Editor’s Note:
In this series of articles, we include important or interesting
videoclips with our comments. This is an article that expresses our
personal opinions about comments made on Television and in Print. It is
NOT intended to provide any investment advice of any type whatsoever.
No one should base any investing decisions or conclusions based on
anything written in or inferred from this article. Investing is a
serious matter and all investment decisions should only be taken after a
detailed discussion with your investment advisor and should be subject
to your objectives, suitability requirements and risk tolerances.
1. Has Bernanke Lost Control of the Treasury Market?
Treasuries fell off the proverbial cliff on Friday with TLT down 3.4% on heavy volume. The yields on the 30-year & 10-year rose by 20 bps and 22 bps resp. Yes, the 10-year Treasury yield rose more than the yield on the 30-year. Even the 5-year yield rose by 18 bps on Friday.
Remember Bernanke’s panic of last week? Everyone except Vice Chairwoman Yellen was deployed last week to tell the market that they had misunderstood Bernanke’s comments during his press conference on Wednesday, June 19. Why did they do so? Because the bond market fell off a smaller cliff in the two & 1/4 days after his press conference. They were stunned to see Treasury yields rise from 3.35% to 3.59% (24 bps) on the 30-year and from 2.19% to 2.54% (25 bps) from close on Tuesday, June 18 to Friday June 21.
Friday’s payroll number caused almost as much damage in one day as Bernanke had caused in 2 days & 1.5 hours. So will the Fed panic again next week and, more importantly, will the market care what they say?
It seems to us that the bond market has now regained its swagger and is essentially telling Bernanke that he is behind the curve. The payroll number of 195,000 surprised so decisively on the upside that the bond market may now be demanding an early taper rather than recoiling from it. And April & May numbers were revised to the upside to 199,000 & 190,000 resp. This makes a 195K+ number for 3 consecutive months.
So now it seems as if Bernanke’s panic of last week was the error in judgement and not his comments on June 19. This realization may be why interest rates shot up like a rocket on Friday.
Assuming Bernanke is now as disturbed at 3.7% & 2.74% yields as he was two weeks ago at 3.59% & 2.54%, what could he do? Any dovish suggestion that tapering might not be as aggressive as he had hinted might now backfire. The last thing this bond market needs a realization that Bernanke might be way behind the tapering curve. Then the vigilantes may actually come back by driving yields higher to force Bernanke’s hand.
2. Rate of Change!
Rick Santelli made the basic rate of change argument on Friday that Jeff Gundlach, Bill Gross et al have made for weeks – that a fast rapid rise in interest rates will end up slowing down the highly leveraged US economy. Rick Santelli may have been right when he said on Friday that 1.5-2 months may not have been enough to see visible impact of higher interest rates. And we understand that employment is a lagging indicator and that payroll numbers might be the last piece of economic data to show any weakness.
But the bond market is now running with jobs as its only indicator. It is not paying much attention to other signs like weak GDP or PMI data. So we have no idea what eventually slows down the rise in yields except perhaps fatigue.
3. Rise in Treasury Yields – 2013 vs. 1994
Look at the percentage rise in Treasury yields since May 1, 2013:
- 5-years – from 65bps to 1.60% – an increase of 146%; 10-years – from 1.64% to 2.73% – an increase of 66%; 30-years – from 2.82% to 3.7% – an increase of 31%.
Percentage rise in yields is not that relevant for trading bonds. But it is the paramount measure for affordability of loans. Consider a 10-year loan for $1 million. The annual interest payment on this loan has risen from $16,300 on May 1 to $27,300 on July 5. Putting it another way, if all you can afford is an annual interest payment of $16,300, then you can ONLY afford to borrow $597,070 now instead of being able to borrow $1,000,000 on May 1. So your ability to borrow has gone down by 40% in just past two months.
Speed Kills, remember! So the effects of this 40% reduction in borrowing capacity might takes a couple of months to be evident in numbers, while the rise in interest rates takes place with a rush.
Go back to 1994 and you will find that the 10-year yield rose from 5.72% on February 1, 1994 to 7.48% on May 9, 1994, an increase of 31% or half of the percentage rise in 10-year yields in the last two months. In 1994, yields based from May 9, 1994 to September 30, 1994; then yields rose again to peak at 8.02% in November 1994. So the trough to peak rise in 10-year yields was 40% in 1994. In contrast, the rise in the 10-year yield in the last two months is 67% with perhaps lot more to follow.
4. Rise in Rates vs. SPX gains – Historical comparisons
1994 and 1987 stand out as two years where stocks remained resilient while interest rates shot up. That has been the theme of 2013 as well.
How do these three years compare? Our simplistic measure = percentage rise in 10-year yield PLUS percentage rise in stocks – to gauge the performance of Long-Short Strategy of being Long Interest Rates (i.e. Short Treasuries) And Long S&P 500. Here is what we found:
- January 1,1987 – October 16, 1987 – 10-year rates from 7.17% to 10.23% (43%) & SPX from 245 to 305 (25%) – total gain of 68%
- February 1, 1994 – May 9, 1994 – 10-year rates from 5.72% to 7.48% (31%) & SPX from 465 to 448 (-4%) – total gain of 27%
- February 1, 1994 – November 21, 1994 – 10-year rates from 5.72% to 8.00% (40%) & SPX from 465 to 461 (-1%) – total gain of 39%
- January 1, 2013 – July 5, 2013 – 10-year yield from 1.84% to 2.73% (48%) & SPX from 1462 to 1632 (12%) – total gain of 60%
- May 2, 2013 – July 5, 2013 – 10-year yield from 1.64% to 2.73% (66%) & SPX from 1583 to 1632 (3%) – total gain of 69%
So the Long Stocks & Long Rates strategy has been more profitable in 2013 than in any other period except in 1987 upto the day before the October 19, 1987 crash.
