the consensus opinion calls for the first Fed Funds rate hikes will occur in 2011. Fragility of the recovery, problems in Europe and a lack of inflation should keep the Fed on the sidelines for 2010. There is one Fed official who believes the fed should get into the rate hike game. Kansas City Fed President Thomas Hoenig is once again urging fed Fund rate increases as he believes the economy has sufficient traction to expand on its own. He repeated is call for the Fed to raise the Fed Funds rate to 1.00% by this September. However, he is a lone voice. Unless we see robust consumer spending fueled by strong job growth and balance sheet transparency from European banks (with good news being reported), it is unlikely that the Fed will begin tightening this year.
The Fed's Beige Book reported that all 12 Fed regions reported improved economic activity, but most region described the improvement as being modest. Fed Chairman Bernanke had this to say:
"Our ongoing international cooperation sends an important signal to global financial markets that we will take the actions necessary to ensure stability and continued economic recovery."
"We will have no easy resolution to the challenges we face in restoring jobs and strengthening the economy."
Any lasting recovery will require consumer spending. Increased consumer spending requires robust job growth (or cheap, irresponsible credit). The Fed is just about out of ammo. However, all is not lost. 3% growth is attainable and after all, 3% is approximately the average annual growth rate of the United States since its founding (at least it was when I was in school).
Meanwhile there are some relative bargains in the market. No not TIPS, they are rich, but one large bank issued three-year bonds today which should price in the 5.30% area. Just some food for thought.
Tuesday, June 8, 2010
Tuesday's Gone With The Wind
Quiet day on the economic data front. The NFIB Small Business Optimism report came in a 92.2 versus a street consensus of 91.0 and a prior 90.6. At 10:00 AM EDT we have IBD / TIPP Economic Optimism (the street forecast is little change). At 5:00 PM EDT we have ABC Consumer Confidence. The street consensus is for a -43 versus a prior -44. Treasury prices are down this morning ahead of today's 3-year auction, the first of three this week. Tomorrow we have the reopening of the 10-year note and Thursday we have the reopening of the 30-year bond. Demand is expected to be strong, especially for the 10-year note.
The strong demand for treasuries has some asking if their may be a bubble in that market. One could make the case. Even if growth is not "terrific," as stated by Fed Chairman, Bernanke, at 3.19% 10-year appears to be a bit overdone. One could make the same case for prices of preferreds and corporate bonds, especially non-financials. However, where is one to invest? The equity market had climbed too far, too fats and continues to correct. Where is the next opportunity? Opportunities are everywhere if one knows where to look and manages expectations. Absence a new technology or global event that requires the ramping up of production, economic growth will be rather sluggish. With their ability to cut payroll and increase productivity limited going forward, corporate profits will probably level off, or possibly decline. The best description of the U.S. economy may be: It is what it is.
PIMCO's Tony Crescenzi believes that governments are out of stimulus bullets. He stated in an e-mailed investor letter (Keynesian Endpoint): "Time, devaluations, and debt restructurings might be the only way out for many nations." Crescenzi wrote in an e-mailed note titled "Keynesian Endpoint" He went on to say that debt-fueled spending programs designed to put economies on the path to recovery are now "being seen as a magic elixir that has morphed into poison."
I view the situation this way. The economy can be viewed as a very large aircraft. The government has trucked out its most powerful engines and the result is that the craft is airborne, but not flying very high. Unless additional power is added from other sources, the economy will be a low-flying aircraft. Where will that power come from? That is a question being asked by economists around the globe. However, the answers have been few, far between and not very encouraging. Since cheap lending won't do the trick this time, a new technology or industry is needed to provide the jobs needed to fuel a sustained robust economic recovery.
In the "there's no place like home segment" we have the results of a Bloomberg News poll which states that investors are choosing the U.S. not only over Europe, but also over the best Emerging Markets countries, so-called BRIC countries (Brazil, Russia, India and China). This is further evidence that the U.S. is the least dirty shirt, least ugly girl at the dance or whatever other cliché' one can think up. It is this sentiment that may have caused a bubble in bond prices. However as illogical as a 3.20% 10-year may appear, a 10-year note over 5.00% sounds downright ridiculous in this kind of environment. Fed Chairman Ben Bernanke said that the Fed will likely begin raising rates before full employment is achieved, but did not opine as to what he believed full employment would be this time around. It is doubtful he believes that full employment is in the 5.00% - 6.00% unemployment rate range we have experienced during the past two decades. If he is waiting for such low unemployment the Fed could be on the sidelines for a very long time.
