Treasury Yield Dive Signals "Barbell" Market

Treasuries are rising as yields plummet. This is leading to a barbell market: gold-and-Treasuries, and is bad news for investment in venture capital and private business. It may presage the next phase of the crisis, just as Bernanke is declaring victory.

This chart is from tonight's STU, which commented: "Short term yields were plunging last fall, even briefly turning negative last December, as investors clamored for “safety” in the wake of the vortex of selling pressure throughout the stock market. But that’s not what is occurring now in stocks, as prices persistently rise in Primary wave 2 (circle), the big bear-market bounce. We are not exactly sure why short-term government paper is plunging (yields), but it does bear watching since a slew of investors (or an investor with “big money”), for whatever reason, want to be safe and liquid."

One possible explanation is the big Treasury buyers (China, Japan) swapping out of long-term to short-term notes, driving down yields. This reflects a heightened fear of a US Peso meltdown, which is still underway. The Dollar Index keeps breaking below supposed support levels, with DX74.50 the next stop before testing the all-time lows around DX71 from last year. The STU notes that we need a bounce back above DX78.70 to confirm a rally.  

David Malpass thinks he knows the odd market dynamic that is developing: a barbell market where investors are hedging against both deflation and inflation by investing at both extremes (eg Treasuries and gold) - a barbell trade to coin a new term.  (If you are not familiar with David Malpass, he was a long-tome economist at Bear Stearns and former senior official at Treasury. He is one of the most astute commentators on the big picture.)  He explains:

We think the Fed is in a box of its own making. By denying the connection between dollar weakness and inflation (Chicago Fed President Charles Evans didn’t mention the dollar in his detailed September 9 speech on inflation), the Fed undermines its credibility. This allows market momentum to create dollar weakness to test the Fed’s limits. The euro at $1.60, $1.80, or $2.00 would probably mean oil at $100 or $120 per barrel, quickly pushing CPI inflation above 2008’s 5.6% rate.

By giving no confidence in the dollar, the Fed is inviting a circular dollar crash. The weakening dollar pushes capital away from the U.S. The resulting economic weakness invites the Fed to keep interest rates low, bringing more dollar weakness and U.S. underperformance.

My perspective is that the crisis is now entering a new phase. The first phase was back in 2001-2, where Greenspan was so worried over deflation he reflated the economy by lowering rates and holding them down too long. He specifically was trying to hold off a Kondratieff Winter (his words). In doing so he created what I call the Greenspan Indian Summer, a false period that led to an even bigger and worse type of bubble. Technology bubbles like 1995-2000, or the auto bubble in 1915-1919, or the two RR bubbles in 1873 and 1893, are primarily investment bubbles, leave behind an asset of great value (RRs, roads, internet) that provides a foundation for future growth. Credit bubbles like Greenspan created and like we had in 1925-29 or 1830-35, are primarily consumption bubbles, and simply pull demand forward from the future without creating a foundation to pay off the excess debt. It must be written off, and that creates a terrible deflation and depression. The Greenspan Indian Summer doubled US Dollar debt from $25T to over $50T in five years, and yet only bought us a cumulative $10T increase in GDP, leaving a $15T or higher debt overhang that must be repaid or written off.

The second phase of the crisis we just lived through. Bernanke applied the Bagehot Remedy (named after Walter Bagehot, the editor-in-chief of the Economist, who proposed it in 1873 at the beginning of what was soon to be called the first Great Depression) by providing liquidity to avoid runs on banks. It worked to stabilize the situation, whereas TARP did not nor was it used for the purposes intended. Despite the stabilization, governments around the world coordinated an historically unprecedented stimulus. (Japan had stimulated excessively after 1989, incurring eventually $6T of additional debt and pushing debt:GDP to well above 100%, to little avail except to put the economy on life support; but this was not a worldwide effort.) 

This stimulus must be expected to have an impact, and a consequence. The impact appears to be a rise in GDP that showed positive in a few places last quarter and should show positive in the US this quarter (Q3). I expect Q4 to be up as well, and maybe Q1, but doubt it sustains any longer. 

The consequence of the stimulus leads to the third phase of the crisis. Equities are meandering up, and the little guy (the retail day trader) is jumping in strongly right now. This might continue well above Dow10K and SP1100. But the massive stimulus is fundamentally being sold as "something for nothing": the debt incurred will be made up by a revitalized economy. History teaches that one can delay the inevitable consequences of a credit bubble, but cannot avoid them; and the delay just makes the inevitable much worse. We already see that with how the Greenspan Bubble was much worse than the prior Tech Bubble. 

