The Flight to Bonds Continues Amidst Deteriorating Economic Forecasts

Bond yields are approaching the historic lows of 2009 during the flight to quality. The rapid drop in the 10 yr in the absence of the 2008 banking crisis is truly historic. Since the April high in stocks all the mid-term Treasuries have raced down in yields (chart from EWTrends):

We may be approaching the end of a 30 year bond bull market, from the highs of 1980s to the potential lows of 2010. This chart from SeekingAlpha shows the trend:

The author raises the caution flag that a protectionist movement may be near. Seems a bit alarmist, but the Chinese currency, which began its float again to great fanfare, has now dropped for five straight days and is lower than it was then!  Congress is now, once again, raising the spectre of retaliation. 

A more prosaic explanation for the rush to bonds is a rise in fear, fear not of another banking crisis but of an economy rolling over again, this time (the fear story goes) with no weapons left to restart it. 

GDP forecasts are being slashed. Goldman joins JP Morgan and Deutsche bank in lowering the coming Q2 revision to the low 1% range, and increasing double-dip odds to 25-30%. Looking forward, ZH reports that a "Philly Fed" forecaster sees Q3 dropping from expected 3.3% to 2.3%, and slower growth in 2011 and 2012. Chances of a negative Q4 are rising. Please refer to the charts in the ZH link for details. 

Japan's GDP came in worse than expected, and led to a plethora of stories of how China has now overtaken it to become the world's second largest economy. Well, not quite, but perhaps by the end of the year. Europe's leading indicators have also rolled over, signaling a coming slowdown. 

The normally bullish Califia Beach Pundit reports that container traffic out of LA is showing signs of a slowdown even as imports are surging. (See first chart below.) While they see that import surge as positive, it may be due to elevated expectations of holiday shopping, expectations that are not being met. There have been a flurry of news stories of how retail is slowing and the dismal back-to-school sales are (they hope) merely delayed. The govt report can be downloaded here. 

 

Another poor sign is the rolling over of semiconductor sales based on a leading indicator. Since gadgets have been doing well, this is an ominous sign. 

 

Given the low rates, corporations are jumping into the bond market. Even junk bonds issuances are increasing as investors scramble for yield. This suggests that all is not fear. Corporations are said to sit on record cash, giving junk bonds a allure of relative safety. 

The question for investors is why buy at these low rates? There is less reason for a flight to quality today than two years ago. 

The wave pattern strongly points to a bottom coming in bonds, and then a bounce (in yields). The Monday STU notes that the gap up in the morning may be an exhaustion gap. Bullish sentiment towards Treasuries is now 98%, approaching the incredible 99% on Dec 16, 2008, right before the all-time high. 

One play is to buy the 30-yr. The recent Fed "QN" announcement targets the 2-10 yr Treasuries, which have dropped the most. The 30-yr may follow. The argument that inflationary expectations are keeping the 30-yr high are likely missing the dynamic that the Fed's intervention is driving the mid-term rates lower. Right now being long the 10 and short the 30 is a likely arb play that may be keeping the 30 yr lower (higher yields). On the other hand, the intervention of the Fed has paradoxically made the 30 yr less sensitive to interest rate changes than the shorter term instruments. Hence the 30 yr may not move if inflation kicks in, while the 10 yr will move more if deflation kicks in. 

Corporate bonds should also be looked at cautiously. The widely held belief that corporations are sitting on hoards of cash needs to be tempered by the even larger hordes of debt they hold. Just as corporate cash is at an all time high, so is corporate debt: $2.6T of cash but $7T of debt. 

Comments

[Les]

The Fed has been pushing down bond yields in front of its previously announced treasury purchase operation today. The actual amount of treasuries purchased in each operation won't be reported till one month later.

http://www.bloomberg.com/news/2010-08-16/fed-may-reemerge-as-bigger-buyer-with-resumption-of-treasury-purchases.html

If past experience with the Treasury QE is indicative, bond yields should start to rise as it did when the Fed added treasuries to its mortgage debt buy program in March 2009.

[Michael]

If you shorted Copper Futures late last week on Yelnick's bearish opinion on copper being in a downtrend you are losing some serious coin. $3.36 last

[Michael]

NYSE A/D line was +800 yesterday and is currently +2025 one hour into the session. Where are all of those Bears now Mamma Bong Bong?

LOL!

[Mamma Boom Boom]

>NYSE A/D line was +800 yesterday and is currently +2025 one hour into the session. Where are all of those Bears now Mamma Bong Bong?

LOL!

Posted by: Michael | Tuesday, August 17, 2010 at 07:31 AM<

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

If your referring to me, you must be some sort of 'laughing fool'. I've been bullish since May.

You must be so stuck on yourself that you never read other peoples posts.

[eager reader]

Could anyone find Joe Pacheco's book?

[Wave Rust]

Yelnick,
I think you left out the word 'rates' - 1st sentence, 2nd word.

the sell on bonds from last week is still on, and soon will push rates much higher than anyone expects in a very short period of time.

bond mini-crash anyone ????

this is the deneoument of "the confuse the bears and the bulls" for the past few weeks.

stocks rally like its a new bull market, especially next week. bonds crashette, especially next week.

recall the "don't marry the bear" just yet?