Speaking of treasuries, today's three-year auction went well, but you wouldn't know it by the reaction of bond market participants and financial journalists. Critics pointed to the smaller percentage of indirect bidders, which include foreign central banks (46.7% versus an average of 53.9% over the last 10 auctions). However the bid to cover ratio, which gauges demand versus the supply of new bonds (oversubscribed) was 3.23 versus an average of 3.03 for the last 10 auctions. What this means is that while interest among central banks waned a bit, overall demand increased. Judging by the headlines, one wonders if the folks at Bloomberg News realize this. The real test will be tomorrow's 10-year auction. The 10-year is the most popular treasury among foreign central banks and institutions, such as insurance companies for duration and, in the case of insurance companies, actuarial reasons.
We should also keep in mind that this is not a new 10-year not coming to market, but a reopening of the existing 10-year. Demand may not be as strong as it would be for a new 10-year with a new maturity. The reason is that some institutions can only own so many 10-years, but since they must own the most current 10-year, they are bigger buyers of new issues.
The markets also reacted positively to Fed Chairman Ben Bernanke's statement that the economy continues to gain traction. However, he also said the recovery will proceed at a moderate pace and that unemployment is unlikely to fall quickly.
I wouldn't read too much into today's rally as a new trend. The equity markets were to optimistic during the past year (after being too pessimistic the year before). We could be in for a year or so of much volatility, but little real movement in either direction.
Look for the dearth of new corporate bond issue to continue as issuers wait for credit spreads to come in later on, hopefully after calm returns to the markets. However, we probably need strong real job gains and more transparency from Europe regarding the health of the PIIGS and bank exposure to their bonds. Europe's reluctance to come forward with this information has understandably rattled the markets sending the euro marching toward parity with the U.S. dollar.
The strong demand for treasuries has some asking if their may be a bubble in that market. One could make the case. Even if growth is not "terrific," as stated by Fed Chairman, Bernanke, at 3.19% 10-year appears to be a bit overdone. One could make the same case for prices of preferreds and corporate bonds, especially non-financials. However, where is one to invest? The equity market had climbed too far, too fats and continues to correct. Where is the next opportunity? Opportunities are everywhere if one knows where to look and manages expectations. Absence a new technology or global event that requires the ramping up of production, economic growth will be rather sluggish. With their ability to cut payroll and increase productivity limited going forward, corporate profits will probably level off, or possibly decline. The best description of the U.S. economy may be: It is what it is.
PIMCO's Tony Crescenzi believes that governments are out of stimulus bullets. He stated in an e-mailed investor letter (Keynesian Endpoint): "Time, devaluations, and debt restructurings might be the only way out for many nations." Crescenzi wrote in an e-mailed note titled "Keynesian Endpoint" He went on to say that debt-fueled spending programs designed to put economies on the path to recovery are now "being seen as a magic elixir that has morphed into poison."
I view the situation this way. The economy can be viewed as a very large aircraft. The government has trucked out its most powerful engines and the result is that the craft is airborne, but not flying very high. Unless additional power is added from other sources, the economy will be a low-flying aircraft. Where will that power come from? That is a question being asked by economists around the globe. However, the answers have been few, far between and not very encouraging. Since cheap lending won't do the trick this time, a new technology or industry is needed to provide the jobs needed to fuel a sustained robust economic recovery.
In the "there's no place like home segment" we have the results of a Bloomberg News poll which states that investors are choosing the U.S. not only over Europe, but also over the best Emerging Markets countries, so-called BRIC countries (Brazil, Russia, India and China). This is further evidence that the U.S. is the least dirty shirt, least ugly girl at the dance or whatever other cliché' one can think up. It is this sentiment that may have caused a bubble in bond prices. However as illogical as a 3.20% 10-year may appear, a 10-year note over 5.00% sounds downright ridiculous in this kind of environment. Fed Chairman Ben Bernanke said that the Fed will likely begin raising rates before full employment is achieved, but did not opine as to what he believed full employment would be this time around. It is doubtful he believes that full employment is in the 5.00% - 6.00% unemployment rate range we have experienced during the past two decades. If he is waiting for such low unemployment the Fed could be on the sidelines for a very long time.
