What a day. What a week. What a month.
Much as happened recently to distract the bond market from it's core strategic motivations. I think we need to hit the reset button and re-evaluate the environment. This post revisits economic fundamentals and questions whether or not they've been drowned out by headline news noise
What is moving the bond market at the moment?
5. TERRORISM: The individual who attempted to detonate a bomb in Times Square, NYC (whose name I refuse to give attention) was said to be talking to authorities so much yesterday that he was unable to appear in court to be properly processed. Investigators wanted to get as many leads as possible out of him while he was willing to share. READ MORE
This sort of stuff---terrorism---spooks me, but what can you do? Seems like all you can do is hope it doesn't happen again. Shifting your long-term trade strategy to protect you from an unexpected "outlier" event (especially in times of heightened alarm levels) makes me feel like the terrorists are getting what they wanted most: an indirect assault on the world's financial superpower. (my own 9/11 conspiracy theory).
This is a non-factor for professional traders.
4. SECOND TIER JOBS DATA: Nonfarm payrolls print on Friday morning at 0830. The release of the Challenger Planned Layoff Report and the ADP National Employment Report provide a peak at the labor market before the official data hits.
FROM THE RELEASE: Nonfarm private employment increased 32,000 from March to April 2010 on a seasonally adjusted basis, according to the ADP National Employment Report®. The estimated change in employment from February to March 2010 was revised up, from a decline of 23,000 to an increase of 19,000.
In addition, the revised estimate of the monthly change in employment from January to February 2010 shows a modest increase of 3,000. Thus, employment has increased for three straight months, albeit only modestly. The slow pace of improvement from February through April is consistent with the pause in the decline of initial unemployment claims that occurred during the winter months.
FROM THE RELEASE: JOB CUTS FALL 43% TO NEAR FOUR-YEAR LOW OF 38,326
After a 61 percent increase in March, the number of planned job cuts announced by American employers fell sharply in April to 38,326, 43 percent fewer than the 67,611 layoffs the previous month.
The April job-cut figure is the lowest since July 2006 (37,178) and comes just two months after the previous low of 42,090 in February. It showed that April job cuts were 71 percent lower than the same month a year ago, when employers announced 132,590 planned layoffs.
Plain and Simple: Job creation may not be burning hot but layoffs are subsiding and payrolls are slowly growing (yes government hiring is playing a part in that). The growing concern is what we do with the poor mopes who have been out of work for +26 weeks and aren't seeing any demand for their skills thanks to advances in productivity and investments in technology. Consensus for the Employment Situation Report on Friday morning is +200k to payrolls and an unchanged unemployment rate of 9.7%. If data confirms the labor market is gaining traction...it would put another check in the "The Fed is Going to Raise Rates Eventually" column of our scorecard.
3. Contagion of Contagion+Shift in Currency Valuations+ Rising Short Term Borrowing Costs Abroad +Technical Retrace in Stocks = HUGE FLIGHT TO SAFETY INTO DOLLAR DENOMINATED ASSETS
Greek riots cost three people their lives when visible anger evolved into physical action today. Reuters says, "Tens of thousands of Greeks took to the streets of the capital and masked youths clashed with police in riot gear, who responded with steady rounds of tear gas and flash bombs which clouded the blocks surrounding parliament." This sort of terrorism isn't helping the situation, but clearly the good people of Greece feel unjustly treated.
The latest development on the fiscal side of the story is the ECB has suspended the minimum credit rating threshold on collateral needed to borrow money from the ECB. This allows Greece to leverage their assets to borrow the central bank funds to cover their short term deficits since conventional money markets have closed their windows to the outstretched hands of the Greek. The IMF liked this idea. READ MORE
Unfortunately, Moody's put Portugal on Review for Downgrade today. This is not good for contagion of contagion. READ MORE
This event happens to coincide near a perfect technical pivot point for stocks. I have to be honest. I tried to pick a top in stocks in July, and then August...I failed both times. Fool me once, shame on you. Fool me twice shame on me. After the second time I finally gave in to the idea that the worst case really had been avoided and stocks were gonna keep rallying until the "worst case" discount was erased. That level, between 1200 and 1300, has been hit. The S&P traded higher for 8 consecutive weeks...all the way through 1200. This essentially erased the majority of the October 2008 to March 2009 "worst case scenario" sell off.
Seems like a great time to consolidate and re-visit strategic (buy and hold) plays.
