Bill Cara: It's all in the slope, folks, Mon., Nov. 21, 2005, 2:46 PM

« Portfolio decision, Mon., Nov. 21, 2005, 10:55 AM | Main | Gold & silver stocks ran to the upside, Mon., Nov. 21, 2005, 5:40 PM »

November 21, 2005

It's all in the slope, folks, Mon., Nov. 21, 2005, 2:46 PM

I have often addressed the problem of a flattening Treasury yield curve, so I thought I'd just show you some screen shots to illustrate the point. These come from StockCharts.com, starting with Year-end 1999, which happens to be the last time I stopped blogging (I knew the bull market had entered the Distribution Zone) in order to return to the securities industry to build another brokerage firm. I next chose (Illustration 2) the peak price of the S&P 500 index near the end of 3Q00, and followed that by selecting (Illustration 3) the confirmed bottom of the 2000-2003 Bear Market, at the end of 1Q03. Finally I show the yield curve as it exists today.

I recommend you follow this link to StockCharts.com and try this interactive tool yourself. If you haven't done this before, I think you'll find it enlightening.

Year-end 1999:

Peak of S&P 500 late 3Q00:

Confirmed end of Bear Market late 1Q03:

Yield curve today:

Note the similarity between the yield curve of today and as at year-end 1999.

If yields of today jumped to those of 1999-2000, by roughly +150 basis points across the board, then I believe that the present housing market bubble would pop, rather than have the air let out slowly as is now happening.

Should the Treasury continue to print money the way it has, and the way it must in order to meet the fiscal deficit of government, then there will be inflationary pressures.

And should the Fed continue to raise rates the way it has, and the way it must in order to stabilize prices (i.e., combat inflation), then the more downward pressure there will be on economic growth. These are also deflationary pressures.

As long as the U.S. Treasury continues to reflate, and the Fed continues to tighten, the yield curve will continue to flatten, and will soon invert, similar to what happened in 2000.

Finally, should the present circumstances stay intact, with conditions of global inflation, and slowing economic growth plus Treasury reflation in the U.S., but the Fed stops raising rates; then there will be an inevitable rocketing of precious metals markets.

In fact, in my view, four-digit gold prices are possible in 2H06, if the new Fed Chair, Ben Bernanke, makes a decision to stop raising rates in the 2Q06.

As a lawyer might say: In this relatively uncomplicated matter, the issues are joined for review."

You be the judge.

Posted by Posted by Bill Cara on November 21, 2005 02:46:11 PM | Category: Economics

Discourse

"If yields of today jumped to those of 1999-2000, by roughly +150 basis points across the board, then I believe that the present housing market bubble would pop, rather than have the air let out slowly as is now happening." As I understand it the more leverage in place the greater the sensitivity to rates (be it a company, industry or consumer). The poorer the balance sheet in regards to reserves the more vulnerable to hardship. The more leverage the greater the sensitivty to a decline in collateral values.

We clearly have more leverage in place today, less reserves (negative savings and negative wage growth) and worse balance sheets for the U.S. consumer (historic lows in safe assets to risk assets).

It does not make sense to me that the real estate market would not crumble until rates got back to 1999-2000 levels (when incomes were stronger, balance sheets were better and Americans felt invincable).

Perhaps the best evidence of the increased rate sensitivity in the U.S. is the past 20 years of business cycles. In each case rates were increased during the recovery phase and got the desired result AT A LOWER PEAK LEVEL than the prior cycle. In each case rates were dropped during the contraction phase and got the desired result AT A LOWER TROUGH LEVEL than the prior cycle.

In addition real estate (like technology) has followed a self reinforcing cycle which tends to be difficult to unwind without disruption- especially when leverage is involved.

"Note the similarity between the yield curve of today and as at year-end 1999."

In 2000 the long bond yield DECLINED by 100 bps following that 'similar' yield curve.

These points I am mentioning not as criticism but rather for discussion so that I might better understand the bear case for bonds.

I have added long dated STRIPS to my TLT position. I am also heavily long gold and miners as I believe that 1) Helicopter Ben will stop raisng rates in 2006 and 2) that you are correct in what that means for gold.

Posted by: stockman at November 21, 2005 4:38 PM [link]