Risk in Treasury Bonds Takes Backseat to Demand
The tape is mostly bullish for stocks right now: the S&P 500 breakout above 1130 appears to have been successfully retested last week. On the other hand, buying activity is far from enthusiastic. Relatively low volume suggests major players lack commitment. Nonetheless, all pullbacks have been rather shallow, and the path of least resistance is up. The next level to watch is 1150.
Market reaction to last week’s Federal Reserve announcement has evolved, and analysis is clearer this week with the benefit of hindsight. For those who may not have noticed, the Fed decided that what we need is more inflation. Not surprisingly, inflation-protected bonds gained strength, gold hit another all-time high, and the dollar weakened. These are exactly what one would expect in a market that anticipates inflation. We have an anomaly in the bond market, however. Treasury interest rates continued to drop. Normally we would expect rising interest rates in an inflation-expecting market, as investors demand a return that keeps up with rising prices for other goods and services.
So why the disconnect? Whatever else may be happening, the Treasury market is still a market that responds to supply and demand. At the moment, demand seems to be growing faster than supply, which means higher bond prices and lower bond yields. Even the quadruple whammy of huge new issuance, a falling dollar, loss of value when rates eventually rise, and the specter of inflation is not enough to quash demand for this theoretically “safe” investment. Banks, flush with cash but unable to find good credit risks among private borrowers, are lending to the government instead.
Another possibility is that bond traders simply don’t believe the Fed will be able to drive inflation significantly higher, even if it wants to. Hence they discount the inflation fears and look at other factors. Stocks, gold, and foreign currencies could be rising for different reasons. Anyone who thinks this way has a point, but they may also be underestimating the ability of central banks to create however much money the banks believe necessary. Printing presses are no longer a constraint on the Fed’s plans. Bernanke does not need to throw money from helicopters; he can do the same thing digitally.
Materials edged ahead of Telecom to take the top spot in our sector rankings, boosted by strong commodity prices and a weaker dollar. Technology continued its climb and moved into the fourth-place position. Many tech stocks have been strong for some time, but the overall sector was being held back by weakness in the semiconductor group. Semis, having finally arrived at the party, are now allowing the sector to climb in the relative rankings. Industrials, Health Care, Consumer Staples, and Utilities are all treading water. Energy is showing some positive short-term momentum but not yet enough to excite our interest. Financials, which lost more ground last week, is the primary sector to avoid right now.
The Style rankings are no longer divided by capitalization, as had been the case for several weeks. Instead we now see a clear delineation along the Growth/Value axis, with Growth having a distinct advantage. Growth owns the top three spots and are ranked in reverse-capitalization order: Small, Mid, then Large. Value is on the bottom, with the Mid-Caps being the strongest of the three groups. Large Cap Value occupies the bottom of the chart. The Growth/Value differentiation is most significant in the Small Caps where an 18 point difference separates the two. As a reminder, the momentum values in our tables represent an annualized return based on intermediate-term trend strength.
Once again, Pacific ex-Japan widened its lead over the other global areas. This benchmark includes only the developed markets of the region: Australia, Singapore, Hong Kong, and New Zealand. Other Southeast Asian markets excluded by this benchmark, like Thailand and Indonesia, are even stronger. Emerging Markets and the United Kingdom tied for second place with Europe trying to make it a three-way tie. China, Canada, and the U.S. were the only regions not to show an increase in momentum over the last week. Japan is still on the bottom of the pile as the Yen easily rebounds from recent intervention.
The charts above depict both the relative strength and absolute strength of various market sectors, styles, and geographic locations on an intermediate-term basis. Each grouping is sorted (top to bottom) by relative strength. The magnitude of the displayed RSM value is a measure of absolute strength, which is our proprietary method of measuring and reporting the intermediate-term strength as an annualized value.
“Inflation is taxation without legislation. “
Milton Friedman (American Economist, 1912-2006)
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