The main goal in times of heightened headline risk is: PRESERVE PRINCIPAL
This resulted in a global flight to safety into dollar denominated Treasuries...and slowly falling mortgage rates. (WIDER YIELD SPREADS)
We have warned of falling victim to floating through knee jerk reactions in the marketplace (rallies made of glass), but this flight to safety seems like it has more legs to it. The devaluation of a major currency is a fundamental motivation to tactically reposition or reconsider directional bias. Eurodollars get more expensive and short term funding costs rise for overseas bankers: LIBOR MOVES HIGHER
Not good for index + margin ARM borrowers or anyone in a forward contract. Rising LIBOR rates increase the cost of short term funding for bond investors in the money market. Below is a table of LIBOR funding rates and how much they have changed since March 1, 2010.
Plain and Simple: Headline news risk has snowballed to the point where investors are too nervous to do anything besides protect, protect, protect. The contagion has evolved and now has a life of its own. The best way to solve this problem is the IMF and ECB act swiftly and aggressively. Its like trying to defeat a swarm of blood thirsty bees....overkill is necessary or you will end up making the hive (market) even more angry at you.
On that note, I need to put my finger in a few eyes.....This is what can happen if policy makers are not quick and effective in their approach to cleaning up "sovereign headline news". Ben Bernanke did the exact opposite and now we're talking about +200k on a jobs report. All along the way, each time contagion has attempted to grip in U.S., both the Treasury and the Fed have acted swiftly and efficiently to disburse the angry mobs.
This biggest battle we will fight in the future: OUR OWN CONFIDENCE
2. WHAT ABOUT DOMESTIC MACROECONOMIC FUNDAMENTALS??? I suppose its time to show you my econ screener.
GREEN vs. Expectations means the actual data beat consensus economist forecasts. RED means it didn't beat. Same concept applies in the "vs. Prior" column.
Since Retail Sales data was released on April 14...54.35% of econ releases have beat expectations while 58.70% have beat the previous reporting period.
Plain and Simple: The BIG PICTURE economic recovery will be inconsistently slow at times, but we will continue to improve in the long haul. A big test is coming in the months ahead though. Housing must maintain momentum to allow banks to wash themselves clean of "bad mortgage assets". Jobs Jobs Jobs. Smarter Mortgage Underwriting Regs. Targeted LLPA adjustments. All things that would add size to the stabilization of the housing market. READ MORE
1. THE NUMBER ONE ISSUE FOR THE BOND MARKET: Supply Supply Supply
We have a lot of debt as a country, our budget deficit is massive. To fund short term spending, Treasury raises money in the bond market by selling their debt. To compensate for lending us their cash, Treasury pays interest to investors on the loan they offered us. If buyers lose confidence in our ability to repay our long term debts, they would require a higher return to lend the Treasury money. This would increase the budget deficit and the need to raise more money and possibly lead to a downward spiral. (This happened to Greece)
It says a lot about a country's when they are able to reduce the amount of money they borrow from the public to pay for government spending. We learned this week that our government will need to borrow much less from the public in Q3 2010.
From the May 2010 Quarterly Refunding Statement:
The U.S. Department of the Treasury is offering $78 billion of Treasury securities to refund approximately $30.9 billion of privately held securities maturing on May 15, 2010. This will raise approximately $47.1 billion. The securities are:
- A 3-year note in the amount of $38 billion, maturing May 15, 2013; The 3-year note will be auctioned on a yield basis at 1:00 p.m. EDT on Tuesday, May 11, 2010
- A 10-year note in the amount of $24 billion, maturing May 15, 2020; The 10-year note will be auctioned on a yield basis at 1:00 p.m. EDT on Wednesday, May 12, 2010
- A 30-year bond in the amount of $16 billion, maturing May 15, 2040. The 30-year bond will be auctioned on a yield basis at 1:00 p.m. EDT on Thursday, May 13, 2010
All of these auctions will settle on Monday, May 17, 2010.
Treasury cut the 3 year note refunding from $40 billion to $38 billion. The 10 year note refunding is $1 billion less than the previous one and the long bond offering was the same.
THIS IS LESS SUPPLY, SOONER THAN EXPECTED. Nothing but good! Less supply will help firm demand for our debt . I see this as a net positive for stocks too. It keeps inflation hawks at bay and bolsters confidence in our ability to repay long term debt. The U.S. is still the world's financial superpower. Invest in the U.S!!!
My point: Our judgment has been greatly clouded by unexpected events. While these outliers are now significant issue, I am confident in the US's ability to innovate and produce profit. The Crisis of Confidence will eventually abate and the headline news risk discount that is currently priced into the market will go away with it (flight to safety). This may not happen in the next day or even in the next two days...but it will happen. We are no longer searching for a bottom, the worst case scenario has been avoided and their is opportunity to invest in the long run recovery of the United States. I think we look back on this one day and say "Wow, I wish I could have bought some stock in XYZ company. It was so cheap back in 2010".