So the powers-that-be are conducting a huge experiment with history, and we are the petri dish. The first experiment by Greenspan failed, and now they are doubling down. 

The consequence of the Stimulus is the drop in the Dollar. At some point it must be supported or the world economy will spiral out of control, and those positive quarters will begin to evaporate. Simply put, commodities go way up again, oil gets expensive, and financing the huge future US deficits gets even more problematic. 

The barbell trade described by David Malpass - swap into short term Treasuries at one end and gold/commodities at the other - is terrible for the US, whose economy will be squeezed from both ends. Capital flows to the wrong places (government debt and commodities) and away from investment in the future. Already we see that the stimulus has NOT helped private investment or consumption: consumer credit is falling, private investment is falling.    

The next shoe to drop is probably raises in foreign interest rates, putting even more pressure on the USD and the financing of the US deficits. It does not help the US to finance with short term Treasuries (two years or less) as they are likely to roll over at much higher interest rates.  

Comments

[lupani]

Wavist, i'm much obliged by your post below.It clears things up.

[tomas]

oh my!!!
i am going to nominate you for ecomomy nobel price!
how can the world live without your point of view?
because you brake all of the econometric rules i know, so if you have an econometry degree, which is sure you have, you must be genius!!!

Stupid! do you know what a higher dollar means?
do you know that all of hedge fund that went bear last year are turning their poositions for a burst of inflation? do you know what is monetary police? and please read again what bahegot said. What ben is using is the austrian liquidity cycle trying to take stocks and inflation to an all times high

ps. what am i doing here reading this ignorant?

[rc]

Excellent article Yelnick. So the question remains: inflation or deflation. I follow Prechter and hope he's not wrong about a forthcoming bust for gold and commodities, and turn for the dollar. (Even if he is, he still provides insightful and valuable analysis, as you do also.)

[min]

You do well to hope and to keep one eye open in regards to Prechter. I guess you are a cautious follower which is good.

Prechter "Insightful" — I suppose?
Prechter relevant to better trading —definitely not save for those with 100 year time frames

Commodity correction coming up —yes
"Bust" —no, sorry.

[Neely the Guru]

Neely is like an empty Can in an ocean of waves. Flip flopping from extreme to extreme in less than couple months. From Financial media to be shut down, and Gold to go bear for 5 years, and then only to discover the low has already been hit in March 09 for the next 50 years.

Talk Logic Rules and Scientific way. He spends more time bashing Orthodox EWavers only to prove he is a bigger fool. Now when his crew hear that, they start talking about how good their trading skills are.

[William]

Yelnik: Excellent article. Very well written. As a learning investor, the clarity and preciseness is appreciated.

[Rich]

Prechter cannot be wrong because he uses strictly applied Elliott rules, which determine social progress and market moves. If he appears wrong it is because you do not realize that Elliott is a probabilistic science. So whoever wrote "If Prechter is wrong about gold..." is either an ignoramus or a jokester.

Prechter has elaborated the immutable truths of Ralph Elliott but he cannot change them nor deny their immortal veracity. It behooves those of you safely nestled in your comfortable perches to study Prechter and avail yourself of his knowledge. I commend Yelnick for providing links to the Free Weeks but I would warn you that a free week here or there will not be enough to keep you and your family from financial and socionomic ruin if you do not pony up and subscribe regularly.

The 3 of III of iii of PRIMARY THREE of GrAND SUPERCYCLE THREE will make the Dark Ages look like a stroll down a sunny lane!

[Mamma Boom Boom]

You should seriously consider this analogy: http://www.bushongbusiness.com/webbbs/index.cgi?noframes;read=18251

It's certainly a strong contender.

[DG]

Neely the Guru,

Neely spends very little time bashing other wavers. He points out what he thinks are gaps in their methods. Do you know of any other way to debate?

Anyway, I'm not defending his announcement yesterday because I think it was unnecessary at this point in time. I already sent him my thoughts on the potential new count and he responded. That's what normal adults do when they have disagreements.

Unless you believe that the markets are completely deterministic, there is no way to avoid uncertainty at times, especially in the middle of a large Corrective structure.

