These days, the stock market doesn't know whether to turn up, fall down, or crawl sideways. One thing's sure, however -- even with the fall from April's peak and the subsequent volatility, U.S. stocks still appear to be pricing in a sustained economic recovery.
But that's unlikely to be what we get -- at least according the $7.9 trillion U.S. Treasury market.
Two markets diverged ....
Whether we're talking stock, bond, or commodity markets, let's first clarify that I don't recommend relying on price action as a measure of future growth in the real economy. Arguably more reliable indicators include GDP or trends in mass layoffs. Markets, after all, are infamously irrational.
That said, there is a time to pay keen attention to market action, and that's when trading in U.S. Treasuries suggests an economic outcome far different from what the stock market expects.
The elephant in the room
Granted, the Treasury market doesn't quite stack up to the roughly $13.4 trillion market cap of U.S. stocks. Yet as a barometer of investor attitude, it does an equally fine job.
With repayment risk as close to zero as realistically possible, the going yield on Treasury bills, notes, and bonds isolates (and reflects) interest-rate and inflation expectations, which in turn broadcasts the market's estimation of future economic health. In general, abnormally low yields suggest a fragile, plodding economy, while unusually high yields may indicate fear that economic expansion or other events will give way to ruinously high inflation.
Enough from me, though. Let's go straight to David Rosenberg, a well-known market strategist who boasts a flair for statistical analysis.
At the end of April, Rosenberg wrote, "We still have the 10-year T-note yield hanging around 3.7% whereas if we were truly in a wonderful reflationary cycle, it should be north of 4.5% right now." In the month since, the 10-year yield has fallen to a current 3.3% (yields move inversely with prices). Importantly, that change may reflect more than market jitters and a concomitant flight to safety.
Bond investors, one might argue, are taking a more skeptical angle on recent economic data points. For instance, Rosenberg notes that the "core control" segment of April retail sales, which excludes autos, gasoline, and building materials, posted the largest month-over-month drop since March 2009. Meanwhile, consumer confidence, although improved, remains smack in recession territory. What's more, consumers' plans to purchase big-ticket items, such as a major appliance or home, trended down in May. That development doesn't bode well for the likes of Sears Holdings
Want more evidence of a shaky economy?
Excluding government backstops, Rosenberg observes that real personal income has "barely budged" and remains well below its peak 16 months ago. Furthermore, citing Wal-Mart's
Something of a golden lining
While evidence of a feeble economy is nothing to celebrate, it looks as though near-term fears of rising Treasury yields -- which, if realized, would likely push up private borrowing costs and potentially cause a double-dip recession -- are overblown.
The now-familiar bond-bear stance argues that a burgeoning supply of Treasuries will overwhelm the market, crushing prices and driving up yields. Rosenberg recognizes the likelihood of such an outcome given an expanding economy, but he counters with the following:
There is no comparison between fiscal deficits and inflation when it comes to bond yield analysis ... With credit contracting, rents deflating, the broad money supply measures now declining and unit labour costs dropping at a record rate, it hardly seems plausible that inflation is a risk at any time on the near- or intermediate-term forecasting horizon.
Rosenberg offers numerous examples to support his claim, including the bond rally of 2002, as the U.S. deficit exploded and deflationary risks simultaneously moved to the fore; the bond bull of the Reagan years, when Treasury supply ballooned; and finally, the Japan of the past decade.
"Yes, Virginia," affirms Rosenberg, "deficits and deflation can co-exist for extended periods of time."
Even so, Rosenberg is a gold bull. Notably, he sees the glittering metal as a hedge against the financial instability engendered by both deflation and its late-arriving cousin, inflation. His gold-price forecast ranges from $3,100 per ounce to $5,700 per ounce, depending on the terms in which one measures former highs.
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