Bonds Triumphant, But . . .

Remember there was a slave assigned to remind the returning triumphant Roman general that success is transient?

Now think of the 10 year bond collapsing in yield from 4.0% on April 5 to 2.60% or less in mid-August, with little major news in this period to cause such an extreme change in price/yield.

In the usual course of events, profits by the buyers the past few months will be taken. Rapid extreme success (to the bond bulls) may be transient, at least temporarily.

The long (30 year) bond has rallied as well but is far less extended on the charts. I continue to mentally target the 10-year backing up in yield or at most stabilizing, while the 30 year trends lower in yield to re-establish the more traditional yield relationship of 50 or 75 basis points difference between them.

So long as the yield is higher from the long bond and the 10-30 spread is at or near historical extremes, the weight of the evidence favors being in the long bond rather than the 10 year.

Copyright (C) Long Lake LLC 2010

The New Bubble: Feds May Need a Stock Crash to Keep Deficit Spending Affordable

We are moving into government bailout bubble territory in the U. S. The state of California had to (could) increase the size of its bond offering. What's up with that? The Feds are helping.

A potentially vast new FHA rejiggering of mortgages to help bail out borrowers and lenders alike with taxpayer funds has just been announced. The money is said to be coming from some prior bailout funds.

The surprising thing is that with the flood of issuance, the 10-year is not back above its peak of last year in yield. Certainly sentiment on the Treasury bond is as bad as can be imagined. Meanwhile "liquidity" is running wild. The "smart money" "knows" that the party will continue until the Fed tightens, thus stocks and junk bonds are buys.

When I look at my Value Line charts, I can find almost no stocks below their "value lines". Some such as Oracle and Mickey D are at their lines, but one is left with TJX and DLTR, Chubb and Everest Re (insurers highlighted by Barron's today), and scattered others. Mostly the chart patterns look long-term weak, short term overbought. You never know with bubbles and can't try to pick the top.

Holding this bubble together is a rickety edifice.

If Treasury yields surge, look out. Since Obamanomics requires low borrowing rates, watch out for the opposite happening. Obamanomics requires Treasuries to have low rates more than companies to have high stock prices. The more people and businesses suffer, the more the Feds can step in and save them. The question is whether the government can keep long rates low or even for them to move much lower. The Japan scenario, in other words. 1-2% inflation would be fine to allow 3% 10-yar treasury yields. Remember that long rates were much lower than today's all through the 1940s and well into the 1950s even as some years of war and post-war high inflation came and went. In other words, sometimes rates can be well below inflation. It just depends on psychology and on relative opportunities. And right now cash is trash and stocks are fundamentally overpriced.

There is no good general investing solution right now other than trading profits, which most people living normal sane lives cannot hope to achieve. I still think that one of these months, we are likely to see a recrudescence of a Treasury buying surge/panic. No idea when, though. But unlike with stocks as a whole, the 10-year pays you to wait.

Gold continues to act as suggested here. It is frustrating traders, short sellers and long-term investors. The more the financial markets inflate in price and gold does not, the more it is likely that gold prices are set to surge.

Copyright (C) Long Lake LLC 2010

Cross-Currents in the Treasury Market

The nearby charts nicely show the conflict between a short-to-intermediate term view of the 10 year Treasury note (bond) and the long-term view. (Click on each to enlarge.)

The 2-year view shows both lower highs in yield conflicting with a more rapid uptrend line that defines higher lows, with the panic December 2008 low the obvious starting point for the uptrend line. Conventionally, the likelihood would be that the more powerful trendline upward would tend to win out and that rates would push higher.

On the other hand, the post-1982 major downtrend in rates is clearly intact.

Very short-term, the 10-year is acting as though it wants to rise in price and thus for rates to move lower. Thus a speculative trade in IEF has chart support, but it is speculative because unlike ownership of an actual bond that pays off at par (presumably) at a date certain, ownership of an ETF is perpetual ownership and theoretically can decline in price indefinitely if yields on bonds continually rise.

The Big Finance companies' charts are of little help now in guessing the future.