Speaking of treasuries, today's three-year auction went well, but you wouldn't know it by the reaction of bond market participants and financial journalists. Critics pointed to the smaller percentage of indirect bidders, which include foreign central banks (46.7% versus an average of 53.9% over the last 10 auctions). However the bid to cover ratio, which gauges demand versus the supply of new bonds (oversubscribed) was 3.23 versus an average of 3.03 for the last 10 auctions. What this means is that while interest among central banks waned a bit, overall demand increased. Judging by the headlines, one wonders if the folks at Bloomberg News realize this. The real test will be tomorrow's 10-year auction. The 10-year is the most popular treasury among foreign central banks and institutions, such as insurance companies for duration and, in the case of insurance companies, actuarial reasons.
We should also keep in mind that this is not a new 10-year not coming to market, but a reopening of the existing 10-year. Demand may not be as strong as it would be for a new 10-year with a new maturity. The reason is that some institutions can only own so many 10-years, but since they must own the most current 10-year, they are bigger buyers of new issues.
The markets also reacted positively to Fed Chairman Ben Bernanke's statement that the economy continues to gain traction. However, he also said the recovery will proceed at a moderate pace and that unemployment is unlikely to fall quickly.
I wouldn't read too much into today's rally as a new trend. The equity markets were to optimistic during the past year (after being too pessimistic the year before). We could be in for a year or so of much volatility, but little real movement in either direction.
Look for the dearth of new corporate bond issue to continue as issuers wait for credit spreads to come in later on, hopefully after calm returns to the markets. However, we probably need strong real job gains and more transparency from Europe regarding the health of the PIIGS and bank exposure to their bonds. Europe's reluctance to come forward with this information has understandably rattled the markets sending the euro marching toward parity with the U.S. dollar.
Saturday, June 5, 2010
Private Eyes
Disappointing jobs numbers today. Not only did the headline Nonfarm Payrolls number disappoint, but the more important (for an economic recovery) Private Payrolls data missed big time. The street consensus called for a 180,000 job increase in private payrolls. The economy added only 41,000 jobs. Most economists believe that the economy needs to add at least 100,000 jobs just to keep up with new workers entering the labor force. Since most of the 390,000 new government jobs were temporary census-related jobs, this is bad news for those looking for gainful full-time employment. The unemployment rate did drop, but the likely cause for that were more displaced workers answering the so-called household survey that they were not seeking employment. A quirk of the household survey is that if an unemployed workers answers the survey that they are not seeking employment at that time, they are not considered to be unemployed. Average Weekly Hours increased. There are two ways that the data can become more positive. The first and best for the economy is for more workers to be added to company payrolls. The other is for existing workers to be asked to work longer hours. It appears that the latter is true at this time.
The fun didn't stop in the morning. After reacting to the numbers (stocks and bond yields both trending lower), things deteriorated in the afternoon. The Dow Jones Industrial Average plummeted during the final hour of the trading session to finish down 324 points and stands at 9931. The price of the benchmark 10-year note finished up 1-13/32s to yield 3.20%.
Some more optimistic pundits have blamed overreaction to problems in Europe or short selling for the markets' correction. I have another theory. I believe that reality is setting in. Market participants are coming to grips with that fact that the global economy is not going to rebound as it had during the past two decades. We have kicked the stimulus can down the road.
In the past, whenever the economy would slow too much for the tastes of politicians, consumers and market participants, governments would stimulate the economy by lowering interest rates. This would promote borrowing, both new debt and the refinancing of existing debt. Newly-found credit would encourage consumer spending. There was another dangerous consequence. By lowering interest rates investors were forced into ever riskier assets to maintain income and rates of return. This led to the expansion of subprime lending. In the past only very aggressive investors would purchase securities backed by subprime mortgages and would demand very high yields to do so. However with interest rates low and continually dropping, more moderate and even conservative investors began purchasing such mortgage-backed securities and they didn't need very high yields to pique their interests.
