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Strategies & Market Trends : Stock Attack II - A Complete Analysis -- Ignore unavailable to you. Want to Upgrade?

To: Trading Machine who wrote (17343)	8/31/2001 9:52:17 AM
From: isopatch	Read Replies (1) \| Respond to of 52237

Here's the latest commentary from Steven Roach. He's one of just a handful of W.S. people I find worth reading. The rest have been on permanent ignore for a long time. Hey I can make mistakes all by myself. I don't need any help!<ggg> Iso "Global: Listening to Markets Stephen Roach (New York) They don’t always get it right. But financial markets can’t be faulted for trying. And they certainly have a better record than most economists and policy makers I know. The collective wisdom of investors is something to be taken very seriously. For economists, it provides a valuable check on the validity -- or lack thereof -- of any macro scenario. For investors, consensus expectations tell you what to bet against when you have a strong out-of-consensus opinion. From either point of view, it pays to know what’s in the markets. In that spirit, there’s no mistaking the increasingly grim message of financial markets these days. The markets are now in the process of pricing in the US-led global recession we have long been forecasting. Stocks are getting battered once again because of earnings risk. Bonds are rallying on the belief that inflationary pressures will recede further. And the dollar has finally softened, as global investors have started to question the once seemingly unique attributes of America’s New Economy hegemony. Suddenly, financial markets are giving serious consideration to the possibility that there may be another shoe to fall in this economic downturn. I find the message from the US bond market particularly intriguing these days. By the end of August, the yield on the 10-year Treasury had fallen to 4.8%, down close to 100 bp from that prevailing a year ago. In order to understand the message from this improvement, it is important to decompose shifts in the nominal yield into those that can be attributed to its real interest rate and inflationary expectations components. On that basis, there can be no mistaking the driving force behind the rally at the long end of the curve over the past year: The bulk of movement can be traced to a rally in real interest rates, whereas a relatively small improvement in the longer-term inflation outlook accounts for the balance. For example, the yield on the 10-year Treasury Inflation-Protected Security (TIPS) -- in my view, the best, and only, market-based proxy for real long-term interest rates -- has come down from about 4.0% a year ago to 3.3% today. That’s enough to account for fully 70% of the cumulative reduction in nominal long-term interest rates over that same period. At 3.3%, yields on 10-year TIPS are now at record lows since their inception back on 1 January 1997. Moreover, these yields are also about 20 bp below those that were hit in the depths of the Asian crisis back in 1998. TIPS-based real interest rates are a gauge of the balance between supply and demand in risk-free capital markets. Make no mistake, the sharp recent reduction in long-term real interest rates in the United States is a classic bet against a vigorous recovery. The move in the inflationary premium at the long end of the Treasury yield curve is far less dramatic than the shift in real interest rates. Over the past year, the TIPS-based inflationary premium -- calculated as the difference between the nominal yield on the 10-year Treasury and the TIPS real interest rate equivalent -- has fallen from 1.8% to 1.5%.. That is at the lower bound of a 1.5% to 2.25% trading range that has generally prevailed over the past two-and-a-half years. But it stops well short of the brief plunge to about 60 bp that occurred in the depths of the Asian crisis, when the world was widely perceived to be on the cusp of a deflationary free fall. By contrast, four months ago, the long end of the Treasury market actually moved aggressively to price in an "inflation scare" -- a scenario traceable to the confluence of rising energy prices, mounting labor cost pressures, and aggressive monetary easing. That was sufficient to take the nominal yield on the 10-year Treasury back up to about 5.5%. Those fears turned out to be short-lived. As they ebbed in the face of an ever-deepening global recession, the nominal 10-year bond rallied almost solely on the basis of a downward ratcheting of the TIPS-based inflationary premium. The subsequent 75 bp reduction in the 10-year yield was almost exclusively attributable to a backing down from last spring's inflation scare. Going forward, I think that there is more of a chance that the 10-year Treasury rallies because of a reduced inflationary premium than a further reduction in real interest rates. The rapidly vanishing budget deficit could alter expectations on the supply side of Treasury markets, as government financing requirements become more of an issue in the minds of investors. That would tend to constrain any major shifts in real long-term interest rates. At the same time, a lingering near-recessionary dynamic for the global economy -- precisely the outcome of our U-shaped baseline scenario of 2.8% average world GDP growth over 2001-02 -- points to the possibility that there could be further reductions in the inflationary premium that is embedded at the long end of the Treasury yield curve. Whatever the outcome, there can be no mistaking the message from the US bond market: Long-term real interest rates appear to be at their cycle lows, pretty much in sync with a US economy that remains on the cusp of recession. And with the inflationary premium currently at the low end of its recent experience, the bond market seems to be comfortable with the notion that inflation will remain relatively stable to slightly lower over the next several years. In many respects, it’s the ultimate soft landing -- a stagnant economy with minimal inflation risk. But therein lies considerable risk. Just as financial markets embraced the glorious saga of an open-ended New Economy boom, they have now moved to embrace an equally improbable soft landing. That may simply be asking for too much from an ever-precarious post-bubble US economy. I suspect that something big has still got to give."