Who’ll Buy Treasuries after QE2 Ends?

April 30, 2011

As expected, because the Fed’s QE pump is still running, the S&P500 managed to grind higher in the face of another round of bad news, domestically and internationally.  Volatility, perhaps because it’s nearly as low as it ever goes, crept up slightly.  Volume was light, as usual for weeks when prices grind higher because of Fed money printing.

More signs of economic slowdown emerged last week.  New home sales for March were the lowest on record for the month of March.  The Case-Shiller index of home prices came in worse than expected, which once again confirmed that the housing market is in full double dip mode.  Although headline durable goods were better than expected, the ex-transportation number was below.  Initial jobless claims have now made a decisive turn for the worse; they came in much worse than expected at 429,000.  The first estimate for 2011’s first quarter GDP growth, at 1.8%, was also worse than expected.

The US economic growth is grinding to a halt.  And this is happening DURING the Fed’s second QE monetization program.

Technically, the S&P on a daily basis is as overextended as ever.  Bearish divergences  are everywhere.  On a weekly basis, the picture is also one of an overstretched bullish rally that’s just waiting to snap back down.

Conventional wisdom is arguing that when the Fed winds down its QE2 program in June, the US Treasury market will lose its largest buyer and therefore, Treasury prices must fall and yields rise.

So a lot of traders are setting up for a bearish period in US government paper.  In fact, one of the largest bond investors—Bill Gross of PIMCO—has publicly announced that he will not buy Treasuries until after QE2 ends and yields rise.

In the last several weeks, we’ve noted that the last time QE ended, the exact opposite happened—instead of yields rising, yields fell.  So we argued that something similar may also happen after QE2 ends.

The question, however, still remains:  WHO will do all the buying of US Treasuries.

Well, the buyers could be the same investors who’ve benefited from the massive Fed easing program over the last six months.

These investors have sold much of their Treasuries to the Fed (and Fed backed dealers) and rotated their capital into stocks, bonds, and commodities.  And these Risk-On assets have—over these last six months—risen tremendously in value, generating trillions of dollars in new wealth for these investors.

How many trillions?

Well, if we consider the stock market alone, using one of the broadest measures (the Wilshire 5000), stockholder wealth has jumped $4.1 trillion since QE2 was pre-announced by Ben Bernanke at the Jackson Hole economic speech in August 2010.

And that’s only the STOCK market!

Imagine how many more trillions of dollars have been created in corporate bonds (investment grade and high yield), in overseas investment gains, and in commodity gains.

Yet the Fed has been printing and buying only about $75 billion of Treasuries per month……..a tiny fraction of all the wealth created over the last six months.

So who’ll buy Treasuries after QE2 ends?

These same investors will.  When the liquidity pump stops, and any reasonably meaningful phase of Risk-Off begins, some of this newly created trillions in wealth will rush into the safety of US Treasuries.

Let’s just guess that a total of $7.5 trillion has been created—in total since August 2010 ($4.1 trillion from US stocks and $3.4 trillion from EVERYTHING else).

And let’s just guess that only 10% of this total would rush into Treasuries.  That would mean that $750 billion would flow into US government debt markets.

The result?

Not only would there be more than enough capital to buy new Treasury issuance for the next six months, but it’s very conceivable that the tsunami of capital (especially if more than 10% rushes in) could shove the yield on US Treasuries DOWN, exactly the opposite of what many experts are calling for later this summer.

In fact, if the Risk-Off phase becomes severe enough, it would not be surprising to see the US 10 year yield drop well below 3.0%, perhaps even below 2.5%.

So THAT’s who could buy US Treasuries.  And THAT’s how low yields could fall.

Let’s Pretend

April 23, 2011

After plunging early in the week, the S&P500 jumped back to finish the week up about 1.3%, but on lower volume than the preceding two weeks when it fell.  Technically, as predicted last week, the S&P did drop quite a bit (almost two percent at one point), but it did not carry through on the sell-off.  As discussed many times over the past three months, it seems that virtually nothing (short of nuclear war perhaps?) is able to counter the power of the Fed’s QE2 stimulus, which is almost 90% correlated with the entire bull market rebound starting in March 2009.  So we will wait patiently until QE2 begins to wind down, over the next 45 days.  And now, technically, in addition to the positive monetary stimulus, the S&P is poised to bounce up even further, if it breaks above the 1335 resistance level.

We could be in for another 30-45 days of Fed-induced stock market pumping.

There wasn’t a lot of macro data announced last week.  Housing starts were slightly better than expected, but much improvement came from multi-family units, not single family homes.  Existing home sales in March were also a little better than predicted, but they were 6.3% lower than they were last year in March.  Initial jobless claims were weaker than expected, again coming in above 400,000.  The Philly Fed Survey shocked everyone by plunging to 18.5, when a reading of 36.0 was expected.  And the FHFA House Price Index fell 1.6%, also much worse than expected.

Charles Hugh Smith, from Of Two Minds, recently published a neatly packaged description of the two faces of the US economy.

