Guest Post: How A Credit Market Prices In Economic Recession

Tyler Durden's picture

Submitted by Tony Palotta of MacroStory

How A Credit Market Prices In Economic Recession

In a prior post I compared the 2007 SPX topping pattern to the current May 2011 high. The assumption being the US economy is on the verge of an economic recession now as it was in December 07 when the recession officially began. The similarities were unquestionable (chart below). The unknown is are we building point E.  Those believing recession is at hand will say yes, those saying it is a soft patch will say no.

Well what do the credit markets say and what explains this 40 basis point move in the 10 year. The end of QE1 actually showed yields falling so history would be on the side of the bond market catching a bid versus the relentless selling going on this week.  Well the comparisons with the 10 year treasury  in the second half of 2007 and the current period are again striking similar.  Equally striking is that we have precedence for such a parabolic move in the 10 year yield.

Point A in 2007 saw the 10 year peak at 5.31% on June 13, 2007, exactly four months before the SPX peak. Point A in 2011 saw the 10 year peak at 3.74% on February 9, 2011 exactly three moths before the SPX peak.

Point B in both instances saw a major move lower in yield.

Point C saw a sharp rebound in yield only to commence another major move lower.

Point D in both cases has coincided with the final ramp job in equities before the real selling finally began (unknown for 2011). 

Point E in 2007 was as parabolic then as it has been this week with the 10 year moving up 40 basis points in 10 calendar days before commencing yet another major move lower in yield.

As of this post the SPX is testing the backside of the 2009 up trend (granted this line can be drawn multiple ways) which for someone seeing economic recession around the corner would find this a pleasant location for Point E.

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bob_dabolina's picture

In a prior post I compared the 2007 SPX topping pattern to the current May 2011 high.

Correct me if I'm wrong, but isn't that like comparing an elephants testicles to spit balls? We didn't have Brian Sack buying blocks of SPY on his e-trade account back then.

Boston's picture

Starting today, Brian Sack's e-trade account has been severely curtailed.  If that's what you need to buy into an equity sell-off, you pretty much have it.

Just give it a few weeks for the "effects" to be felt.  Remember, last year's QE1 ended 3/31. Equities kept on rising for almost three more weeks, until they finally turned down.


Common Man's picture

"Well what do the credit markets say and what explains this 40 basis point move in the 10 year. The end of QE1 actually showed yields falling so history would be on the side of the bond market catching a bid versus the relentless selling going on this week."

Bonds caught a bid cos QE2 was expected....not the same with QE3... not yet atleast

Boston's picture

Bonds caught a bid cos QE2 was expected


T-notes started rising weeks after QE1 ended.  You're trying to say that the market was expecting QE2 right then, in late April, when the Fed was in fact discussing asset sales!?

You're off by about six months dude.


dcb's picture

I think you would be better off with a comparison at the end of QE one, and that insane ramp from that level. this was the best rally for two years and stock prices well above long term cyclical PE fair values. So to me it is a BS rally, with short covering to push it up some. also there is the end of repo 105, which should always be considered. the main thing to remember know is that without Qe and the constant money infusion the market will have to drop to go higher and profits taken to be put back into buying stocks at a lower level. we should not be able to sustain the endless rallies that were a product of government manipulation. I believe it is likely the profit cycle peaked, but that's my view.

Atomizer's picture

SIFI - FSB surprises. :)

WikiLeaks' Brilliant MasterCard Commercial Parody


Atomizer's picture

It has been gone long ago, this is why MeoObama is pretending to be in control with another 5-1/2 years left.

Atomizer's picture

Obama: If you don't raise the debt ceiling, all government services will be suspended. We must pay our china interest bill first.



taca's picture

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buzzsaw99's picture

ah, the good old days when there was a correlation. One glaring difference was that Point A in 2007 witnessed a ffr of 5.25%. This is a different environment with a different type of criminality at the helm. zirp 4evah bitchez.

KennyG09's picture

Sorry this is OT...

I've been thinking about the whole bitcoin ordeal. You think the recent takedown in bitcoins through Mt. Gox has anything to do with Wikileaks? I ask this because of the banking blockade put on the site. They started accepting bitcoins instead. Can anyone offer some insight? 