I have been long and staying long

wave rust

[Les]

Watch for gapping up in the index futures overnight before Tuesdays when the Fed conducts the purchases. The Fed forces the newly printed money into the equity market by forcing buy programs to be kicked off.

[Wave Rust]

i-speculate:
the great crushing begins with aug 24th primaries and the view that the DEMonics are out and some wonderful change is coming - read euphoria. it gets squashed on thursday by jobless data and then on Friday the 27th, the numerous GDP revisions that Yelnick has mentioned by GS, JPM etc. become a reality.

that's when the market could begin dumpster diving which could easily turn into abyss diving.

when the Fed is out of bullets, fading the Fed is out of the question.

wave rust

[Wave Rust]

FDR was a socialist elitist schmuck. Period.

he was a creep, imo.

wave rust

[Michael]

No one cares about politics Wave.
It's a waste of time to even talk about it. Traders care about making money.

And I hate to break it to you, but the stock market and earnings by and large actually has a negative correlation with the economy. (see numerous studies on the subject, not too mention Lewellen, Kohari, and Warner, 1970-2000). The correlation that you continue to imply given your posts about GDP revisions and other meaningless data does not exist.

[Molecool]

All I see here in this comment section are insults and strong emotional opinions - how can you guys survive trading with such a mindset? This is not a rhetoric question.

[yelnick]

wave, thanks for the correction!

[yelnick]

eager reader, I think this is it:

http://www.amazon.com/WING-PRAYER-Memories-fighter-pilot/dp/1599269244/ref=sr_1_fkmr2_3?ie=UTF8&qid=1282062701&sr=8-3-fkmr2

[Mamma Boom Boom]

>All I see here in this comment section are insults and strong emotional opinions - how can you guys survive trading with such a mindset? This is not a rhetoric question.

Posted by: Molecool | Tuesday, August 17, 2010 at 09:21 AM<

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

That takes a lot of nerve. Your as big a prick as any of them!

[Michael]

"how can you guys survive trading with such a mindset? This is not a rhetoric question." - Morocco Mole

The answer is quite simple.
No one here really trades actively, or for a living.

Period.

[Mamma Boom Boom]

>The answer is quite simple.
No one here really trades actively, or for a living.

Period.

Posted by: Michael | Tuesday, August 17, 2010 at 10:12 AM<

Correction! Very few!

[Les]

Others have picked up on the presence of POMO futures ramps.

http://www.zerohedge.com/article/tradition-mindless-stock-ramping-fed-pomo-days-back

I think it'll also depend on the amount of new supply from treasury auctions during those periods.

[Mamma Boom Boom]

Odds are fairly high that we, now, go down and fill the gap at 1068.

[joe]

your chart from carl fucia should be questioned . i see how he counted it and i realise i might be wrong , but looking at the market from a timing persepctive the high on aug 9 2010 fits with in lindsays time spans of a bull market from the nov 2008 lows . take it one further the run from march 2009 to the april highs was 414 calander days which was a rare time span that lindsay also noted . if you look at the dow from a weekly chart perspective the 3 peaks domed house pattern fits better if the aug 9 2010 high was point 7 . this implies points 8 9 and 10
dead ahead and is bearish on a medium term basis . looking at the same count on a monthly chart
we should expect lower prices into may of 2011 .
regardless of the larger picture i would still consider the market bearish into nov 2010 .
this is basically a repeat of the last time the dow ran up following a bear market low lasting 414 calander days .

[Michael]

Joe,

Interesting viewpoint.

Can you tell us how many "data-sets" you are using going back in history using the 414 calendar days from a bear market low?

How many times has this occurred over the last say 80 years?

What is the average decline, over what period, after being 414 days from the bear market low?

Thanks!

[Wave Rust]

michael,
you take blog comments too seriously. it isnt gospel. it's opinion. everybody has one and everybody has a navel and an *******. you seem focused on trying to be the condescending version of the latter.

lighten up michael.

the economy and most of the markets have been in synchrony for months ,,,, very very unusual.

someday, when the next bull market begins, you might look back and see what an old man sees today ,,,, in some form or variation on the form.

politics rarely matters to markets (e.g., JFK's assasination, 9/11, etc.) for very long. but when it does matter, politics becomes a critical linchpin to the path chosen by the economy and the markets. hint: when the economy moves from perceived to visceral, thats when you must pay close attention ,,,, at least for awhile. you have to look out the window instead of the just at the data.

thats a lesson from peter lynch

wave rust

fwiw, obama is an FDR-wannabe on steroids and yet even more narcissistic.

[Wave Rust]

molecool
your blog has to be one of the most emotional blogs out there ,,,, profanity and derision are boundless,,,, you quit it too because you were wrong for so long.

your words of criticism are empty, imo. your technical analysis suffers from your overt emotional flip flopping.

i dont read you anymore. who needs it.

wave rust

maybe I'm only right about 80% of the time, but thats good enough for me. The other 20% of the time I will either exit and stay in cash, or go the opposite way.

In fact, I rather like being wrong every so often. it eliminates one of the possible market options. :))

being wrong isn't bad, being stupid when wrong is real bad though.