You may not want to hear it, but Neely has done a pretty good job of trading this market over the past year, public announcements or no public announcements. If you were a buy and hold investor over the past 52 weeks, you are underwater year-over-year. If you followed Neely's trading advice, you are up. Period. If you can't acknowledge that because of some personal animosity toward him, that's your own issue.

[LDA]

A few weeks back I asked a question here with regard to the S&P 500 cash chart and I'll ask it again...Does anyone else think that it looks like a head & shoulders bottom on the daily S&P and doesn't that tie in with Elliot Wave bottoming price action?

[P.W.B.]

Hey Rich -

A 3 of 3 of 3 of 3 of 3 is BY DEFINITION an impulsive move. You're basically talking about (almost) the biggest and fastest growth allowed by Elliott rules.

Maybe you meant 3 of 3 of 3 of 3 of C...

Or maybe you don't know what you're talking about...

[yelnick]

tomas, the whole point of the barbell is to prepare for either deflation or inflation, meaning the market is uncertain as to which. Sure, some hedge funds are betting on inflation, but the trend is now towards both extremes, meaning the market is at the edge of chaos and is seeking order, but does not know which way. This is typical behavior when we near a trend change.

I think Bernanke would be amused to be called an Austrian. The charts showing a huge increase in money supply are misleading in that the banks aren't increasing lending plus velocity is dropping, meaning there is little inflationary pressure - in fact we have been deflating for over a year as debt gets written off. There comes a point where the Fed cannot reflate, and we may have hit that point. We also hit it in the '30s.

The Fed has tried direct intervention, Quantitative Easing (QE) to direct buy Treasuries and Agency Paper and put cash into the seller's bank accounts. This is one way to print money, but - I have written here previously how QE is really Bernanke's way to repair the balance sheet of the Fed, since last year he swapped quality reserves for bank junk in order to improve bank solvency (a very good thing to have done), and is now swapping back slowly.

If you feel up to a substantive response, feel free to come back and comment. Before you do, you might review Taylor's op-ed in the WSJ today about how the Stimulus has failed. The economy is not behaving as either Keynesians or Monetarists expected. Maybe Bernanke will become a latter-day Austrian, but he would never admit it.

[Hank Wernicki]

forget the head and shoulders ... it's a wife's tale !

[Iris]

As a wife, and one highly versed in technical analysis, including Elliott Wave (which has the predictive value of a fair coin), I take exception to Hank Wernicki's comment. "Head and shoulders" is about the only formation that correlates positively with market drops. It's an extremely valuable tool. But not quite as valuable as a loving, loyal, brainy, beautiful wife!

By the way, Don Prechter's service is a real bargain at only thirty bucks a month or so. If you want to survive the imminent 3 of THREE of 'three' of "THREE" of TTHHRREE!!! of III of iii of (iii) catastrophic tidal wave/black plague/nuclear armageddon, you will need it.

You have been warned!

[elliott is d bomb ya]

yeah i love me some elliott wave precther shi*t

and that sociolomics is de BOMB!

gonna survive me the CREST of the crash Wave III, dudes!

Joe Wilson's incivility was predicted beautifully by the superb work done by Roger Prechter (Yale grad! Dude is SMART!) at his prestigious Sonionomic Society Elliott Institue for Advanced Doctoral Training in Rigors of Scientific Socionomics.

Make me some MONEY!

[yelnick]

Iris, I would take a brainy wife over any newsletter or TA pattern any day! Mine has saved me from all sorts of trouble.

A H&S pattern is a stock distribution formation, similar to the end of many ewave patterns (from end of 3 to start of C or 3 down, the 4-5-1-2 look like a H&S at times). It indicates rotation out of positions and can signal a change of trend. My understanding is it is at best 50% predictive, which means it should not be used by itself but in conjunction with other indicators.

[yelnick]

Ned, check out Yves comment at Zerohedge today, tying USD and 1987 together with current market: http://www.zerohedge.com/article/problem-competing-views…

I asked if he wanted to expand in a guestpost here. Or would you like to?

[DG The King of Dimwits]

DG, see if you can get this through your thick and biased head: Most people are NOT TRADERS! Most people WORK FOR A LIVING and have always used the Buy & Hold out of necessity, either through direct account management or a fund or a retirement account.

THEY ARE NOT TRADERS, DIMWIT!

What has DESTROYED any semblance of a market and turned it into a complete raging casino are the DAMN TRADERS! This includes every DAMN DAY-TRADER and Wall Street trading floor.

