Granted, while the recovery that some economists and media market pundits envision may be government-stimulated mirages, further along the time horizon one can recognize signs of stabilization and a plausible escape from Dante’s 9th level of hell in a handbasket. Yet, key industries, e.g. financials, autos, housing, commercial real estate, and consumer retail are fragile or broken and still dependent upon various forms of corporate and social welfare.
Speaking of welfare, the issuance of record amounts of national debt accompanied by declining treasury tax receipts continues to influence my unfavorable secular view on the supply-demand scenario for treasuries. However, with an overextended and overvalued 6 month rally in equities, I suspect that "safe haveners" instead of "yield whores" are buttressing the containment of rising interest rates. According to Bloomberg, some of the larger pension funds have developed a phobia for risks (see video below) which I interpret as a partial explanation for the phenomenon of rising equity prices on contracting volume.
Of course, all of this is debatable as the weekly chart below shows demand for treasuries at yields approaching the 4% range tends to consistently attract buyers (see weekly chart below). The recent trend for 10 year treasury bond yields is up, but the secular trend remains down (see monthly chart below). Lest we forget, 10 year treasury yields ranging from 4% to 5% are not abnormal under normalized economic conditions and inflation trends in which stocks are expected to offer potentially superior risk adjusted returns. Currently, both the earnings yield (at 3.66%) and dividend yield (at 2.65%) for the S&P 500 are below the 4% level.
Weekly Chart of 10 Year Treasury Yields
Monthly Chart of 10 Year Treasury Yields
Until we arrive at the new normal - i.e. historically lower nominal GDP growth at 2.5% - 3%, high mid-single digit unemployment rates, and more modest consumption rates - the economy must endure the abnormal, provided America’s creditors will continue to lend. Monday’s TIC report confirms that this continues to be the case.
Nominal GDP growth in the range of 4% - 5% would be nothing short of miraculous and I do not believe the existing fundamentals support such rates. It looks like we have been sentenced to a Faustian deal with the devil of inflation for the sake of reviving a few banks which supposedly "represent" the U.S. banking system.
Judging from the relative performance of 10 year bonds vs. stocks and the recent move above the 20 day moving average (4 week moving average), the bond bogey-man is not coming out anytime soon. Banks still require more time to earn their way out of some of the potential writedowns they will inevitably take. When the bond bogey-man re-emerges, look for 10 year yields to break out above the resistance of the weekly chart’s downtrend line and the June 2009 high (see weekly chart above).
For now, the recently established long-term uptrends for stocks remain intact and it looks like investors might be witnessing the beginnings of a long overdue correction in stocks and tactical re-allocation of capital.
