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Are Treasuries the Last Diversifier Left?

Leo Kolivakis's picture




 

Via Pension Pulse.

Luca Di Leo and Darrell Hughes of the WSJ report, U.S. Growth Slowed in 2nd Quarter:

The
U.S. economy slowed in the second quarter as the government said the
recession was deeper than earlier believed, adding to concerns over the
recovery's strength.

The Commerce Department Friday said U.S.
gross domestic product, or the value of all goods and services
produced, rose at an annualized seasonally adjusted rate of 2.4% in
April to June. In its first estimate of the economy's benchmark
indicator, the government report showed growth was lifted by business
investments and exports. Consumer spending, a key growth engine for the
U.S. economy, made a smaller contribution to growth.

 

Economists
polled by Dow Jones Newswires were expecting GDP to rise by 2.5% in
the second quarter. Stock futures weakened after release of the data;
Standard & Poor's 500 futures were recently down about 11 points to
1086; Dow Jones Industrial Average futures were off 82 points to
10327.

 

In the first quarter, the
economy grew by 3.7%, revised up from an originally reported 2.7%
increase. But growth estimates all the way back to the start of 2007
were revised lower.

 

The report showed a bright spot continuing in
the economy: the growth of business spending on equipment and
software. This spending continued to surge, increasing by 21.9% in the
second quarter, compared with a 20.4% rise in the first three months.
The figures highlight the contrast in the economy between high company
profits and a persistently feeble jobs market keeping consumers at bay.

Business spending actually climbed at the fastest
rate since 1997, but the big story was the downward revision in the
level of real GDP in Q1 2010, a point that Yanick Desnoyers, Assistant
Chief Economist at the National Bank, addressed in his comment on the
report:

The
U.S. economy increased 2.4% in the second quarter, slightly below
market expectations. Q2 delivered slower GDP growth compared to Q1 but
with a marked acceleration in real domestic demand from 1.3% to 4.1%.
We prefer to see a weaker GDP growth due to a rise in imports with
strong domestic demand than a weaker GDP growth due to a weaker
domestic demand.

 

That
said, what was more striking in today’s report was the BEA’s annual
revisions to the National Income and Product Accounts. The level of real
GDP in the first quarter of 2010 was revised down by $100 billion.
From a component perspective, consumption registered the largest
revisions in dollar terms with a decrease of $134 billion. Accordingly,
U.S. consumption is not in an expansion mode as originally reported but
rather still in the recovery stance.

 

There
are mainly two consequences with the BEA’s revisions. First, it means
that the savings rate probably was higher than first thought and job
creation is more than ever needed to sustain consumption growth
(conversely it means that the U.S. consumer is deleveraging more
quickly than expected). Secondly, the U.S. output gap is deeper in
excess supply territory than before the BEA’s revision.

 

Bottom line: The Fed is on the sidelines for a longer period of time.

The
output gap is deeper than we previously thought, but there is another
reason why the Fed will remain on the sidelines for longer than we
think: it wants to see asset reflation translate into mild inflation and
avoid a protracted deflationary scenario at all cost.

Importantly, Fed policy remains geared entirely towards banks,
allowing them to continue borrowing on the cheap to invest in risk
assets all around the world as they shore up their balance sheets. This
is why I remain bullish on stocks.

But what about bonds? I recently wrote a comment asking whether or not we're on the cusp of a global bond hiccup.
My point was that global growth will put upward pressure on bond
yields, and I thought the US economy was in better shape than what most
analysts thought.

Obviously today's downward revisions in US GDP
will continue anchoring down long-term inflation expectations. Some
strategists think that Treasuries are still a buy:

Treasury yields fell Friday, with the 2-year note hitting a record low 0.55%, after the government said U.S. GDP grew a weaker-than-expected 2.4% in the second quarter.

Get used to both more weak economic data and lower Treasury yields says, Yves Lamoureux, investment advisor at Macquarie Private Wealth.

 

"If
you're looking at leading [economic] indicators, they are pointing
down," he says.

 

"There's no doubt the next quarter and the one following
are going to be disappointing." (On Friday, the ECRI said its weekly leading index
rose to 121.1 for the week ended July 23 from 120.6 the prior week;
but the index's growth rate fell for an eighth-straight week.)