So the hell with your NeoWave guru and his RIGHT FOR ONE YEAR.

I don't trade or invest in stocks, but I do like watching the CROOKED MARKETS.

One man who has been very (not 100%) accurate with what appears to be a GOOD COUNT, since the markets appear to be following it, is Dr. McHugh. I have been following him for a couple of years and HIS INDICATORS ARE DAMN GOOD!

[Mamma Boom Boom]

Yelnick, let him. I'm not windy enough to write the piece, nor do I recollect enough details to be accurate. Too long ago.

But I do remember the rubber band of overbought being stretched and stretched and stretched!

[Mamma Boom Boom]

DG The King of Dimwits,

I brought up the same thing to him, although slightly more tactfully, many months ago. That's why I've always divided my Market Opinion into 3 time frames. If I ever go Pro, I'll sell it that way, too.

[DG]

DG, see if you can get this through your thick and biased head: Most people are NOT TRADERS! Most people WORK FOR A LIVING and have always used the Buy & Hold out of necessity, either through direct account management or a fund or a retirement account.

There's a Neely subscriber who posts here who's been managing an IRA account quite successfully over the past year using Neely's recommendations. So, it can be done, if a person take an active role.

Oh, and I'm a "dimwit"? You're on a site where, as a guess, I'd say 90% of the posts refer to short to intermediate term trading, and you complain about me posting someone's short to intermediate term trading track record?

One man who has been very (not 100%) accurate with what appears to be a GOOD COUNT, since the markets appear to be following it, is Dr. McHugh. I have been following him for a couple of years and HIS INDICATORS ARE DAMN GOOD!

The McHugh listed at the bottom of this "guru" guide?

http://cxoadvisory.com/gurus/

Yeah, it's a "dormant" review, but 36% accuracy? Come on, man, that's not "DAMN GOOD" that's "DAMN CRAPPY". You got one thing right, he's not "100% accurate".

Thanks for the laughs.

[Eventhorizon]

Ned,

"That's why I've always divided my Market Opinion into 3 time frames. If I ever go Pro, I'll sell it that way, too."

So you would do it the way Neely does?

What will you be looking for to identify that the elasic band has snapped?

[Mamma Boom Boom]

>>So you would do it the way Neely does?<<

I don't know, I've never seen one of his letters.

-----------------------

>>What will you be looking for to identify that the elasic band has snapped?<<

That's not easy, it's why it catches everyone off guard. But when my indicators go into negative territory (not just neutral) I will act.

[DG The King of Dimwits]

DG: "The McHugh listed at the bottom of this "guru" guide?"

Source: SafeHaven?????

BWhahahahahahah!

They judge him from old missives that he USED to publish about four times a year, and then with very little data and scope.

Gee! Maybe they should try actually READING his Daily/Weekend Reports in all their detail. Maybe track him using REAL REPORTS and over an EXTENDED period of time.

No! Thank YOU for the good laugh!

BWhahahahahahahahah!

[DG]

They judge him from old missives that he USED to publish about four times a year, and then with very little data and scope.

Gee! Maybe they should try actually READING his Daily/Weekend Reports in all their detail. Maybe track him using REAL REPORTS and over an EXTENDED period of time.

No! Thank YOU for the good laugh!

BWhahahahahahahahah!

First off, the site isn't affiliated with "Safe Haven", and even if it was, that's called an "ad hominem" attack and is the first logical fallacy one learns in a logic class. Hint for you, a "fallacy" is something that isn't a valid argument.

Secondly, they were "grading" the gurus on their directional market calls, not the down and dirty details of those calls. So, unless McHugh was saying the market was going in one direction in his publicly available information and saying the opposite in the Daily/Weekend reports (which would be odd, no, since presumably the publicly available information was designed to solicit subscribers, so why would he not want to put his best prognostications in there, to persuade people to pony up for the subscriber detail?), their "grade" is reflective of exactly what he was saying the market would do.

64% of the time, the market, apparently, did the opposite.

Still laughing?

[David]

You know the irony of all this?

Q. What sector would get killed in BOTH the inflation and deflation scenarios outlined?
A. Banks.

Q. What was the perceived purpose of all the FED actions from TAF, to TARP ect?
A. Help the banks.

Q. What does it all mean?
A. If you ever hear someone say, "We're from the government and we're hear to help", RUN FOR YOUR LIFE!