Archive for May, 2014
Let’s talk a little more about divergence. As in wacky divergences.
Last time out, we looked at divergence through the lens of interest rates and how rates – principally measured by the yield on the U.S. Treasury 10-year note – were going lower when they were widely expected to start moving higher as the Federal Reserve tapers its monthly bond purchases.
We also noted that stocks were moving higher in the face of falling interest rates, whereas falling rates generally signal slackening in the economy and less demand for money.
Some wacky divergences, indeed.
But there’s another divergence at work in this whirlpool of divergences, and it strikes me as not only wacky, but dangerous, if you’re piling on.
I’m talking about the rising prices of emerging markets stocks and bonds.
Before I get to emerging markets, let me give you some relative background, the kind of background you need to piece together to make sense of this whirlwind of wackiness.
Here’s what you need to know…
On Monday, I explained why, when you’re considering investment ideas, you should always keep the bond market in mind. That’s because stocks and bonds are inextricably interconnected.
They’re inextricably interconnected because interest rates matter.
When expected relationships between stocks and bonds (interest rates) diverge, therefore, it’s important to take notice, try to understand what is happening, and consider what the divergences could portend for both stocks and bonds.
Markets are experiencing a divergence now, and a lot of analysts are getting worried.
Stocks have been moving higher as the yield on the 10-year U.S. Treasury note has been falling (“bills” have a maturity of one year or less, “notes” go up to 10 years, and “bonds” have maturities of more than 10 years).
The 10-year Treasury note is now the “benchmark” interest rate that’s widely watched and viewed as a proxy for the general direction of interest rates. It’s currently yielding 2.53%. That means you give the Treasury your cash, and it gives you a note that pays you 2.53% annually for 10 years, and then you get your principal back.
When the Federal Reserve, which has been manipulating interest rates down to historic lows, said it was going to begin “tapering” its massive purchases of Treasury bills, notes and bonds, and mortgage-backed securities, the bond market got nervous. The Fed had managed rates down by exercising its quantitative easing (QE) program and announced it was paring back QE purchases because it saw the economy picking up.
(In its QE program, the Fed buys bonds from banks to flood those banks with cash in the hope that all that cash would trickle down into the economy.)
The yield on the 10-year note moved from about 2.25% to 3% in short order.
The thinking goes that if the economy is picking up it doesn’t need the Federal Reserve to keep a lid on rates. That’s because accelerating growth will increase demand for money and loans, which puts upward pressure on interest rates.
And letting the economy stand on its own two feet and letting interest rates rise modestly wouldn’t be bad for the economy, right?
Further, if interest rates rise gently, investors and businesses will take that as a sign that the economy is indeed picking up, and that will be reflected in the demand for loans and money, which ultimately shows up in rising interest rates. So, if rates are rising, things are getting better.
However, things don’t look like they’re working out that way. And now I’m going to tell you what actually happened and what this means – maybe – for your portfolio.
Over the past couple of months, I’ve been sharing with you some tips about how new investors can break into the market. And I think it’s the perfect time for our next lesson – looking this time at the inextricable connection between stocks and bonds.
Although I tend to write about the stock market as if it were a singular entity, I’m usually talking about the markets in the plural. Not just the Dow, or the S&P 500, or the Nasdaq – when I’m talking about the stock market or stocks, I am talking about ALL the indexes.
But when I use the word markets, I’m talking about not just the stock market indexes but also the entire bond market.
The bond market isn’t just the U.S. Treasury bond market. The bond market is to me, and should be for you, all the different bond markets, including but not limited to Treasuries, corporates, sovereign bonds, and junk bonds.
The word markets encompasses stocks and bonds because they are inseparable. There is an immutable relationship between stocks and bonds. They are connected at the hip. From now on, you, too, should always think of markets as both the stock market and the bond market.
It’s OK to only think about stocks when you’re making stock trades, analyzing your stock positions, or just chatting about the stock market. But always keep the bond market in the back of your mind when you’re thinking about stocks. Remember the bond market when you’re listening to pundits talking about stocks and when you’re reading about stocks or the stock market.
And now I’ll tell you why you almost always have to think of stocks and bonds together.
Based on preliminary first-quarter data, U.S. gross domestic product (GDP) growth is 0.1%.
That’s not much.
But then again, what do you expect for $3.4 trillion of Federal Reserve spending to boost the economy.
First of all, the preliminary GDP number, which is the total output of goods and services produced by labor and property minus imports, will be revised on May 29, 2014.
Most economists are already revising this estimate down into negative territory. The consensus view expects the revised first-quarter GDP number will show the economy contracting by 0.5% to 1%.
However, the second quarter is not expected to be bad just because of a slow first quarter. In fact, most pundits, including the Federal Reserve itself, are saying because the first quarter was so bad the economy will rebound in the second quarter.
But if they’re wrong and the second quarter shows negative growth, that’s really bad.
It’s bad because two consecutive quarters in a row of negative GDP growth is the technical definition of a recession.
So, how did we end up with non-existent economic growth or, worse, negative growth and possibly another recession looming when the Federal Reserve, since September 2008, has spent $3.4 trillion to prime the economic pump?
You’re not going to like the answer to that rhetorical question. The truth is frightening…
You can call it a bailout, a rakeover – I mean, takeover – or socialism for cash. It’s all that and more.
But, whatever you call it, it’s not going to last.
The $187.5 billion bailout of Fannie Mae and Freddie Mac back in 2008 was absolutely necessary.
Before you tell me I’m crazy, let me tell you why…
Ahhh… the warm breeze I’m feeling. I can’t figure out where it’s coming from.
Oh, there it is. It’s the air of confidence wafting over me knowing everything’s as it should be with our too-big-to-fail banks, and that they’re not going anywhere.
That they’re safe, that they have a handle on their assets and liabilities and that the Federal Reserve’s stress tests are a warm blanket that lets us all sleep well at night.
No, it doesn’t bother me at all…
In fact, I’m going to sleep like a baby tonight… How about you?
Late last month, depending on how you look at it, either something wonderful happened – or the feds continued their cowardly, conniving ways.
A group of federal prosecutors met in Washington and in New York with various financial regulators to discuss filing criminal charges against and coercing guilty pleas out of two giant banks.
David O’Neil, head of the U.S. Justice Department’s criminal division; Preet Bharara the U.S. attorney for the Southern District of New York; and Cyrus Vance Jr., the Manhattan district attorney, met in Washington with regulators and lawyers from the Federal Reserve and the Office of the Comptroller of the Currency (OCC). And then they took the Acela Express up to the Big Apple to meet with Benjamin M. Lawsky, New York State’s first superintendent of financial services.
During these meetings, they discussed extracting guilty pleas from Swiss megabank Credit Suisse Group AG (NYSE: CS) and giant French bank BNP Paribas (Euronext: BNP).
Credit Suisse is accused of helping U.S. citizens evade federal taxes, while BNP Paribas is charged with knowingly doing business with nations, such as Sudan, that face U.S. sanctions.
Send up the fireworks, right? Federal prosecutors are actually doing their job! They’re punishing the patently criminal activity that’s so frequently perpetuated by big banks.
This looks to be a historic occurrence. But two things tell me we shouldn’t pop open the Champagne…yet.
Let me show you why.