There’s the “let’s pretend” economy that’s touted by the government and media propaganda machines, and then there’s the real economy, “which is in decline”.

He cleverly compares the “let’s pretend” economy to the game little children play, and lists the number of ways our leaders are brainwashing us into believing that the “pretend” economy is real.

First, he states “let’s pretend that jobs are coming back”, and ignore the fact that total payrolls today are lower than where they were in 2001, and not much higher than they were last  year.  And we must ignore the little fact that the employment population ratio (the simple percentage of all folks in the US who are working) has fall back down to levels from the 1970’s.

Second, he says “let’s pretend that households, corporations and government are reducing their debt”.  So we must ignore that total credit market debt is still—today—at record highs, almost two years after the so-called recovery began.

Third, he asks us to “let’s pretend that wages are rising”.  Just ignore the fact that real wages age back to the “pre-dot com bubble days of 1996, when–as mentioned above–the household debt loads have soared since then.

Fourth, “let’s pretend corporate profits are the most important metric of our financial well-being”, and that “those corporate profits trickle down to the greater good”.  Forget the reality that the record corporate profits mostly benefit the upper 5% of income earners and wealth holders in this country.  And nevermind that the lower 95%, who depend on pensions in retirement, are still severely damaged by the Great Recession because their pension fund assets have not fully recovered.

Smith concludes that we can keep playing this game of “let’s pretend” for a while longer.  But eventually, this game—as all games do—must end.  Eventually, we will have to return to the grown-up world and face reality.

And the reality is very scary.

Technically Speaking

April 16, 2011

The S&P500 lost 0.6% last week on light, but growing volume.  The down week, the second in a row, is suggesting that the post Japanese tsunami rebound is losing steam.  The last several weeks have all the makings of a dead cat bounce.

The big picture in the economy is deteriorating.  During the last week, several large Wall Street banks have announced major revisions–downward–to their 2011 economic growth forecasts.  Last week, we learned that the US trade imbalance grew larger, and more importantly, larger than expected.  Retail sales also rose less than expected.  Initial jobless claims jumped back solidly into the grim 400,000 range; they were expected to fall to 380,000.  Producer prices rose a bit less than expected (good news); but core PPI rose more than expected (bad news).  Consumer prices met expectations; core CPI rose less than expected.  Industrial production was better than expected, but this is often a lagging indicator.

Other developments also raised warning flags.  Several key (first quarter 2011) corporate earnings results were very disappointing. Alcoa’s sales missed expectations.  Bank of America missed badly on the bottom line–even after making several positive accounting adjustments.  And Google disappointed.  All three were hammered in the stock market losing between 5% and 10% each.

Technically speaking, the dead cat bounce over the last four weeks could be the second top of the bearish double top formation.

What makes this second “top” bearish are the multitude of indicators that did not rise nearly as much as prices rose—prices almost recovered to the February highs.

For example, volumes behind the second top were notably lower than the already anemic volumes behind the first top.

Also, momentum waned.  The momentum indicators during the peak of the second top were far weaker than they were during the first top’s peak.

Breadth also faltered.  The difference between the number of stocks setting new highs and the number setting new lows measures how broadly stocks participate in a rally.  The more breadth, the stronger the rally.  But that’s not what happened during the second top.  A comparison of new highs to new lows, and their derivative indicators (the McClellan Oscillator and Summation Index), show a deterioration in breadth during the second top.

Another important breadth indicator also faltered.  The percent of stocks above their 50 day moving average was much higher during the first top compared to the number above their 50 day moving average during the second top.

Finally, the money flow indicators also weakened during the second top.  More money flowed into the stock markets during the first top than during the second top.

What does all this mean?  Does the appearance of a double top guarantee that the stocks will now correct severely?

The analysis doesn’t guarantee anything—just as a meteorologist can’t guarantee that it will rain a week from now.  But it does help establish the odds.  And the odds suggest that there’s a better than 50/50 chance of rain over the next two weeks.

It might make sense to bring along an umbrella…..just in case.

2008 All Over Again?

April 9, 2011

The S&P500 inched down last week by almost half a percent.  Volume ticked up, again demonstrating more conviction behind price drops than price increases.  Volatility ticked up which also supported the validity of the price drop.  Momentum also continued to wane; the bounce after the Japanese disaster is now waning.  The breath of rising vs. falling stocks also weakened; many more stocks fell than rose last week.

There was little in the way of macro news last week.  The most important, the ISM services index, came in well below expectations.  Initial jobless claims were close to expectations, slightly below the 400,000 mark.  And consumer credit, while rising more than expected, was horrible beneath the surface.  Why?  Because the rise was fueled by growth in student and auto loans–but all of this debt was provided by the federal government.  And this is not sustainable.

Here’s some interesting food for thought:  Several recent developments are eerily reminiscent of events in 2008.

Oil prices are going through the roof.

Gold and silver prices are soaring.

The US dollar is plunging relative to other major global currencies.

