March 2010

Every equity market correction (1987, 1994, 1998, 2000, and 2007) had a brief but significant runup in treasury yields

What's important in investing as mutual funds often mention is negatively correlated assets. Unfortunately, they don't follow their own advice and end up buying the same 'risk' assets as everyone else and thereby lose money. What is negatively correlated? (treasuries and cash)

See link:

Equity Market Correction Worry List

...Spook the equity market since another 25bps of upside pressure could then generate a fund-flow spiral as was the case in the summer of 2007 — 3.85% (where we are now) ostensibly is a trigger point for selling of mortgage bonds. As rates rise, homeowners are less likely to pay their mortgages early, which extends the life of the mortgage and that in turn encourages mortgage investors to neutralize the duration of their portfolios by selling T-bonds and notes. We have seen this happen before and while it will likely provide a nice buying opportunity given the deflationary headwinds the economy now faces, the prospect of a spasm in the Treasury market is worth considering. Every equity market correction in the past — 1987, 1994, 1998, 2000, and 2007 — was preceded by what turned out to be a brief but significant runup in yields...

Looks like Deflation risk to me

See chart from calculated risk blog updated for Jan 2010 data. Median CPI has a straight down trajectory.

You can see latest (Feb.) FRB Cleveland CPI at 0.8% here...

Current Median CPI

 

see also $5.2 trillion off balance sheet assets for banks...

Banks’ Hidden Junk Menaces $1 Trillion Purge: David Reilly

Hidden Junk 

March 25 (Bloomberg) -- The U.S. government wants to clear as much as $1 trillion in soured loans and securities from bank balance sheets with its latest bailout plan.

That might prove a short-term respite. No sooner might the Treasury Department mop up those assets than $1 trillion or more in new ones spring up to take their place.

That is due to the potential return of assets held in so- called off-balance-sheet vehicles that banks may soon have to put back onto their books. The end result may be that banks are in no better shape to increase lending even after the government bailout.

So investors betting for quick solutions to the financial crisis could be disappointed. The tangled web that banks wove over the years will take a long time to undo.

At the end of 2008, for example, off-balance-sheet assets at just the four biggest U.S. banks -- Bank of America Corp., Citigroup Inc., JPMorgan Chase & Co. and Wells Fargo & Co. -- were about $5.2 trillion, according to their 2008 annual filings.

Federal Debt / Credit Growth Slows

Below is all credit growth, Z.1. Trouble is ahead shortly as federal debt growth slows. Overall Z.1 falls to record low 1.6%. There's a lag of course. High Federal debt growth took 3 quarters: 2008 Q3, Q4 and 2009 Q1 before impacting the stock market.

I love all this inflation talk as the disparity between reality and market fiction is very great. Always the best time for profit opportunity....

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I plotted the quarterly federal debt growth through the 2008 crisis and using the most recent data Feb. 28, 2010. Federal debt growth has slowed to just 11.6% as of the last 3 months. After tax refunds in Feb and March, economic data turns south. Expect weakness in May as data from April is announced.

Oil Crossover on USD

Oil has traded above USD but due to turn. Oil normally trades opposite USD so I would expect underperformance. This is bullish to TLT as falling oil prices and accelerating core disinflation support it. Weakening stimulus and economy will also accelerate in second half.

 

See my chart of growth in Fed Assets Components. I see very little Treasury buying since middle of 2009. Almost all new purchases have been MBS.

Updated Mar 25, 2010.

 

See comments by Lehman Head ..

Writedowns

Highlight here:

Lehman Head Bryan Marsal has warned that Wall Street had not learned its lesson in the credit crisis and that another megabank bankruptcy is likely. Marsal made the remarks while in Berlin for a bankruptcy conference in an interview with German business daily Handelsblatt, which I have translated below. A link to the full German text is provided at the bottom of this post. His comments serve as a reminder that the megabanks are still too large and complex, and, therefore pose a risk to the entire global banking system.

Text of the interview

Handelsblatt: you are handling the largest bankruptcy in human history. Can anything like this happen again?

Bryan Marsal: It is even likely that a case like Lehman’s will repeat itself – in any event, as long as nothing fundamental changes in financial regulation and in financial institutions. Wall Street has not really learned a lot from the situation. There is still too much leverage in the market, and credit default swaps remain completely unregulated. Even with regulators and in the companies little has been done after the global catastrophe.

