Please, click here to read this article in pdf format: december-17-2010 This week we have been a bit confused with the market action. Although we believe that the recent increase in yields is due to higher output expectations, which drive a reallocation in portfolios out of fixed income and into equities (i.e. expected to provide [...]
Please, click here to read this article in pdf format: december-17-2010
This week we have been a bit confused with the market action. Although we believe that the recent increase in yields is due to higher output expectations, which drive a reallocation in portfolios out of fixed income and into equities (i.e. expected to provide higher returns adjusted for risk), we think that the recent price action has not been so clear to prove us right.
As the charts below show (source: Bloomberg, five last), the downward trend in the long-end (30-yr) is clear. However, that was not the case for the S&P500 in the past five trading sessions.
Gold and commodities also plunged this week (charts not shown). What is this telling us? Most have suggested this drop was caused by a stronger US dollar. Are we seeing the glass half empty here? The Euro, in spite of all the bad news out of Ireland and Spain (ratings outlook reviewed by Moody’s) has not moved below 1.32. The Canadian dollar, in spite of all the weakness in commodities, has only been trading around parity with the USD. Where is the USD strength, we ask?
On August 18th, we wrote the following:
“…those who still see a double dip in the horizon base their forecast on a double dip in the US housing market. Yet, when stocks rise, the resources and materials sector seem to lead and most monetary policy is specifically addressed towards the housing market. Why not base the double dip on a sovereign crisis in the US? Did the government not assume private sector’s liabilities last year? And if indeed the double dip is finally triggered by a sovereign crisis, why not bet on the sure thing? Why bet on precious metals rather than short Treasuries? The collapse of the Treasuries market looks more certain than the rise in the price of gold. The collapse of Treasuries will precede and fuel the rally in gold and gold shall only rally if it rallies against all currencies, we think. But first, capital must flee from government debt and only then, among other alternatives, it can choose to go to gold…“
The market action we have seen so far, sort of fits with the above prediction. Sort of, because stocks and the Euro have been trading within a range…Will this continue? Was this simply the effect of illiquidity close to Christmas? Was it profit taking?
We note that, if following the price action vs. the prediction above, we concluded that we are at the initial stages of a sovereign (i.e. US) and currency crisis, we would be using inductive reasoning…and we despise induction at “A View from the Trenches”. Therefore, we still stick to the portfolio reallocation theory, until we see evidence of stocks and oil falling out of their respective recent trading bands.
However, the US hasn’t even drafted a plan to seriously cut its fiscal deficit, while at the same time keeps doing everything possible to scare capital out of its borders. Latest data show a relevant outflow of foreign money from municipal and federal US debt (refer: Bank of America’s “Situation Room” report, December 15th, 2010).
In the meantime, as we pointed out on November 29th, Europe is taking slow but steady steps to consolidate its monetary union…
Martin Sibileau.