Assuming that economists will judge that the economy bottomed last year, then if the current economic cycle follows the pattern of the past several, we can look forward to an irregularly-rising yield on the 10-year until the next economic downturn, when new lows in yields can be projected on the charts. This would be the Japan scenario. If this happens soon, before much real wealth can be created, then the Japan/Ice Age scenario would be a reasonable outcome. One of the straws in the wind in favor of this is diminishing foreign appetite for our debt. The Japanese government keeps selling more and more bonds to Japanese, and thus any default will be almost exclusively an adjustment of accounts within the family, perhaps consensual, perhaps contentious. That could certainly happen here.

Copyright (C) Long Lake LLC 2010

Comments on Treasuries: What's the Trend?

The accompanying graph is that of the continuous 7-10 year duration ETF with the ticker symbol IEF. Think of it as a proxy for the benchmark 10-year Treasury.

Now that the ECRI and David Rosenberg are agreed that the peak rate of expansion has already ended, historically this is a classic time for a rally in bond prices (and thus in the IEF) and a decline in rates.

Typically, the markets price in a cyclical reduction in governmental deficits as employment and the pace of business pick up and then positive surprises appear; and simultaneously, inflation actually diminishes as there is so much excess labor and machinery and other spare capacity that businesses and labor are both happy to just bring in net income as unexpected new business and new hiring appears.

On the chart, we have a well defined series of higher lows in price going back to 2007, following a double bottom in price in 2006 and then 2007.

Not shown are some ugly moving average charts.

Also, the charts on JPM and GS are looking toppy, and declines in financial stocks often correlate with declines in yields. Of course, we are at an extreme in short term rates and the Federal deficit is projected to be unusually large for some time to come, with many states hurting as well.

Going back to the chart above, one can envision that IEF is near a support level in price, bounded by a declining line between the peaks starting at the end of 2008. A break above that line could signal an upmove worth playing. Conversely, breaking support around 88 suggests a move to 85 as a first target.

If inflation really gets moving and the Fed stays easy, a meltup in rates is feared.

Unprecented times mean unprecedented possibilities.

Big Finance loves this. They have the best information, plus of course they help control what's to be.

Copyright (C) Long Lake LLC 2010

JPMorgan Chase Stock and the 10 Year Treasury

In followup to yesterday's post about the importance of watching JPM, here is a 5-year chart showing the close correlation between its stock price and the 10-year Treasury yield. The higher the yield, the higher the stock price.

Bears on JPM might be safer with the 7-10 year Treasury ETF with the stock symbol 'IEF'.

Bears on the 10 year Treasury might want to express that point of view by being long JPM.

Copyright (C) Long Lake LLC 2009

Afghan Election Fraud, Gold and Interest Rates

Yours truly has commented that given the slack in the economy, the biggest risk to a significant return of price increases would likely be a large war in Afghanistan. The President is widely reported to be rethinking his previous emphasis on winning there.

Anyone interested in the idea that there is a government worth fighting for in Afghanistan may want to read What I Saw at the Afghan Special Election.

My conclusion is that the Karzai government is not worth another American life, 8 of which were lost in a battle Saturday.

The article also describes the current warfare as a civil war between Pashtuns. Presumably they are fighting over control of the drug trade. So rather than buy off Mr. Karzai, why not just buy off both sides in the war?

So far as we are given to believe, al-Qaeda is largely headquartered in Pakistan, anyway.

The financial markets are quiet in Asia. So long as the political situation stays stable there as well, the 10-year Treasury still appears to EBR to be pointing toward a 3-3.1% yield and the 30-year to an even more surprising 3.7% yield or less.

Louise Yamada, who called the gold bottom about 8 years ago, disclosed very recently that she now has a target of $1300/ounce for the metal during this ongoing move upwards. She does not however predict both price and time, but generally her time frame for this sort of prediction is not years and years (which would render the prediction useless).