 

With
the economy slowing, the "secular bull market" in Treasuries should
continue, Lamoureux says, predicting 30-year bond yields will fall as
low as the average of comparable debt in Japan and Germany, which is
currently 2.575%.

 

Furthermore, he
argues the high rates of the 1970s and 1980s were the "black swan"
resulting from the Fed's mismanagement of the money supply. Excluding
that period, Treasury yields have mainly been in the 2-4% range since
the 1900s;

 

Lamoureux calls that the "natural equilibrium" for yields,
while expressing faith the Fed has learned its lesson of the 1970s.

 

"I
believe the Fed won't make the same kind of mistake again," he says.
"From a long-term perspective, inflation is coming down. You will not
get a big inflation shock."

Lamoureux's reasons for why Treasuries are still a good buy (and not in a bubble) also include:

 

Financial deflation:
While the price of many goods and services continue to rise,
Lamoureux estimates there has been a 2-4% annual contraction in the
money supply since 2008. In other words, deleveraging is overcoming the
expansion of the Fed's balance sheet.

 

Diversification: Treasuries are "the only asset class that compensates you" if stocks go down, he says, calling U.S. debt the "last diversifier left."

You
can watch the interview with Mr. Lamoureux below. His views on
financial deflation are echoed in Hoisington Investment Management's Q2 economic letter.

Also,
his point on diversification is important because in a low interest
rate environment, asset classes tend to be a lot more correlated than
investors think. With so much pension money flowing into real estate,
private equity, commodities, and infrastructure, this should worry us.

If
a protracted period of deflation does materialize, it will ravage
private markets. The Fed will do whatever it takes to avoid such an
outcome. Bottom line: We might be in for a long period where both bonds and stocks trade in a range. Better pick your spots carefully.

 

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Tue, 03/22/2011 - 18:40 | 1087685 epayroll
epayroll's picture

explained the actions of these two, I dare not say morons as they are a brilliant man in one. http://www.jankovicllc.com

Sun, 08/01/2010 - 10:00 | 498478 ZackAttack
ZackAttack's picture

So, riddle me this - 10y at 2.9%, 30y mortgage at 4.5% - the point of QE2 would be *what*, exactly?

Sat, 07/31/2010 - 17:26 | 498138 swamp
swamp's picture

so, there I was driving down the freeway…..

 

when I come up on a prius.

 

on the rear bumber was the osama/biden 08 sticker.

 

then it hit me……and explained the actions of these two, I dare not say morons as they are a brilliant man in one.

 

obama/biden=osama bin ladin. they just reversed a few letters.

 

its all clear to me now. its been in front of us all this time. or in back of us on the bumper.

Sat, 07/31/2010 - 15:44 | 498056 Grand Supercycle
Sat, 07/31/2010 - 14:10 | 497924 spinone
spinone's picture

We have a privitaized, debt based fractional reseve currency.  Once it is debt-saturated, it is broken beyone repair.  And it is.  People are defaulting on their loans, and there are fewer and fewer borrowers with collateral.  The currency in circulation can no longer grow through the fractional reserve system.  So people can't get their hands on the money to pay back the principle PLUS interest.  So more people default on their loans.  A self-reinforcing cycle.

The FRN is toast.  Dead man walking.

Get out of treasuries and equities, and anything dollar denominated.  Go into the currencies of resource rich countries.

Exchange some FRN's for gold and silver while you still can.

Sat, 07/31/2010 - 13:12 | 497864 4shzl
4shzl's picture

Nobody dislikes what Bill Gross represents more than I do -- he's a shrewd sleazeball who's figured out how to parlay political influence to offset his screwups as a portfolio manager.  By whining, threatening, and blustering about the "systemic risks" posed by GSE debt, he managed to get a boatload of Pimco's toxic MBS offloaded on taxpayers making him one of premiere corporate welfare queens of our time.  HOWEVER, regardless of how you may feel about him, it is not a smart idea to be on the opposite of a trade with Gross.  Anyone thinking of shorting Treasuries should listen carefully to the Bloomberg interview with Gross linked below.  Pay special attention to his reference to Bullard's recent speech and to the swarmy manner in which he slimes his way around the question of whether he's "one of those doom and gloomers who believe that a depression is inevitable."  This guy is going to eat Nassim Taleb and the other Treasury bears for lunch.

http://noir.bloomberg.com/apps/news?pid=newsarchive&sid=axOlI7jOQOmc

Sat, 07/31/2010 - 11:26 | 497763 laosuwan
laosuwan's picture

 have always wondered, how did the rich stay rich during the great depression in america? This might be the key to understanding how to play the coming collapse of the dollar. during the depression, banks failed and stocks went to zero, right? Where, exactly, did the rich stash their wealth to ride through all that?