The other way to measure the relative attractiveness of 10-Year Treasury vs. S&P 500 is the traditional discounting method which essentially measures the difference in the rise in rates & rise in S&P 500. You can quickly approximate that by subtracting the S&P 500 gain from the percentage rise in 10-year yields. It will also tell you that the relative difference in 2013 between S&P 500 performance and interest rates is only comparable to 1987 up to the day before the great crash.
5. Are such historical comparisons meaningless?
This period of QE4ever from the Fed with simultaneous liquidity guarantees from Europe and even greater QE from Japan is unprecedented. No other period in financial history can compare. So it is quite likely that all historical comparisons will prove meaningless.
So we urge all to treat the above historical comparisons as mere illustrative exercises. We may have seen nothing yet, especially if we get 300,000+ payroll number by September as CNBC Fast Money trader & Option Monster founder Jon Najarian said on Friday.
The hawkish rhetoric on June 19 followed by an intense backpedaling of the hawkishness the following week and now the big beat in payroll number. All this suggests to us that Bernanke is now confused and clueless about what to say and do. And that he is perilously clo
se to losing any semblance of control over interest rates.
We fervently hope that we are totally wrong in what we sense. Nothing would make us happier than to take back our words. At the very least, we hope for a quiet next week.
Featured Videoclips:
- Louise Yamada on CNBC Fast Money on Friday, July 5
- Carter Worth on CNBC Options Action on Friday, July 5.
1. Stocks, Rates & Gold – Louise Yamada on CNBC Fast Money – Friday, July 5
Louise Yamada, the well known technician speaks to anchor Melissa Lee.
Stocks
- Lee – the S&P 500 managed to close above a 50-day moving average. How important is that given the volume in today’s session or lack of?
- Yamada – I think it was a good thing to have happen. it’s usually a slow day, the day after the fourth. so I think what we want to see is if it can get even higher, back up above the 2012 uptrend line that was violated there and possibly above the June peak that came into play at around 1650. The possibility we end up with aid trading range between 1670 and and the 1550, where we came down is very real. I mean, there’s no guarantee here that we’re going off to new highs, but I think that it’s an improved rally. The only caveat would be if we came under that recent low.
Rates
- Lee – all right, Louise, let’s move on to bonds here. Obviously with yields nearing two-area highs, everybody wants to know what’s going to go on with the ten-year.
- Yamada – well, you have penetrated a seven-year downtrend here, which is very impressive. there’s a 2 1/2 year base in place already, two-year base in place. and bond cycles – they’re 22 to 37 years, we really think that are almost 33 years into this, that this is the beginning of a reversal into a new rising rate cycle. So we would be eliminating long-end positions. And if one needs to hold, move into the short end, but you push through 2.50%, which is one of our targets. 3.00% would be next. 3.50%, and then you move into a fair amount of resistance up here around 4%. But take one at a time; it’s going higher.
Gold
- Lee – Louise, let’s talk gold. what’s the downside here?
- Yamada – well, we’re close to our measured move. the measured move from the larger triangle here suggested about 1155. we came very close. i think what’s interesting is that none of the rallies have been able to get back to the prior breakdown levels, which have become resistance now, a form of support. so 1155 is as far as we can get on a measured move, but the possibility of going lower is always there. we suggest you don’t want to try to catch a falling sword.
- Yamada – we’d have to see if there’s some stabilization so we can get another measured move. but, basically, I mean, you hate to say it, but it could go all the way back to the 2008/2009 breakout level at $1,000.
2. Street Selling Gold; Do the Exact Opposite – Carter Worth on CNBC Options Action – Friday, July 5
Carter Worth is the resident technician at CNBC Options Action. Here he speaks with anchor Melissa Lee about his views about Gold. Worth makes the point Tom McClellan made last week when he compared today’s negative sentiment about Gold today with the negative sentiment about stocks in March 2009.
- first, what’s important is, we have almost the mirror image of what was going on at the highs, which is to say when it’s quite euphoric, you cannot get anyone to sell, and when it’s quite despondent, you cannot get anyone to buy. That’s the human condition. and in my work, anyway, we have the latter.
- people are despondent, enough capitulation, and I think the charts really reflect that. let’s look at the one-year chart. and what’s most pronounced is the recent aggressive clutch, which has taken place over the last two-three weeks. we touched a low of $1180 an ounce just last week. Now we’ve bounced up a bit here, closing around $1225 today. but it’s that last tail, literally, people popping up, getting margin calls, abandoning something that has been beloved for almost 10, 12 years.
- on a longer term basis, if you want to look at the eight-year chart that I have here. and this includes the smoothing mechanism, the moving average, we are so far below trend, meaning, the moving averages, a general way to measure trend. you get too far above it, the presumption is you’re going to come in, too far below it, and the presumption is that you’re going to throw back.
- At this point, if you look at the long term, our high was 1920 an ounce. we hit a low of 1180. that’s taken place over almost two years. so basically a 38% sell-off on a two-year basis; this far below trend, below the 100-day moving average. We think it is right to do the exact opposite of what is being done on the street now. you’re getting downgrades, you’re getting people talking about gold about to get much worse. we are taking the road less traveled.
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