Copyright (C) Long Lake LLC 2009

Sometimes Being a Contrarian on Bonds Means Agreeing with Goldman Sachs

From Mortgage Insider, with the quote within the post in bold:

Goldman sees 10-year yields falling to 3%
September 17th, 2009, 7:02 am · 1 Comment · posted by Mathew Padilla
In my last post, I noted the possibility mortgage rates could rise in January, if the Federal Reserve stops buying mortgage-backed securities as planned. But 30-year fixed mortgage rates are indirectly linked to 10-year Treasury notes, and Goldman Sachs sees their yield at “risk” of falling toward 3% amid low inflation. Here’s more from Bloomberg:

The U.S., the U.K. and Australia will be the “main beneficiaries” of a rally in longer-maturity government bonds, Francesco Garzarelli, chief interest-rate strategist in London at Goldman Sachs, wrote in a research report. Australian 10-year securities are the “cheapest” among markets tracked by Goldman and should trade at yields below 5 percent, he wrote.
“We see risk skewed in the direction of 10-year yields breaking towards their 200-day moving average of 3 percent, from their current 3.4 percent level,” Garzarelli and Michael Vaknin wrote in a separate note to clients. “The global bond premium remains elevated, although off the June highs, and there is plenty of excess liquidity in banks balance sheets which needs to be put to work.”

Inflation risks are subdued by high unemployment and under utilization of industrial capacity. But with a weak dollar, big government deficits, and the Fed spreading money around the inflation threat should not be ruled out. So 3% Treasury yield is probably less likely than Goldman suggests.

(End of Mortgage Insider's post)

DoctoRx here again. I present the above this way because no matter how bright Mr. Padilla, the blogger is, I submit that Goldman is well aware of all his points. Goldman is also well aware that yields have always bottomed after recessions end, often in conjunction with a stock market relapse. The contrarian in me would be alarmed if Mr. Padilla had argued that Goldman was not bullish enough on yields fall and instead had argued with David Rosenberg for a challenge of the December 2008 low around 2.1%. Now, the contrarian in me says that Padilla is with the majority that sees blue skies for the economy and lots of inflation pressure.

A 10-year yield bottom in the 3-3.1% range smells very reasonable to me.

Copyright (C) Long Lake LLC 2009

Might Treasuries Have Another Rally Left in Them? And Why It's OK to Own Them Even if They Don't

Please look at the chart of the yield on the 10-year Treasury bond for the past 2 years. The red line shows the 50 day (10 week) moving average of the yield, and the green line shows the 200 day (40 week) moving average. The other chart shows a multi-decade look at the rise and fall of 10-year yields. Who is to say that the wild and crazy peak of the yield in 1980 is not equivalent to the wild and crazy fall in yield in December 2009, and that an even wilder and crazier low in yields is coming relatively soon just as a higher high in yields came in 1982?

While history does not repeat, it has been said to rhyme.

One year ago, the recession either was not accepted to have occurred or was expected by most seers such as the ECRI to be a mild one. In expectation of such, the bond went into enough of a bear market that a "golden cross" of the 50 day ma above the 200 day ma occurred.

Now, the MSM has told us that the recession is over. Yet the yield on the 10 year is just where it was one year ago. The yield is also exactly where the 200 day ma was a year ago. The 200 day ma is now horizontal at around 3.1%. Those with a long memory and an interest in numerology will recall that the 10 year yield bottomed in the last Treasury bull market (2000-3) at 3.1%.

The DoctoRx system of chart analysis also gives weight to the fact that it took only about 2 months for the yield to collapse from about 3.7% to about 2.1%, whereas it took half a year to rise to that level. When the sharp move is in the same direction as the major trend toward lower Treasury rates that has been in force for nearly 3 decades, and price deflation and asset, real estate and labor under-utilization is pronounced, the conservative investor who has been directed toward the stock market takes heed of the chart.

Gary Shilling, an economist who has been bullish on lower Treasury yields for many, many years continues to be bullish. He stated recently that he expects chronic deflationary pressures in the U.S. and lower Treasury yields. He also stated in this Yahoo.com interview that people don't buy long-term Treasuries for income.

