Intermarket Relationships to Declining Bonds
By Michael Hartman, August 1, 2003
The financial markets were all over the board this week. U.S. Treasury instruments continued their brutal sell-off, but this week has been different because stocks are now going down right along with U.S. Treasury Bonds. Right when you think that interest rates should stabilize, they keep heading higher as investors continue dumping bonds. This could continue, as the Treasury is going to borrow more money next week than it ever has for a quarterly refunding. It's beginning to look like the Feds needed interest rates to go higher just so they would have enough buyers next week to sell $60 billion in new Treasury debt.
Treasury bonds have now declined in six out of the last seven weeks for an overall loss of 14%. This week the 30-year bond fell from 109.66 to close at 106.12 forcing the yield to 5.33%, while the 10-year note fell from 113.19 to 110.70 for a yield of 4.41%. According to Steven Berkley, head of fixed-income indexes at Lehman Brothers in New York, "Treasury's haven't had a more dismal month since February 1980, making the month of July the worst performance for U.S. Treasuries since Jimmy Carter and the Iran hostage crisis." The death blow to bonds has caused the rates on 30-year mortgages to go back over 6% for the first time in the last year. This week the average rate on 30-year fixed mortgages has gone from 5.94% to 6.14, according to Freddie Mac. This is clearly the beginning of the end for double digit increases in home prices and equity extraction via refinancing.
Bad Spin on the Economy
The absolute worst spin that Wall Street continues to spew forth is the notion that interest rates are going up because of improving economic conditions. They have to spin it that way, otherwise how can higher rates be justified. The fact of the matter is that the Fed blew a bunch of smoke while they were screaming worries of deflation. The smokescreen of deflation gave the Feds the green light to inflate, inflate, and inflate some more. The bond market took the head fake initially from the Fed back in May and early June, and bought Treasuries only to get the big let down when Alan Greenspan addressed Congress to say that they probably wouldn't need to support the bond market. The selling hasn't stopped since then. Bonds are selling-off due to inflation fears, not because of an improving economy. Would someone please tell me what is better about the economy?
They just came out with second quarter GDP and everyone is waving the banner that the economy is on the mend with GDP growth of 2.4% versus 1.4% last quarter. Remember that last quarter the initial number released was 1.9%, which was later revised to 1.4%. If the second quarter follows suit, it will be revised down to 1.9%. For the last quarter, the biggest part of the 2.4% gain was increased defense spending which accounted for 1.7%. The second largest contributor to growth was consumer spending. The increases in consumer spending came in auto sales due to cheap financing and large rebates, and from cash-out refinancing to purchase just about anything.
Now we have declining auto sales and rising interest rates, not to mention the horrible jobs report today. At first glance we see unemployment dropping from 6.4% to 6.2%, but overall the economy lost more jobs. We have lost jobs here in the U.S. for six out of the last six months. This is supposed to lead to economic recovery? The reason the unemployment rate fell is because people that were looking for work have given up looking. That means they are no longer part of the statistic. They are no longer considered part of the workforce in America because they are discouraged. As far as I'm concerned, the consumer will not be able to buy enough stuff to save the economy. As consumers we have already borrowed too much to buy all the stuff we can no longer fit into our closets and garages. There is a glut of stuff and a glut of corresponding debt.
Our government leaders have sworn that we will have 3.5% GDP growth this quarter. With the horrors in the job market and the consumer choked with debt, how can they be so sure of the growth? I'll tell you how. They know a ballpark figure of how bad the economy is really doing, so they Federal Government just needs to borrow the difference and spend it right into the economy.
Like I said earlier, 1.7% of the 2.4% increase in GDP came from government borrowing and spending on war items. This is the largest increase in military spending since the fall of 1951 during the Korean War. Now-a-days, when we look for similar economic and financial conditions we have to go to the history books. Just remember that back in 1951 we were the biggest creditor nation on earth, while today we are the greatest debtor nation in all of world history, and piling it on at the fastest rate ever!
Bonds Down, Stocks Down
I have posted the charts on the left so we can take a look at the monster decline in bond prices and compare it to the last two times bonds declined rapidly. You can see the highlighted areas around October 2002, March 2003, and Mid-June to present. Notice that when bonds sold-off the last two times, stocks got a nice bounce in excess of 20% each time.
This time around bonds have fallen twice as much. Rather than increasing by 20% as in the last two selloffs, stocks have gone down as well since the last peak in bond prices. The dollar has been moving opposite bond prices, so nothing much has changed in that regard. Note that if the dollar was falling at the same time bonds are melting down, foreigners would be selling dollars in massive quantities and running for the hills.
We are not simply seeing the hot money run back and forth from stocks to bonds and back to stocks. Based on the two commodities (I use that term loosely, because gold is very unique as a commodity item.), it looks like a portion of the bond money is moving from paper assets to physical assets. On the first two counter-trend rallies in the dollar, gold and oil came down more, relative to the dollar strength. In the current dollar rally, which is now above 5%, gold and oil have fallen proportionately much less.
With the current fall in bond prices, the money didn't just run back to stocks. The charts are now telling us that the stock market is ready to head down. Note that the S&P 500 closed today below its 50-day moving average, which doesn't bode well for next week. As the money flows out of stocks, the bond market is looking oversold, so the proceeds from stock sales will probably find its way to shorter-dated Treasuries. Next week we have the big Federal debt sales of 3-year, 5-year and 10-year notes totaling $60 billion.
With bonds oversold and stocks ready to run for safety, the market is being conditioned to purchase Treasury debt. If they can’tsell all the debt, no problem. The Federal Reserve will just have to print up a few extra bills to take the new debt off of the Treasuries hands. I don't mean to be cynical, but this printing-press Fed is no way to fix a broken economy. We need to purge the excesses, not create more of them!
Have a great weekend and may you prosper in all your trades!
|Comparative Relationships to Prior Bond Declines|
|Index||October 2002||March 2003||June-July 2003|
|S & P 500||+20.2%||+25.6%||-1.8%|
© 2003 Michael Hartman