The demand for yield attracted buyers to MBS. The increased demand pushed MBS yields lower and thereby pushed mortgage rates lower. It also permitted mortgage lenders to lower their lending standards in an attempt to create more MBS. Profits among lenders soared. The ratings agencies, seeing the historical performance of such loans, began giving bonds with ever lower quality mortgages AAA credit ratings. Quantitative modelers at the banks looked at the same data and came to similar conclusions. What few realized (or was willing to acknowledge) was that old default data no longer applied. Why did it historical data no longer apply? First: There were borrowers receiving loans who previously would not qualify. Secondly: In the past, if need be, borrowers could easily refinance their debt if they became over extended as rates trended lower and home prices rose. In cases of extreme distress, home owners could simply sell their homes at higher prices and move on. Modelers apparently did not take these facts into account.
Things are different today. Rates cannot be made lower. Lending standards are once again responsible. Home prices have corrected or are still correcting. The stimulus pumped in to the economy by the government has gotten us off of the bottom and has averted an economic catastrophe, but it cannot push the economy back to previous levels, levels which were not fundamentally sustainable. This is Bill Gross's "new normal".
Mr. Gross of PIMCO fame has been very vocal stating the economy is at a "new normal." By this he means that there is nothing to drive the economy higher. There is no new technology, transportation innovation or stimuli to drive job creation. Job creation and / or wage growth is necessary to increase consumer wealth to accelerate spending and driver stronger growth. The economy was able to expand due to cheap and plentiful credit. That could only go so far and has run its course. The evidence of this is in yesterday's Nonfarm Payrolls report. The private sector added a pitiful 41,000 jobs and while once should not become overly pessimistic due to one bad jobs report (or overly optimistic when there is a good jobs report), there is now nearly unanimous opinion in the markets that the recovery will be much slower than what was hoped and inflation is not a problem.
Inflation and higher rates have been on the minds of investors who tend to have a myopic view of the U.S. debt situation. They believe that because the U.S. has infused mega stimulus and has issued huge amounts of debt interest rates in the U.S. must rise. That would be true if the economic troubles were isolated and unique to the United States. However, this is a global problem. Currently the U.S. is the least ugly girl at the dance or, as Bill Gross termed it yesterday: "The U.S. is the least dirty shirt." Economics is like bear hunting with your friends. When the bear charges you don't need to be faster than the bear, just faster than your friends. Currently the U.S. is faster than its friends. We can only hope that economic policy keeps us out in front. Although poor policy decisions in Europe and Asia have been helping to keep us out in front, pending legislation promised to cause the U.S. to stumble. Still I agree with Mr. Gross. The U.S. will be the best of a bad bunch and interest rates will rise only modestly in the coming years, topping out at historically low peaks.
Try enjoy the weekend. Monday is only two days away.
The fun didn't stop in the morning. After reacting to the numbers (stocks and bond yields both trending lower), things deteriorated in the afternoon. The Dow Jones Industrial Average plummeted during the final hour of the trading session to finish down 324 points and stands at 9931. The price of the benchmark 10-year note finished up 1-13/32s to yield 3.20%.
Some more optimistic pundits have blamed overreaction to problems in Europe or short selling for the markets' correction. I have another theory. I believe that reality is setting in. Market participants are coming to grips with that fact that the global economy is not going to rebound as it had during the past two decades. We have kicked the stimulus can down the road.
In the past, whenever the economy would slow too much for the tastes of politicians, consumers and market participants, governments would stimulate the economy by lowering interest rates. This would promote borrowing, both new debt and the refinancing of existing debt. Newly-found credit would encourage consumer spending. There was another dangerous consequence. By lowering interest rates investors were forced into ever riskier assets to maintain income and rates of return. This led to the expansion of subprime lending. In the past only very aggressive investors would purchase securities backed by subprime mortgages and would demand very high yields to do so. However with interest rates low and continually dropping, more moderate and even conservative investors began purchasing such mortgage-backed securities and they didn't need very high yields to pique their interests.