I disagree with Dr. Shilling on this last point. Receiving 4% income now with a reasonable certainty of getting the (nominal) principal back later beats 1% from a bank now with no greater security of principal return. Do the math. Receiving 1% a year for 2 years turns $100 into $102. At that point, one would have to receive 5% a year for the next 8 years to simply equal what one would have gotten by taking 4% a year for 10 years.

After the first period of Treasury yields well over 10% during the Civil War, yields bottomed, but it took a lifetime till about 1941 to do so. So maybe yields have bottomed, but maybe they will stay low or go lower for longer than the herd expects.

In the meantime, at the bottom of the post-World War II stock market when "everyone" feared another Great Depression, the Dow yielded 7% in dividends (and then there were retained earnings) and both long and short term Treasury rates were around 2%. Companies that 10 years ago had low dividend yields and were viewed as growth stocks, namely Eli Lilly and Bristol-Myers Squibb, now have 10X or lower prospective P/E's and about 6% dividend yields. Perhaps by 2020, Microsoft and Intel will be so viewed.

So for technical and fundamental reasons, direct ownership of intermediate to long-term Treasury bonds probably makes sense for a great many investors who are afraid of the "risk" but are happy to own "blue chip" stocks such as Walt Disney or Oracle that yield 1% dividends and can be purchased from insiders in the companies at prices far above what the companies are worth under generally accepted accounting principles.

Copyright (C) Long Lake LLC 2009

Advance GDP Data Show Domestic Consumption Collapse

The Advance GDP data are out.  Spinmeisters will crow about the decline ending, as massive inventory reduction accounted for much of the downturn.  What will receive little publicity is the following, taken from the BEA Press Release (www.bea.gov, see "Latest Release"):

Real gross domestic purchases - - purchases by U. S. residents of goods and services wherever produced - - decreased 7.8% in the first quarter, compared with a decrease of 5.9% in the fourth.

This shows a true collapse in domestic consumption.  My quick explanation is that imports collapsed 34% while the smaller quantity of exports collapsed less, at 30%.  Thus the country enjoyed a significant diminution in its share of the world's goods and services (consistent with the need to start running trade surpluses).   The implication appears to be that consumers could not afford imported goods.

Please recall that GDP relates to domestic production.  As a reductio ad absurdum, if the U. S. became a colony of another country and produced only for export except for food and water etc., GDP could grow and grow but the American people would not see any of that production.

So what good is GDP?  That's a good question.

Stock market futures are up on the GDP report.  They are also reportedly experiencing a relief rally that the swine flu pandemic is not as bad as SARS, or some other thought of the day.  This blog advised readers on April 27 to more or less ignore the swine flu news in their investing activities.  This pandemic is a non-trivial problem, but there is no way EBR sees to profit from it.  Overall it is obviously bad for worldwide economies, so on a short-term basis, it is a negative for stocks, but over the long run (which is what stock prices are supposed to discount)

what we see now is unlikely to have major macro effects on the economy of the world.

In the meantime, all the money-printing is converting bears to bulls.  Yet as Louise Yamada points out, there is no real leadership, unlike 1982, when long-suffering groups such as consumer goods showed real relative strength all throughout the 1981-2 bear market and had long bases from which long advances began when the bear market ended.  In contrast, leaders of one year ago, such as gold and oil, are going nowhere, and the high-quality Dow leaders of 2008, WMT and MCD, have stock charts that are becalmed.

Fitting that theme, a recent report found "millionaires" more confused than ever as to where to put their funds.  Increased interest in investing in both stocks and bonds was reported.  Meanwhile, a recent poll of money managers showed only about 4% bulls on Treasuries.  Louise Yamada has pinpointed about 3.1% on the 10-year Treasury as a recent top in yields, which corresponds exactly to the low yield in the prior cycle (2001-3), and therefore feels it may represent support in price/resistance in yield.  Given that mortgage-backed securities are now a bit rich historically vs. Treasuries, a trade from the former to the latter may be of interest.

Copyright (C) Long Lake LLC 2009