Market Musings
It was reported by some observers that today's 195 point liftoff in the market was due to the release of FOMC minutes that indicated only one or two more tightenings would be necessary. Didn't everybody know that already?
We think bond yields have overshot on the upside with 10-year treasury note yields up 70 basis points from mid-January lows to 5%. The Fed Funds rate has increased nearly 400 basis points from cycle lows. Prices of the intermediate to longer-term treasury market usually rally after the end of tightening cycles. Several developments indicate we are within striking distance of the top in intermediate-term rates. The first is the recent acceleration in the decline of the US Dollar. The cycle peak of the US Dollar Index occurred in mid-November of 2005 with a secondary peak in mid February/early March of this year. This week's rout takes it down to January lows with momentum likely to carry through to new lows. We think this is significant particularly since 10-year US treasury rates were already 100 basis points over a blended euro sovereign yield and showing signs of rolling over (source: UBS). Foreign inflows of capital, by definition, offset domestic savings. This would indicate higher savings, probably due to less home equity extraction.
Second, confidence and consumer spending growth appear to be highly influenced by swings in gasoline prices. The recent jump in crude oil prices to $71.50 per barrel will pinch consumer spending on other items. We would also site the recent collapse of the housing market index (HMI) nearly a year after the peak in June of 2005.
Strategy Update: our bond strategy managers have lengthened duration in anticipation of a peak in rates. Bond strategies are classic contrarian investments. Discounts to NAV on closed-end funds widen (as they have recently) and fund managers shorten to the point of having prospects for minimal gains on a break in rates. We bought a bond mutual fund in 1984 when treasuries were yielding 14% in anticipation of big gains when rates dropped. Rates dropped and NAV barely budged. When the quarterly report came in the mail later it showed that this "intermediate" bond fund had an average maturity of 18 months! We believe the early part of any rate drop is where the easy money is made and you need to make a contrarian bet to be there. Usually, the discounts to NAV on closed end funds will tell you the right time as the lemmings exit.
We think bond yields have overshot on the upside with 10-year treasury note yields up 70 basis points from mid-January lows to 5%. The Fed Funds rate has increased nearly 400 basis points from cycle lows. Prices of the intermediate to longer-term treasury market usually rally after the end of tightening cycles. Several developments indicate we are within striking distance of the top in intermediate-term rates. The first is the recent acceleration in the decline of the US Dollar. The cycle peak of the US Dollar Index occurred in mid-November of 2005 with a secondary peak in mid February/early March of this year. This week's rout takes it down to January lows with momentum likely to carry through to new lows. We think this is significant particularly since 10-year US treasury rates were already 100 basis points over a blended euro sovereign yield and showing signs of rolling over (source: UBS). Foreign inflows of capital, by definition, offset domestic savings. This would indicate higher savings, probably due to less home equity extraction.
Second, confidence and consumer spending growth appear to be highly influenced by swings in gasoline prices. The recent jump in crude oil prices to $71.50 per barrel will pinch consumer spending on other items. We would also site the recent collapse of the housing market index (HMI) nearly a year after the peak in June of 2005.
Strategy Update: our bond strategy managers have lengthened duration in anticipation of a peak in rates. Bond strategies are classic contrarian investments. Discounts to NAV on closed-end funds widen (as they have recently) and fund managers shorten to the point of having prospects for minimal gains on a break in rates. We bought a bond mutual fund in 1984 when treasuries were yielding 14% in anticipation of big gains when rates dropped. Rates dropped and NAV barely budged. When the quarterly report came in the mail later it showed that this "intermediate" bond fund had an average maturity of 18 months! We believe the early part of any rate drop is where the easy money is made and you need to make a contrarian bet to be there. Usually, the discounts to NAV on closed end funds will tell you the right time as the lemmings exit.
posted by WRA Strategy Group at 8:00 PM
0 Comments:
Post a Comment
<< Home