Macro thoughts and the Bond Market ...
Hi Cush. I had gathered some thoughts together on another board, and thought they might be relevant for posting here. Some references to some very good articles ... but in particular the Donald Coxe article, which I have quoted extensively later in this post. Would be most interested to hear any thoughts or comments.
The recent Bond Market Debacle
For those not don't pay close attention to the bond and credit markets, it's been an extraordinary past few weeks (6 to be specific). Have a look at the following 3-year charts:
10-year US T-note yield
stockcharts.com[w,a]daclyiay[df][pb50!b200][vc60][iLa12,26,9!Lp14,3,3]&pref=G
30-year US T-Bond yield
stockcharts.com[w,a]daclyiay[de][pb50!b200][vc60][iLa12,26,9!Lp14,3,3]&pref=G
Zoinks! Did you have a gander at the reversal in the 30-year T-bond! This is the most severe correction in the 30-year long bond at least since 1929 - surpassing the collapse of the long-bond carry trade reversal of 1994.
For some good commentaries on the bond market 'debacle', please see the following links:
321gold.com
(BTW, David Chapman writes a TA article each issue for Investor's Digest of Canada)
... and the following from July 22nd from Morgan Stanley Dean Witter's Chief Global Economist Stephen Roach:
morganstanley.com
(see the top article Global: Losing Control)
morganstanley.com
(see top article Global: Warning shot)
Ahh, what interesting times we live in ...
Intermarket analysis - implication
There is a branch of Technical Analysis called Intermarket Analysis. The father of this black art as a TA discipline (to my knowledge) is John Murphy, who in 1991 wrote Intermarket Technical Analysis : Trading Strategies for the Global Stock, Bond, Commodity and Currency Markets. See the following link on Amazon if interested:
amazon.com
Alternatively, for a brief introduction to Intermarket Analysis, you can listen to the following Puplava interview (titled "The Basics of Intermarket Analysis") of John Murphy at the following link:
financialsense.com
(BTW, this really is a VERY good interview)
Anyway, the point of Intermarket analysis is that movements in equity, bond, currency, and commodity markets are highly interrelated, and that movements in one market often foreshadow correlated movements in the remaining markets.
Bond markets are typically viewed as more sophisticated, for example, than the equity markets. Bonds also form a more "foundational component" of the investing world and financial system compared to their equity brethren (but sit above the currency markets, which are even more foundational). Movement and volatility in the bond market consistently foreshadows behavior in the equity markets. For example, the US bond markets had a significant rupture in the early 1970's, which preceded both the 1973-73 bear market in equities. The 1987 stock market crash was preceded by troubles in the bond markets in the spring of 1987, and with associated currency volatility.
A brilliant Donald Coxe interview
So what will the recent traumas in the U.S. debt markets portend? ... particularly with the bubble in the mortgage-backs (or home mortgage loans), which Donald Coxe of Jones Heward (a subsidiary of BMO) terms "the Achilles heal of the U.S. bond market. Quoting Don Coxe from his client conference call from this past Friday "Our bond desk tells me that the duration of the mortgage component of the Lehman aggregate index - and BTW mortgages our now the biggest component of that index - has gone from 1 1/2 years to 3 1/2 years in a matter of a few trading hours." Don Coxe continues to flesh out the implications of this dramatic bond reversal to mortgage-backs in the remainder of his call - and the effect it will have on foreign holdings of U.S. mortgage bonds.
Actually, Don Coxe's recent ½-hour conference call was one of the most informative and insightful macro interviews I've heard for a long time. For anyone interested, they can listen to his most recent cc at the following link:
jonesheward.com
A few gems of insight from this interview:
- "the great stock and bond bull market that got underway Friday 13th August of 1982 ... may have actually come to its end ... at least the joint activity one (by which he means stock and bond bull).
- "If you take together the real fiscal deficit of Washington - which is adding in the deficit on trust funds (which includes Social Security, the Highway Trust Fund, and the Pension Trust Fund) - then what your looking at is a fiscal deficit of somewhere north of $650 billion (this is fiscal DEFICIT BTW, not debt!), and then you add the current account deficit, then combined what you've got is something like 12% of GDP. Coming back to Stein's Law (whatever that is?!), clearly something has to give."
