There's an old adage: When bond prices go up, stock prices go down, and vice versa. Over the past three months, Treasury bond yields have taken a big hit (bond prices and bond yields move in the opposite direction). The benchmark 10-year bond yield dropped from 4.01% in April to its present 2.79%. David Rosenberg of Gluskin Sheff has researched bond yields and their corresponding effect on the stock market. According to an article on CNBC.com, Rosenberg found that if yields fall more than 1.20%, a bear market in stocks is just a couple of months away. He cites the bear markets of 1990, 2000 and 2007 as examples.
He may be right. On Tuesday, the Federal Reserve has indicated renewed quantitative easing. The Fed will reinvest the proceeds from maturing mortgage backed securities, bonds and notes and buy more securities. Buying Treasury securities is the Fed's way of keeping interest rates low. In turn, the Fed hopes low interest rates would spur the economy and avert deflation. The Fed is a bit more than nervous about the economy if it is reverting to stimulus.
The fact that the Dow sold off following the Fed news is not good. The Dow was down 54.50 points to close at 10,644. Usually, days with Fed announcements are good days for the market. But not only stocks decline, commodities also sold off with oil and grain prices down -- all deflationary moves.
No one really knows where the market is headed. Nevertheless, it's wise to pay attention to the bond market and to bond yields. It's also a good idea to follow the money flows. In the recent reporting week, equity funds saw outflows of $688 million, while bond funds increased by $2.1 billion.
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Reader Comments (Page 1 of 1)
8-11-2010 @ 8:09PM
sfamilyent said...
Major investment managers are taking the safer play of reducing cash positions, increasing bond positions and avoiding the uncertainty of the equity market. When there are clear signs of economic growth, they will change their play. Do not forget that this is a midterm election year and that things can change significantly after November.
8-12-2010 @ 1:43PM
John said...
Yesterday, the Fed announced plans for "QE2" – Quantitative Easing, the sequel. It'll be using the principal payments from its mortgage-backed securities to buy Treasury Bonds.
In other words, the Fed will be both selling and buying T-Bonds.
In more words... the fed will be monetizing debt.
This is a big, BIG deal. The market seemed to ignore the potential effects on Tuesday. But it looked like investors finally got the picture yesterday, when the market spent most of the trading session down more than 2%.
It's a big deal because the Fed is basically using its Visa card to make its MasterCard payment. Yes, it's a relatively small amount. But healthy entities don't do that. And it's a slippery slope.
Think about Argentina in 2000.
Think... liquidity crisis.
Of course, it's a big leap to go from a small amount of debt monetization to a complete financial meltdown. After all, one small child throwing a pebble into the ocean isn't going to create a tidal wave. But in the current economic and psychological environment, small moves have big ramifications.
Everyone knows the U.S. will never be able to pay off its massive debt load. Yet, everyone keeps piling into Treasury bonds at record-low interest rates. We all know it's a Ponzi scheme, but we all keep playing the game.
The only way to survive a Ponzi scheme breakdown is to get out at the first sign of trouble.
Debt monetization – even just a small amount of it – is a sign of trouble.
In a liquidity crisis, everything gets sold. Stocks go down. Bonds go down. Even precious metals get hit.
Cash – in the form of U.S. dollars – is the only thing that holds up. That may seem counterintuitive. After all, if the Fed is essentially printing money to buy its own debt, the value of a dollar should fall. But in times of crisis, everyone rushes to own dollars. The demand for dollars more than makes up for the increased supply.