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The U.S. Treasury Department sold $18 billion in 5-year Treasury’s yesterday, and the bid-to-cover ratio was 2.48. Given that this is the best b-to-c ratio on the 5-years since August 2000, and that the 3-year auction (Tuesday) was the worst such auction since 1983, one has to wonder what happened in the span of 24-hours…
Obviously no investor knows exactly why one day a government t-debt auction is shunned by investors and the next day it is cheered. To be sure, there could have been unknowable forces influencing the auctions: perhaps the Fed has found a way to secretly do what it has repeatedly dared it would do (buy Treasury’s), or perhaps China was told that its Yuan peg will no longer be denigrated so long as a little extra Yuan finds its way to Pennsylvania Avenue. These speculations aside, there is also the more believable possibility that from Tuesday to Wednesday investor’s figured out that with equities not responding to positive economic news that bonds were the place to be (for the moment).
Whatever the case may be, gold has been unable to do much of anything this week, silver has retrenched below $5 an ounce, and the U.S. dollar wobbled into Wednesday morning but staggered higher into Thursday (this morning). What does all this mean? That the apocalyptic bond crash scenario may be petering out of view…
Inflation Doesn’t Exist until the Consumer Sings
Following Tuesday’s sell off in equities – which was a tiny correction given what the markets have done since March – CBS led with the banner ‘Dow rings up triple digit loss on inflation fears’. For lunatics that do not wish to differentiate between inflation and rising interest rates, the above headline may make sense. However, for every other sane person the above headline is laughable.
Non-farm payrolls are still declining, the housing market may be on the verge of collapse, consumer confidence is waning, and virtually nothing (product wise) is in short supply. These points alone, which all tie into something called ‘supply and demand’, ensure that inflation is not a threat.
As for the arguments that rising commodity prices could unfurl inflationary pressures -- I don’t buy it. Quite frankly, if you take a historical business cycle perspective of commodity prices and/or fiddle with enough monetary stock/commodity charts, you can make the argument that commodity prices are ‘low’ (many have). However, these comparisons and speculations only make perfect sense when the stars are aligning (i.e. during ordinary business cycles). I am not sure what you call what has happened to the U.S. economy since 2000, but I do know that consumers do not typically come out a recession in worse shape debt-wise than when they went in. Furthermore, I know that the U.S. housing market never relentlessly roars ahead during and after a recessionary down cycle. Accordingly, the commodity/inflation arguments - while quaint, neat, and backed by many interesting theories (i.e. the 1990s was the decade of paper assets and it is now time for hard assets) – do not make much sense.*
*Think about it this way – if rising interest rates are about to soon hurt the housing/refi market and/or help slow the U.S. economic recovery, then rising interest rates ensure that inflation is nothing more than a transient threat.
In short, unless the consumer can further increase their pace of spending, companies will not be readily able to raise prices. Forgetting everything else, this is what needs to happen for inflation to rear it ugly head for more than a moment. If this happens stocks would do well, at least until the apocalyptic bond crash scenario begins to get more airtime.
But exactly how does ‘this’ happen? How do deal hungry, debt laden consumers unable to go another refi round place the overcapacitized U.S. production machine in short supply? Does the dollar crash/Yuan rise and everyone lives happily every after? Does America simply ‘import inflation’ due to currency machinations, allowing companies to increase export profit margins?
Conclusions
What is becoming increasingly clear is that simply because the bond market isn’t suffering a meltdown, this does not mean that equities are about to be greeted with another meltup. On the contrary, the less than 2% average dividend yield on SIC rated stocks that many were touting as a fabulous reason to buy stocks yesterday looks like a pitifully weak argument today. To be sure, and tax it any way you want it – a 4+% yield on the 10-year Treasury is ‘safe’, and no normal investor jumps for joy over a 2% yield in ‘risky’ stocks.
Accordingly, it may be the case that Bush’s reduction of the dividend tax has given many investors the false sense of confidence they needed to plunge into the markets. The logic being that ‘heck, even if the markets stagnate or drop slightly I’ll get my dividend yield – but if the economy recovers I’ll make double digit capital gains!’.
I note this investment approach because it is undeniably true that dividends have caught the attention of many investors in recent months, and it may take a serious sell off in stocks before the brainwashed lambs head to the slaughter. I call those that use stocks as a way to bet on an economic recovery as ‘brainwashed’ because these investors apparently didn’t learn anything from the ‘new economy’ delusions that were running wild in the 1990s. Rather, today, as in the 1990s, stocks have rallied to absurd valuation levels because enough investors believe that eventually something great – anything – is about to happen.
$18 billion worth of 10-year Treasury’s are set to be auctioned off today.
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