Jack Napier's picture

Forget BitCoin unless you want to do Silk Road, keeping in mind it is not nearly as anonymous as people think. Anybody can setup a bridge and monitor traffic. And how are you supposed to cash them in if infrastructure breaks down? It's dependent on the internet which will certainly not outlast gold and silver.

As for your question, I don't know, but it makes sense that they would choose BitCoin due to its decentralized nature which does have its benefits. No bank can put a stop on BitCoin commerce, but could certainly manipulate it if they wanted to. Judging from the 66% drop in a week last month, it's probably already happened.

KennyG09's picture

I've noticed a trend that most people on ZH that ask questions get junked to high heavens. I'm fine with that. Pertaining to BitCoins, I never said I was interested in them. Just doing some honest research into the cause and effect of how the system works. I found it interesting that WikiLeaks took them as payment. With all the attacks on their site and the bank blockade, I thought it plausible that there might be something down that road.

Pertaining to the credibility of BitCoins, I most certainly agree. I would add that they have no value in themselves. They aren't backed by anything. In the final analysis they're just like fiat currencies. They rely heavily on the next guy buying into the scheme. I think the reason they became so popular shows the kind of times we're in. Times where people are looking for a way out of the corporatist monopoly on paper currency.

Jack Napier's picture

I didn't mean to imply contrary to what you just explained. Sometimes I just get going ;) I think it's just as simple as WikiLeaks using whatever medium works when there are no other better options available. And you are right that the attraction is being outside the control of banksters, in addition to the built in deflation due to a hard limit on how many can exist in the future coded into the protocol. I think this deflationary aspect is what will cause BitCoin to fail when a BitClone comes out and people jump ship to get in on the same type of deal earlier on in the lifecycle for better profits.

Cthonic's picture

Though not as familiar with Bitcoin as I should be, I get a very bad vibe from the entire operation.  Before utilizing a such a system, there are three key questions one might ask:

1) Who am I trusting explicitly,

2) Who am I trusting implicitly,

3) What are the downsides when that trust is compromised.

Really don't have the time or inclination to post my background with regards to this sort of venture, other than to ask if anyone here ever read J. Orlin Grabbe's original proto-blog.

Eternal Student's picture

It's a misnomer to say that bitcoins were taken down. The bitcoin market operated surprisingly well without Mt. Gox. It was Mt. Gox that was taken down, not bitcoins. Please don't confuse the two.

Mt. Gox was taken down by their own incredible ineptitude and stupidity. They were a complete accident waiting to happen. Understaffed, undertalented and absolutely no idea whatsoever about security. Really, they did so many things wrong it's staggering that they could get as far as they did.

And, mark my words, they will go down again. That's just the way these things work. They won't be putting in the proper security procedures, because they don't know how to, and don't have the right attitude about it.

If I had money in bitcoins (which I don't), I wouldn't touch Mt. Gox with a 10 foot poll. Use an exchange with an unblemished record. Tradehill perhaps. You simply deserve to get burned if you use Mt. Gox. The next time though, it will be due to your own stupidity, and not Mt. Gox's.

Boston's picture

One more interesting point to support TD's earlier point about this week's equity spike being mostly about short-covering.  Take a look at the McClellan Oscillator's weekly close at 89.65

1. This is the highest weekly cloe in several years. 

2. After every spike like this before, a major reversal (back down) ensued, within a week or two.

In other words, a very compelling (risk/reward) shorting opportunity is being set up.  But given the force of the move (up) this week, we'll probably see some follow thru before the reversal begins.


mcguire's picture

look how far out of the boligner bands today's move is... 

Boston's picture

Yup, on a lot of charts---S&P directly, McClellan, VIX, etc. etc.  A reversal is around the corner.

mcguire's picture

tony, you should redo the charts, now that 'point e' has blown through 1320 all the way to 1340... 

snowball777's picture

So it looks even more like 2007?

baby_BLYTHE's picture

Ben has never been correct in any of his predictions

"No Double-Dip"- Benocide 2009

He is going to eat those words soon. I look for it to come apart spring 2012, if not sooner.

Itsalie's picture

The first chart showing the 2009 SPY uptrend line looks strange; I have not seen any chart showing SPY/DOW has crossed below that uptrend line, eg last week GS's John Noyce showed the Dow and SPY and Kospi all touched the line, but reversed strongly this week; only Shanghai has crossed below, and is now back above that uptrend line. But market needs to go south again sometime in July, before Jackson Hole right ?