The demand for yield attracted buyers to MBS. The increased demand pushed MBS yields lower and thereby pushed mortgage rates lower. It also permitted mortgage lenders to lower their lending standards in an attempt to create more MBS. Profits among lenders soared. The ratings agencies, seeing the historical performance of such loans, began giving bonds with ever lower quality mortgages AAA credit ratings. Quantitative modelers at the banks looked at the same data and came to similar conclusions. What few realized (or was willing to acknowledge) was that old default data no longer applied. Why did it historical data no longer apply? First: There were borrowers receiving loans who previously would not qualify. Secondly: In the past, if need be, borrowers could easily refinance their debt if they became over extended as rates trended lower and home prices rose. In cases of extreme distress, home owners could simply sell their homes at higher prices and move on. Modelers apparently did not take these facts into account.
Things are different today. Rates cannot be made lower. Lending standards are once again responsible. Home prices have corrected or are still correcting. The stimulus pumped in to the economy by the government has gotten us off of the bottom and has averted an economic catastrophe, but it cannot push the economy back to previous levels, levels which were not fundamentally sustainable. This is Bill Gross's "new normal".
Mr. Gross of PIMCO fame has been very vocal stating the economy is at a "new normal." By this he means that there is nothing to drive the economy higher. There is no new technology, transportation innovation or stimuli to drive job creation. Job creation and / or wage growth is necessary to increase consumer wealth to accelerate spending and driver stronger growth. The economy was able to expand due to cheap and plentiful credit. That could only go so far and has run its course. The evidence of this is in yesterday's Nonfarm Payrolls report. The private sector added a pitiful 41,000 jobs and while once should not become overly pessimistic due to one bad jobs report (or overly optimistic when there is a good jobs report), there is now nearly unanimous opinion in the markets that the recovery will be much slower than what was hoped and inflation is not a problem.
Inflation and higher rates have been on the minds of investors who tend to have a myopic view of the U.S. debt situation. They believe that because the U.S. has infused mega stimulus and has issued huge amounts of debt interest rates in the U.S. must rise. That would be true if the economic troubles were isolated and unique to the United States. However, this is a global problem. Currently the U.S. is the least ugly girl at the dance or, as Bill Gross termed it yesterday: "The U.S. is the least dirty shirt." Economics is like bear hunting with your friends. When the bear charges you don't need to be faster than the bear, just faster than your friends. Currently the U.S. is faster than its friends. We can only hope that economic policy keeps us out in front. Although poor policy decisions in Europe and Asia have been helping to keep us out in front, pending legislation promised to cause the U.S. to stumble. Still I agree with Mr. Gross. The U.S. will be the best of a bad bunch and interest rates will rise only modestly in the coming years, topping out at historically low peaks.
Try enjoy the weekend. Monday is only two days away.
Wednesday, June 2, 2010
Tipping One's Hand
Equity markets are set to open higher this morning while treasuries are little changed. Pending Home Sales data is set to be released at 10:00 AM EDT. The street is forecasting more modest gains than indicated by last month's data. The street is focused on employment data set to be released tomorrow and Friday. Tomorrow we have Jobless Claims and ADP Employment. Friday brings Nonfarm Payrolls and the Unemployment Rate.
In fact, some people already know what the data will say. Equity markets rallied and treasuries sold off after both President Obama and Vice President Biden independently commented that Friday's employment data will be strong. After the close critics dismissed our leaders' enthusiasm by pointing out that many of these jobs were temporary, such as census workers or Gulf cleanup personnel. Both the president and vice president broke an unwritten rule by tipping the numbers before their release. I guess different rules apply to different people. Those looking to invest at the same level or above the government in troubled companies. The government can do what it wants and leap-frog you, cram you down, etc. if it deems it necessary to do so.
In fact, some people already know what the data will say. Equity markets rallied and treasuries sold off after both President Obama and Vice President Biden independently commented that Friday's employment data will be strong. After the close critics dismissed our leaders' enthusiasm by pointing out that many of these jobs were temporary, such as census workers or Gulf cleanup personnel. Both the president and vice president broke an unwritten rule by tipping the numbers before their release. I guess different rules apply to different people. Those looking to invest at the same level or above the government in troubled companies. The government can do what it wants and leap-frog you, cram you down, etc. if it deems it necessary to do so.