Sat, 07/31/2010 - 06:59 | 497580 Ned Zeppelin
Ned Zeppelin's picture

Apparently the trucking industry  is reporting no luck with their share of the global liquidity tsunami.

http://www.businessinsider.com/trucking-industry-says-economy-is-slowing-2010-7?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+clusterstock+%28ClusterStock%29

Went to a seminar on short sales yesterday - looks like as HAMP craps out the next step Treasury has in the works is managed short sales of all those houses. Apparently there is a fair amount of sentiment that the HAMP program has been a bust (no shit) and that it is time to start taking the medicine, but foreclosures and turning all thoses homes into REO makes for REALLY big losses so this is the step just before liquidation.   Programs timelines have been shortened, and you even get a check for "relocation assistance" and release from residual liability as you step away from the underwater wreckage that used to be your dream home. Sales prices are far below comparable sales.  Ugly.  Look out below. 

Sat, 07/31/2010 - 03:24 | 497550 NERVEAGENTVX
NERVEAGENTVX's picture

So can anyone tell me how much of reported GDP growth is simply new debt creation and how much of it is real productivity?

Sat, 07/31/2010 - 01:33 | 497528 Orly
Orly's picture

Thanks, Leo.  The Hoisington report was a good read.

Fri, 07/30/2010 - 23:59 | 497494 DoChenRollingBearing
DoChenRollingBearing's picture

I have some medium-term Treasuries that I bought years ago.  They, of course, have gone up.

A year or two ago I thought I would partly hedge that position by buying some TBT (the ETF that goes UP twice as fast as bonds go DOWN).  Bad hedge!  But, I would not buy any Treasuries now, I own enough thank you.

If we do get real deflation, cash will be almost as good as Treasuries and gold will not do too bad.

Danger everywhere!  The markets are very treacherous.

Sat, 07/31/2010 - 00:29 | 497507 dnarby
dnarby's picture

Repeat after me:  Leveraged ETFs are for short term (3 weeks or less) trades ONLY.

Now repeat that until you pass out.

...My work here is done!

Sat, 07/31/2010 - 09:41 | 497686 Leo Kolivakis
Leo Kolivakis's picture

Agreed, mostly hedgies trading these leveraged ETfs and retail suckers buying and holding them. Most of you should avoid them at all cost.

Sat, 07/31/2010 - 12:52 | 497841 4shzl
4shzl's picture

This is the absolute, mathematically demonstrable truth.  Only an ETF-shill or a cretin would junk this comment.

Fri, 07/30/2010 - 23:29 | 497478 Astute Investor
Astute Investor's picture

Chinese solar stocks are the last diversifier left...

Fri, 07/30/2010 - 22:41 | 497429 vxpatel
vxpatel's picture

did the author mean treasure, like pirate's booty?

Fri, 07/30/2010 - 21:22 | 497352 pitz
pitz's picture

Japanese deflation isn't a monetary phenomenon, but rather, one of the state of external demand. 

This is the mistake that commentators often make when they try and discuss Japan, and try to link Japan's monetary policy with deflation.

Fri, 07/30/2010 - 22:43 | 497431 litoralkey
litoralkey's picture

A simple way to demonstrate this would be a 4 axis graph that shows:

1. start at 1980 or so(maybe the start of Carter recession?)

2. Japan trade flow, import, export, net from then to present

3. US trade flow, import, export, net from then to present

4. US-Japan trade flow, paired, and net.

Add second graph showing GDP , debt and debt to gdp ratios of each country.

then be snarky and add in Argentina and Greece as addendum graphs.

 

All to drive home your point:

Japan didn't collapse due to exports.  The US and PIIGS have no such saving grace.

This is not rocket science.