- "What we have ... is that we may be in a situation of Catch-22: If the US economy does recover, then the problems of the bond market - which was so overextended, and where you had all these hedge funds involved - could be acute ... and we could have the kind of problems we had in the last economic recovery, which was 1994, where Kidder Peabody and David Aspin went bust, and it was the worst year for Treasury bonds since 1927.
"Conversely, if the U.S. economy does not recover, or it limps along at a 2% growth rate, then we've got a situation where the stock market is in serious trouble ... because the stock market is now building in great expectations.
"So what we have then is that the bond market could do to the stock market what it did in 1994, which is behave so badly that even though the economy was strong and corporate earnings were coming back, the stock market went nowhere. And remember, the stock market went nowhere from a much lower P/E ratio than it has today, because it hadn't built in the "new era" thinking, and we didn't have the baby boomers converting their life savings into stocks back then.
"Now the other catch-22 is the global economy. ... last week I spoke about signs we might get a global economic recovery. The indications were that we had, in one week, all 5 base metals going to new highs, all leading base metals stocks breaking out, and then most of them going to new 52-week highs. ... So I took these things as evidence that we might be getting a global pickup, and the surprise will be how strong economies are abroad.
So what’s the catch-22 in all this? The catch-22 is that the US$ right now is performing as strongly as it is because of the continued conviction that to the extent that there is economic growth it is occurring in the U.S. and nowhere else. So if we do get a pickup in Germany & Japan & France & Korea … then what we’d have is reasons for people not to invest in the US, with all the problems that the US$ has based on its twin deficits, the over-indebted consumer, total level of debt in the economy, etc.
“I truly believe we may be at a “major turning point” …
The China Factor
To continue with the Coxe interview … his thoughts on China:
“Now, another interesting development is the question of what China is going to do. What we’ve had is a situation where Secretary Snow came out saying China had definitely to do something about floating the Renminbi. … and what we’ve been getting is open cacophony on the subject of unfair Chinese trade behavior.
“Well, let me say this … As far as the Bushies are concerned, yes, there’s no question that the Chinese are manipulating trade by holding down their currency, but China, Japan, Taiwan, and Korea together are financing over ½ of the U.S. fiscal deficit by buying treasuries.
So I wonder if whether the sudden breakdown – the day that was one of the worst days for mortgage-backs and treasuries since 1994 – might have been a day in which the Chinese, instead of adding to their Treasuries, actually sold some … and word was passed along quietly saying “don’t push us too hard” … in which case backroom conversations are something like “we (the U.S.) will continue – because we have an election coming up – to make noises about this, but we won’t bring the case to the WTO. In other words, we’re going to do nothing serious about it … we’ll confine our trade mechanisms to the Canadians and Europeans – which have been so notably unhelpful to us – whereas you are being helpful, by buying our paper which is grossly overvalued.”
“But there’s no question if the Chinese were forced to float the renminbi, what you’d want to own is gold, and you wouldn’t want to hold long-term bonds … because the effect would be enormous … if they (the Chinese) actually started to sell (U.S. long-term bonds).
“We’re at a situation, according to JP Morgan, at year-end East Asia will own 70% of the world’s exchange reserves. 70%! This is absolutely amazing! When you think of the rest of the advanced industrial world, there’s not a single other advanced industrial country in that make-up.
“So the potential clout you (i.e. China) have, if you (a) even stop adding to your Exchange reserves, what that’s going to do to the U.S. bond market – because we (i.e. the U.S.) still don’t have the domestic savings to support it.
In Summary
I continue to look for financial market, and corresponding economic, performance that has a trajectory much like that argued by Didier Sornette as discussed below:
ess.ucla.edu
Sornette very accurately forecasted the recent “echo bubble” that comprised the bear market rally since mid-October of 2002. If this really is a K-wave type bust, now is where the interesting fireworks begin.
Any thoughts on the above analysis? Supporting opinions? Contrary?
Regards,
Glenn |
