Yes Virginia, Bonds Can Go Down
As intentional inflation usually does, last week’s Federal Reserve action made stocks take off to the upside. Gold and most commodities did the same. The main loser was the greenback, which cratered at first but subsequently recovered all its losses and then some. The U.S. Dollar Index ended today at its highest level since the end of October. Stocks and gold gave up some of their gains but remain ahead of where they were before the Fed announcement.
The bigger story is bonds. Treasury rates jumped after the Fed meeting, then dropped to the lowest level in three weeks before climbing completely back and then some. Net result: 10-year Treasury bonds are roughly where they were two weeks ago, closing today at 2.67%. Long-term Treasury bond yields have gone sharply higher, and a telling result is that the Vanguard Extended Duration Treasury ETF (EDV) lost -9.0% this past week and -19.9% since late August. That’s nearly five year’s worth of interest payments lost in about 10 weeks.
The new stimulus has somewhat contradictory effects on the credit markets. On the one hand, the creation of new money adds to inflation forecasts, which causes investors to demand higher yields on their money. Somewhat offsetting this, at least in the short run, is that the Fed’s new bond demand will prop up bond prices and keep yields down. To the extent it is difficult to make a decent return in Treasury securities, investors will be motivated to buy stocks and corporate paper. This is probably what Ben Bernanke really wants: to encourage risk-taking. An increased risk appetite will, in turn, give the economy the support it needs to keep recovering.
That is the theory, at least, but investor behavior over the last two years is not encouraging for such a strategy. The lucky people who have extra money lying around learned the hard way that safety can be more important than yield. As the old saying goes, “Forget the cheese, just let me out of the trap.” Confidence shaken as severely as it has been in this recession is not easily recovered. This isn’t news to the Fed governors, of course; they do not expect quick results. Their goal is to look like they are “doing something” without making the situation any worse. It will not be an easy balance to achieve.
Materials solidified its hold on the top sector ranking thanks to the Fed-induced commodities rally. Now we have a horse race for second place. Buoyed by oil prices back above $87, Energy is dueling with Technology for the #2 spot. Technology is firing on all cylinders with semiconductors finally joining the trend. Financials had a huge move immediately after the Fed news, but the sector has been declining ever since. Nonetheless, it was enough to push Financials out of the cellar and into seventh place. The bottom of the list is now occupied by Utilities, which has not been performing badly, it just hasn’t kept up with the rest of the market.
The broad stock market surge helped all the Style segments. Micro Caps continued to rise through the ranks and are now at #2, just behind Small Growth. We have some nice symmetry with the top two segments’ polar opposites of Large Value and Mega Cap in the bottom two slots. The market bias continues to favor smaller and more growth-oriented stocks. This is consistent with the Fed’s risk-encouraging strategy as discussed above.
Driven mainly by strength in Hong Kong and Singapore, Pacific ex-Japan recaptured the top Global spot after relinquishing it for the last three weeks. China also continued to climb and is now in second place. Increased bank reserve requirements had little effect on trading of China funds in the U.S. today. Europe continued to fall from its lofty perch; after being on top of the list for two weeks, the continent slipped to #2 last week and is now in the lower half of the rankings at #7. New sovereign debt fears are making traders suspect Ireland will need a bailout soon, which won’t be good for the Euro. Finally, in the “some things never seem to change” department, Japan still has a lock on last place.
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.
“There’s a bigger bump on the horizon than people would like to admit. “
Peter Mathews, banking analyst, on the potential home value write-downs looming in Ireland
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