A Time of Risk
Board: Macro Economics
The Control Panel looks almost exactly like May 2010 and 2011. Every indicator has fallen out of bed (out of the recent stable trading range).
The G-8 meeting in Camp David ended with the many borrowers urging "growth" (i.e. lending at low rates) and Germany, the lender, urging fiscal responsibility (i.e. borrower austerity so the lender can be repaid). China, a big lender, is not part of the G-8, so Germany was pulling against 7.
When lenders see risk, they charge higher interest rates. It's easy to read the charts and news today:
Extreme risk of a severe risk-off trade in the next few months!
Stock prices will drop. Leveraged buyers and ETFs will throw out the baby with the bathwater to raise cash.
Bond prices of high quality, flight-to-safety bonds will rise. The 10 Year Treasury bond yield is 1.7%, an all-time low, and the fun has hardly begun. The Wall Street Journal is predicting 1.5%. If and when the U.S. economy recovers, Europe stabilizes and the Fed frees the bond market, real yields will rise to their historical average of 2.3% + inflation and the owners of $15 Trillion of Treasury debt (including the Fed) will be decimated.
Treasury real yields, which are already negative, will become more negative as the 2012 crisis intensifies in the next few months. The dollar will rise and gold may rise as a flight-to-safety asset even if the dollar also rises.
A 2008-like international banking/sovereign debt default crisis may ensue. (The risk of this type of crisis is lower than a 2010/2011-type problem, which I regard as almost 100%.)
Greece's likely departure from the Euro zone may cause dramatic repercussions, possibly including other insolvent nations, such as Portugal and Spain. The 10-year Spanish bond yield is over 6.25% and spiking.
Every market indicator points to an upcoming recession, including the "mungofitch indicator" of the copper:gold ratio. The sensitive SPX:Gold ratio is also dropping like a stone, since the SPX is dropping while gold is rising mildly.
The St. Louis Fed Financial Stress Index has bottomed at a higher low than in early 2011. This is a weekly report, so it is very timely. While the Financial Stress Index may remain stable, I don't think it will. HYG, the iShares High-Yield corporate bond index is dropping like a stone, just as it did in 2010 and 2011. Junk bonds are sensitive to both economic conditions (because the companies are financially weak) and credit conditions (because lenders may cut off lending completely to weak companies, as they did during the 2008 credit crunch).
YOY M3 growth is about the same as YOY inflation. Excess money will not support across-the-board asset price inflation, so assets will compete. If bond prices rise, stock prices will fall. This is the historical norm, but the Fed has pumped so much excess money for the past 3 years that investors are used to stock and bond prices rising simultaneously.
The U.S. economy still appears to be growing slowly. A few indicators hint at possible slowing, but most are within their recent channels. If not for the threat of another credit crisis, I would be optimistic about the markets because stability engenders confidence.
M2 is still rising, but the velocity of M2 in 1Q2012 fell again to a post-1957 low. M1, the M1 multiplier and M1 velocity are also low.
Sorry, no confidence today! Every stock market sentiment indicator is going wild. Volatility, bullish percent, New Highs-New Lows, Advance-Decline -- all have suddenly and dramatically deteriorated, just as they did in 2010 and 2011. This presages an even worse drop over the next few months.
This is a time of very high risk. As METARs, we read the indicators and predict the weather. A storm is moving in and the first gale flags are waving. Personally, I began to take cover in April, when the sun was still shining. The barometer is dropping and the anemometer is whirring. The winds are picking up and the rain is beginning to fall. If you are a storm-chaser, enjoy the risk. If you are risk-averse, shed risk before the real storm hits. We have seen this before, so we know what is coming.