Tater Salad's picture

ISM will soon go below 50, that should make for quite a set up given the market's full on tard ramp of the last week.

carbon based unit's picture

very pretty pictures ... except that you left out the last two days of the SPX rally for some reason.  its not like they hadn't happened yet and you've got the chart adjusted so that they aren't displayed;  they clearly take the SPX up above your descending trend line.


i'm not saying you necessarily did it intentionally; nor am i saying that your example of history rhyming is wrong.  what i am saying is there are some cracks in the thesis that for some reason you're not divulging.  

MacroStory's picture

The SPX post I reference was two days ago so not updated at the time of the credit related post.  I still see Point E on the equity scenario in play.  My reason for studying the relationships posted to sense how psychology is at market tops. One way to look at this ramp job of this week is capitulation of the bears and final euphoria of the bulls.  Anyway, that's the reason the SPX 1340 was not included.

Highrev's picture

This article and the first of the series both give many reasons both technical and fundamental why last week's rally is the second of the two possibilities I pointed out yesterday.

BTW: Daneric has a possible running triangle count (as the author comments, his A-B-C-D-E is different from the Elliott Wave that Daneric uses).

Worth the look and reflection on the bullish possibility all the while asking yourself the same that Tony Palotta asks in his first article:

In this highly leveraged, exuberant and low cash market why are we to think 2011 is any different?

qussl3's picture

My personal inclination is that we are wil-e-coyote past the cliff, but in the interest of exploring all possibilities, and giving myself reasons to hedge, this is why it may be different.

China going full retard on divesting its USD assets.

For better or worse the algos are keyed into weak USD - markets up, and barring a major exogenous event i do not see that programming changing.

Thus it is entirely possible that China in its efforts to undermine the petrodollar, may attempt to press it below what the GCC will accept. Since they already have the Ruskies lined up with ruble-yuan swaps so they may get away with importing most of thier energy needs ex dollar.

By killing the petrodollar, there would be little reason for ALL nations that carry a trade surplus with the states to recycle USD fx receipts into USD assets, they would be better off converting into assets or currency of thier other trade partners. Thus the USD will reflect its true trade weighted value - much lower than what it is now, which would in turn goose both algos and repatriated profits.

Shoot away.

oldmanagain's picture

On the last bottom I felt a good rebound was in order due to stimulus, etc. I also expected more infrastructure, Washington spending, then I envisioned another long wave down due to resource headwinds.  Somewhat like the seventies, particularly in the bond market where higher interest rates curtailed growth periodically.

I did not forsee QE or the threat of Austrian wet dreams. One can further inflate the effects of the resource headwinds while the Austrian contraction curtails growth and other practices needed to combat real world problems. As some economists have pointed out, a trillion dollar cut in government is about a 14% contraction in multiplier and real loss in GDP.

What we seem to be doing is somewhat facing the derivative problem, somewhat for the derivative people own the governments. courts.  The other is a vicious, emotional, paid campaign to discredit any efforts in needed regulations, taxes, or sympathy for about 98% of the population. Most of this is just name calling and labeling. Look at ZH.  MSM.

The targets of the venom, (some of it is directed at real culprits, but most is also against those opposing the real culprits,) is misdirected.  Not only that, they refuse to acknowledge how we got here and what the real problems are that confront us.  Some how this has even gotten mixed up with religion. At least the pay for opinions sections.

The Ron Paul section of this mess endorse default.  For many others, it is lets get Obama for various reasons.  Krugman will likely prove correct, we should have completed the task when it counted.  The paid disinformation is so prevasive that it now rules. When I am not reading ZH, or other sites, I think default is not possible.  I wake up and find it could happen. We racing up the volcanoe to see what all the commotion is about and to give a token of worship to the gods.

Our future looks to be one of contraction, with heavy periodic periods of high prices/scarcity.

Stocks were priced at ten times valid earnings if a solid company.  Fifteen time for growth.  
Twentty for wild, exceptional potential THAT LOOKED very likely. We are about 40% overvalued on that scale.  However, that does not factor in a batsh't crazy political/econ theory dictating our complete Austrian induced collapse.  When do the sheeple see that the volcanoe of resource depletion is erupting and will kill  all.