 

Fri, 07/30/2010 - 20:25 | 497313 Bagbalm
Bagbalm's picture

Do you notice all the revisions are to worse numbers? If it was an honest miss some would be a little high some a little low. But ALL the revisions are bad news. This is because the government numbers are all bare faced lies from scum sucking criminals who wish to suck you into making bad decisions based on falsehoods about fake prosperity.

Don't fall for it.

Fri, 07/30/2010 - 20:05 | 497298 Hedge Jobs
Hedge Jobs's picture

good post Leo, thank you.

your comment "Fed policy right remains geared entirely towards banks, allowing them to continue borrowing on the cheap to invest in risk assets all around the world as they shore up their balance sheets. This is why I remain bullish on stocks."

i agree with you, this may continue and from a trading perspective go with the flow. You are correctly saying that markets are artificially inflated and this is the problem. From an investment perspective though no one is going to touch this market except the fools, until you run out of them.

coat tail the algo's and the FED and trade it up if you can but based on your post investors should continue to come out of any artificialy inflated markets. As we all know too well artificiallly inflated markets can only remain detached from reality for so long.

Fri, 07/30/2010 - 20:03 | 497292 RSDallas
RSDallas's picture

Leo,

Just keep up with Hoisington's newsletter.  It will tell you everything you need to know.  It's all about debt baby, debt.

Fri, 07/30/2010 - 19:44 | 497269 Rainman
Rainman's picture

If the Fed will do whatever is necessary to combat deflation, so far the bond market has grown more and more brazen in dissing Ben. I also remain skeptical the Fed can win that fight. The 10y at 2.9 is amazing to me, but makes perfect sense under the pressures of a slaughtered housing market coupled with the work of the invisible hand and the growing prospect of a hard landing on deflation island ( aka Japan ).

I agree, though, that deflation will create a lot of dead bodies. More casualties than we want to imagine. But it looks like it will be hard to avoid. Take away the effects of stim and QE and you're looking at negative organic GDP. We can easily build an argument for stagflation under those assumptions. Going forward is all red ink on public sector joblessness, maybe a half million. I don't think the electeds have the balls to bail the States before November and afterward the one party rule extravaganza will likely be over.

If we see prolonged defaltion and a long term continued suppression of fear ( covertly suppressed/covered by our masters of course ),  the biggest brain fart I have is  about commodities. Especially gold.

In a modestly compromised environment, a lot of this would just be the normal blurry. Today I am nearly blind.

  

Fri, 07/30/2010 - 19:20 | 497250 UncleBen
UncleBen's picture

Leo, you've said many times that they'll reflate the "markets" at ALL costs. What you never seem to want to consider is that once the TBTF's and CONgress-trolls have completed their escape from said market, the rest of the great unwashed that are long will not know what hit'em during the ensuing cascade lower that is sure to come

Sat, 07/31/2010 - 09:22 | 497666 A Proud Canadian
A Proud Canadian's picture

The SM was chased up in the 80s and 90s (along with housing and "toys") because of that massive hive of Boomers.  Now, "we" are retiring and there is just no replacement for our extra cash to drive the market higher.  You can't ignore the effect of the boomer generation...from schools and universities in the 50s to 70s to housing boom and the SM boom.   We have turned the corner now, though, and the buying days are over......well, maybe catfood.

Fri, 07/30/2010 - 18:52 | 497226 Rogerwilco
Rogerwilco's picture

Yes, near-zero interest rates make perfect sense, so load up on treasuries!

Who are these tools?

Sat, 07/31/2010 - 00:26 | 497506 dnarby
dnarby's picture

"The output gap is deeper than we previously thought, but there is another reason why the Fed will remain on the sidelines for longer than we think: it wants to see asset reflation translate into mild inflation and avoid a protracted deflationary scenario at all cost."

 

Well then...  They better get QEv2.0 online ASAP.

Oh and "mild".  Ha ha.  Ha ha ha ha.  Heh.  Good 'un.

 

"Importantly, Fed policy remains geared entirely towards banks, allowing them to continue borrowing on the cheap to invest in risk assets all around the world as they shore up their balance sheets. This is why I remain bullish on stocks."

 

Annnnnd...   This is why the S&P, adjusted for inflation, has returned -30% for the last ten years...And is poised to double that return!  What a steal, stocks 'r cheap BUYBUYBUYBUYBUY!!!

Holy crap.  This is so thouroughly pooched.

Do people really believe this horse$@#%?

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