HB: But financial regulators around the world are now pulling in the reins …

Marsal: Oh, really? That’s just for show. The regulators are overworked and underpaid. Someone who earns $80,000 a year cannot seriously compete with someone who gets $400,000 for finding ways to get around the system. And so far no one from the regulators at the SEC, at the FDIC or our government has asked  how the Lehman collapse could have been avoided and what countermeasures could be taken to prevent a recurrence.

TLT excellent buying opportunity now

TLTs are an excellent buy right now as inflation falls dramatically across the economy. Commodities and gold are very dangerous holds at this point.

Clearly pricing power for companies has gone and will show in profits shortly and thereby stocks.

From Mish website:

Mish Inflation Where Link

Consumer Inflation


Restaurants



Home Improvements



Apparel



Movies



Telecom



Books and Newspapers



Grocery Stores



Autos



Electronics



Personal Care Pharma



Dave Rosenberg writes ...

There is much more underlying deflation pressure today — core at 1.3% with the CRB having run up more than 40% since February 2004 really tells you something about Corporate America’s ability to pass on cost increases and deliver top-line growth.

Moreover, it looks like the trend in core inflation is going to head even lower because the three-month pace is close to 0% and the six-month trend is down to 0.814% (to the third decimal) which took out the June 2003 nearby low of 0.939%. The last time the six-month trend was this low was back in August 1965, but the difference being that CAPU rates were closer to 90% and the jobless rate was around 4% back then, so there was far less spare capacity in the labour and product markets. Deflation remains the primary trend. The only question for investors is when the equity market figures out that this is not conducive to pro-growth pro-risk strategies.

Regional Fed "hawks" appear to have gained the upper hand

From article below the real market drivers are shown:

- Concerns that the Fed may soon reverse quantitative easing altogether have caused a sharp rise in credit spreads in recent weeks

- The bank has already wound up its main liquidity operations

- Regional Fed "hawks" appear to have gained the upper hand. This has echoes of mid-2008 when the Fed talked of tightening, arguably setting off the chain of events that led to the collapse of Lehman Brothers

US bank lending falls at fastest rate in history

Bank lending in the US has contracted so far this year at the fastest rate in recorded history, raising concerns that the Federal Reserve may have jumped the gun by withdrawing emergency stimulus.

By Ambrose Evans-Pritchard, International Business Editor

Published: 8:43PM GMT 17 Feb 2010

Comments 85 | Comment on this article

US Federal Reserve - US bank lending falls at fastest rate in history

David Rosenberg from Gluskin Sheff said lending has fallen by over $100bn (£63.8bn) since January, plummeting at an annual rate of 16pc. "Since the credit crisis began, $740bn of bank credit has evaporated. This is a record 10pc decline," he said.

Mr Rosenberg said it is tempting fate for the Fed to turn off the monetary spigot in such circumstances. "The shrinking in banking sector balance sheets renders any talk of an exit strategy premature," he said.

The M3 broad money supply – watched by monetarists as a leading indicator of trouble a year ahead – has been contracting at a rate of 5.6pc over the last three months. This signals future deflation. The Fed's "Monetary Multplier" has dropped to a record low of 0.81, evidence that the banking system is still broken.

Tim Congdon from International Monetary Research said demands for higher capital ratios and continued losses from the credit crisis are both causing banks to cut lending. The risk of a double-dip recession – or worse – is growing by the day.

"It is absurdly premature to think of withdrawing stimulus while bank credit is still sliding. To have allowed this monetary collapse to occur a full 18 months after the financial cataclysm is extreme incompetence. They seem to have forgotten that the lesson of the 1930s was the falling quantity of money," he said.

Paul Ashworth, US economist for Capital Economics, said that certain Fed officials are clearly worried about lending since they slipped in a warning that bank credit "continues to contract" in their latest statement.

However, regional Fed "hawks" appear to have gained the upper hand. This has echoes of mid-2008 when the Fed talked of tightening, arguably setting off the chain of events that led to the collapse of Lehman Brothers later that year. China has also been calling for a halt to QE, accusing

Washington of "monetizing" its deficit in a stealth default on Treasury bonds.

The bank has already wound up its main liquidity operations. Concerns that the Fed may soon reverse quantitative easing altogether have caused a sharp rise in credit spreads in recent weeks.

Fed chair Ben Bernanke first made his name as an expert on the "credit channel" causes of slumps. It is unclear why he has been so relaxed about declining bank loans this time.

"The reason the Great Depression became 'great' was the contraction of credit. You would have thought that a student of the Depression like Bernanke would be alarmed by this," said Mr Ashworth.