Headline inflation is creeping higher.

Major commodity prices, especially food grains, are spiking to record heights.

Global anger is growing over dangerously high food costs.

Several foreign equity markets are near record high levels.

US small cap stocks are near record highs.

In a bid to lean against inflation, the ECB raised interest rates.

And there’s more.  But what most interesting is what happened later in that year, 2008.  As record input costs kept surging, and with financing costs growing in Europe, the global economy had a heart attack, a heart attack that was nearly fatal.

What’s different this time, in 2010?

That’s the scary part.

This time, the global lifeguards–the major sovereign governments of the world–are struggling to stay afloat themselves.  They’re up to their eyeballs in debt and have used most of their monetary policy bullets.  In short, the major governments of the world may not be able to “save the global economy” should it suffer another heart attack.

Last week Portugal joined Greece and Ireland as the third of the PIIGS to fail financially and require a bailout from the EU and IMF.  Spain could be next.  But it really may not matter.  Because if the global economy hits the wall later this year, then the possible failure of Spain will be the least of the world’s worries.

And given that virtually NONE of the underlying causes of the global financial crisis, and the ensuing Great Recession, has been fixed, then it’s virtually certain that the world will enter another crisis.  And it will enter this crisis without the rescue ability of the major sovereigns.

The major unanswered question is simply–when?

Scary indeed.

Global Stimulus Fading Fast

April 2, 2011

The S&P500 moved up another 1.4% in a continuation of the bounce from the mid March sell off.   Volume fell even further, again implying that there’s very little conviction behind the buying.   Volatility fell, but only slightly.

The macro data were mixed.  Personal income was lower than expected; spending was higher.  So folks are saving less, which is not good in the long-term.  The Case Shiller home price index pretty much confirmed that a double dip in housing is underway.  Consumer confidence is dropping.  Initial jobless claims are still hovering around levels tied to recessions:  400,000.  Factory orders fell, when they were expected to rise.  Construction spending plunged.  Nonfarm payrolls met expectations.  The unemployment rate fell slightly to 8.8%.  But average hourly earnings growth, at 0.0%, were far below expectations. The labor force participation rate remained at 25 year lows.  And the percentage of the population that’s employed also hovered near 25 year lows.  Worst of all, about two-thirds of last months job gains were low quality–part time jobs, low-end service jobs, etc.  The bottom line:  people are taking survival jobs, but their incomes are not growing, and often their take home pay is dropping.  They are struggling to get by.

Technically, the downtrend starting from the February 18th peak has been broken, to the upside–on the daily charts.  But the technical damage on the weekly charts is still in effect. The weekly charts do not say go long now.

Again, it’s important to remember that technical analysis is far less important at a time when the Federal Reserve is hell-bent on printing money to prop up stock prices.  So many of the signals, that in normal times would point to impending downside moves, lose much of their validity because of the Fed’s—admitted—manipulation of stock markets and prices.

And as we all know, the Fed’s latest round of money printing, QE2, will be winding down in less than 60 days.

But what else could be affecting the economies and markets of the world?  Specifically, what are the other large states doing with their monetary or fiscal measures–measures that also propped up the GDP’s and equity markets in the aftermath of the global financial crisis?

Unfortunately, the answers are not good.

China–whose stimulus package as a percentage of GDP was much greater than that of the US–is hitting the brakes.  After raising reserve requirements and lending rates several times in late 2010, China is poised to do the same in 2011.  China will most definitely not provide the same stimulative boost going forward as it did in 2009 and 2010.

Europe is also hitting the brakes.  Fiscally, the PIIGS and the UK are adopting a harsh policy of austerity.  Government expenses are being slashed; new taxes are being imposed.  While Germany is still doing well because of its exports, it will still be vulnerable to diminished demand within Europe.  And monetary policy is about to reverse–the ECB is strongly hinting at a rate increase in the next several weeks.   Europe will clearly not be the engine of growth for the world.

Japan, sadly, is still reeling from the effects of the earthquake, the tsunami and the nuclear meltdown.  When combined with the most precarious fiscal position in the world (government debt exceeds 200% of GDP), Japan will be very hard pressed to rescue itself, much less anyone else in the world.  Japan’s exports—its only economic strong point— are falling and the government has almost no room left to spend and borrow more.

The other major areas of strength are at risk of being pulled down too.  As China’s growth slows, the major economies that exported materials to China to support its growth will also slow.  These include Australia, Canada, Brazil and Russia.

There you have it.

The US is about to lose most of its monetary stimulus.  Much of its fiscal stimulus will wind down at year-end.

Meanwhile, the rest of the world’s stimulus is fading, and in many cases, going into reverse, and deliberately slowing down the affected economies.

How this will translate into strong corporate sales and profit growth is a mystery.  But apparently not to the Wall Street salespeople who–by being bullish on the stock market–are expecting just that:  boom times to continue, with no end in sight.

We’ll know if they’re right in short order–in one quarter, or two at the most.