Today's Wall Street Journal Credit Markets column discusses how the drop in long-term interest rates caught investors by surprise. I hate to spoil the excitement surrounding the article, but while many investors and some economists were surprised, many, if not most, bond market participants (traders, managers and strategists) were not that surprised. Most bond market participants had their year-end 2010 10-year treasury yield forecast with a 4.00% handle (there were some notable exceptions). Some of us were in the lower end of the 4.00% range. The problem with investor sentiment is that investors tend to be equity oriented and rely on historical trends without putting historical data into their proper contexts. never before has the U.S. provided current amounts and types of stimulus in a global economy in which many of its trading partners are also experiencing economic difficulties.
The article states that many experts were surprised that U.S. treasuries were used as the global safe haven. Where did they expect money to go? Europe (problems worse than ours)? Japan (low rates and deflationary). China (can't deliver the bonds outside of China and it has its own asset bubble)? Emerging Markets (not large enough and are dependent on the developed world for their economic activity)? Gold was the only alternative, but even gold has its limitations (delivery, etc.). Nope, it all comes down the the U.S.A. the least ugly girl at the dance.
This is not to say that long-term won't be higher this time next year. Inflation is likely to be modestly positive and long-term rates are likely to follow suit. Those buying TIPS and floaters to outperform the market will likely be disappointed, at least for now. Buy TIPS as a hedge against unexpectedly-high inflation and buy step-ups for unexpectedly-high interest rates. Hedge is the operative word here.
Tuesday, June 1, 2010
Summertime Blues
The U.S. is advising Europe to conduct stress tests of its banks to indicate potential writedowns should one or more sovereigns fail. Last year, EU officials declared European banks healthy stating that they were not very exposed to the kind of toxic assets which plagued U.S. banks. However in this go around, it is not toxic mortgage assets which worry government officials and investors alike, but sovereign debt form the so-called PIIGS. U.S. officials are vocally advocating European stress tests. Although some countries are agreeable, others (most notably Germany) are reluctant to do so. One official called last year's U.S. stress tests a public relations ploy and stated that the tests were designed for the banks to pass. He is not incorrect, but at least it gave a picture, albeit an optimistic one, of the conditions of large U.S. institutions. Ten banks were forced to raise capital. Even if the criteria of the stress tests was not very stringent, raising capital did make some banks materially stronger. That instilled confidence in the banks and led to the recovery of the financial markets. At some point the Europeans will have to accept reality for the markets will foist it upon them.
The capital markets may have a case of the Summertime blues. Today's economic data was, for the most part, encouraging (however the Dallas fed report was disappointing). The markets responded positively. Concerns about global growth and BP's inability to cap its underwater gusher sent the markets into negative territory and bond yield lower late in the trading session. It appears that market participants are awakening to what many of us have known all along. The recovery was a stimulus driven market recovery.
All eyes will now turn to this week's employment data. The street consensus is calling for the addition of over 500,000 jobs (up from a prior 290K). There very well could be a healthy jobs report. Before the European crisis the dollar was weak which helped U.S. exports. the key will be if the U.S. can add jobs based on domestic economic growth now that the dollar has strengthened. Unless Europe can embrace reality, there ain't no cure for the summertime blues.
The capital markets may have a case of the Summertime blues. Today's economic data was, for the most part, encouraging (however the Dallas fed report was disappointing). The markets responded positively. Concerns about global growth and BP's inability to cap its underwater gusher sent the markets into negative territory and bond yield lower late in the trading session. It appears that market participants are awakening to what many of us have known all along. The recovery was a stimulus driven market recovery.
All eyes will now turn to this week's employment data. The street consensus is calling for the addition of over 500,000 jobs (up from a prior 290K). There very well could be a healthy jobs report. Before the European crisis the dollar was weak which helped U.S. exports. the key will be if the U.S. can add jobs based on domestic economic growth now that the dollar has strengthened. Unless Europe can embrace reality, there ain't no cure for the summertime blues.
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