Tower Private Advisors
- Interest rates around the world go through the roof
- Tax bill signed into law
- Economy continues to grudgingly improve
Capital Markets Recap
This week there was a Dow Theory (DT) buy signal produced. DT says that the Dow Transports and the Dow Industrials should confirm each other, otherwise a move is suspect. So, for a example, a lower low recorded by the Industrials is just that, a new low. So long as the Transports don’t put in a new low, the sell signal of the Industrials is unconfirmed. Likewise, a new high by one index has to be confirmed by the other to be validated. This is an oldie that still seems to have some merit. Charles Dow figured that if the industrial companies were booming they’d ship more stuff, and those changes would be seen in the indexes. ‘Enough about Dow Theory, see it at right. If history is any guide, it suggests that stocks will go higher for a while.
As far as I’m concerned, the biggest story in capital markets is the rapid and dramatic back up in interest rates. The 10-year U.S. Treasury note’s yield is charted in the upper half of the chart below, while the 10-week rate-of-change is shown in the bottom half. Since 1995, only two times has the yield backed up as fast.
Here’s a look at the percentage change in the yield, a stunning 48.6% increase.
A question we’ve heard is along the lines of, “I thought the Fed’s quantitative easing was supposed to prevent this.” The Fed can not stop the bond market having its way with interest rates. The Federal Reserve has said it would buy $600 billion of bonds–at a pace of something like $75 billion per month. The trouble is the average daily trading volume in Treasury debt alone has been running at an average pace of $667 billion in 2010, and the total U.S. bond market daily average trading volume is $1.2 trillion.
Well, it’s about time. Those Milton Friedman disciples are about to get their just deserts. You crank up the printing press; you pay the piper.
Not so fast, Captain America; hold your ethnocentric horses. Indeed, as the chart further down the page points out, inflation expectations–if not inflation–are headed north, but the jump in yields has been a global phenomenon, and some are saying the Bond Vigilantes are back in the saddle. “Bond vigilantes” was a phrase coined in 1983 by Ed Yardeni, when he referred to the bond market’s tendency to police–like a group of vigilantes–monetary and fiscal policy by buying or selling bonds, pushing interest rates wherever the vigilantes thought they belonged.
There’s something else afoot here given the global interest rate spike, as the chart immediately below evidences. Cumberland Advisors pins the blame on a global reallocation of asset classes, and suggests it’s a shift from bonds to stocks and commodities.
Here’s the last of the dreadfully dry interest rate stuff. It supports our general thinking here that rates have backed up too fast. What is shown below is the 10-year Treasury Yield (top half) with a technical measure (Relative Strength Index) of overboughtedness. It shows that yields are approaching levels of being overbought (i.e. bonds being oversold) that have corresponded with historic peaks in interest rates.
The biggest non-story of the week was that the so-called Bush Tax Cuts were extended. By now you know that. What you don’t know is that there are cool graphics involved. The first one below is from the New York Times, and it shows how the votes fell out. Click on the graphic to go to the New York Times interactive version.
The second is from the Washington Post. It features four tabs at the top. Clicking each will show you what the various tax brackets might have been under the various scenarios.
Finally, if you don’t like pictures but would rather read about it, you can click on the graphic below to read a dreadfully boring synopsis from our estimable friends at the firm of Shambaugh, Kast, Beck & Williams . . . estimable but boring.
If you’re a real glutton for punishment you can click here to get the entire text of the bill. Or you can get my Wordle version of the entire text below. The resemblance to a pig is purely coincidental, although I have to admit I did assist in helping your imagination. Wordle works by making the most-frequently occuring words the largest. Surprisingly, the word “votes” was missing.
We’ve spent a lot of 2010 urging IRA clients to consider converting their traditional IRAs to Roth IRAs. Before 2010, conversion was limited to those with incomes (adjusted gross income) of $100,000 or less. In 2010 the income limits were removed, opening up the possibility of conversion to the wealthiest. An additional feature added to conversions in 2010 was the ability to pay the tax bill over two tax years, splitting it equally between 2010 and 2011, with the 2011 bill payable no sooner than April 2012. The tax bill, however, would be payable at the tax rates then prevailing, and many worried that 2011 tax rates would be higher. Now, “then prevailing” has been converted to “now prevailing,” with the passage of the tax bill. Unless there is a reason to expect 2011 to be a big income year, it makes sense to now pay the tax over two years. [Insert silly no-tax-advice, consult-your-accountant boilerplate here.] You have until December 31, 2010, to convert your IRA. Click here to e-mail your questions to our savvy Certified Financial Planner Bob Nicholas.
Economic news this week was largely positive. Here is the summary. NFIB Small Business Optimism was better (93.2) than both the consensus guess (92.3) and the October release (91.7). It also marked the highest reading since December 2007, exceeding the September 2008 figure, which was released the Friday before Lehman Bros. went belly-up. In addition, perhaps the most important individual component of the survey, Hiring Plans, approached the September 2008 level, but remained below it. Importantly, the topline optimism index broke through the 5-year moving average (green line in the chart at right), which suggests the long-term trend is up. The hiring plans component remains below the 5-year moving average.
Both regional surveys–Philly Fed and Empire State Manufacturing–blew away estimates. That took the Philly Fed index to the highest levels of the last five years, along with some of the component indexes. There is an 83% historic correlation between the indexes so the dual improvement isn’t surprising.
Housing Starts and Building Permits were reported. The former exceeded estimates (555,000 v. 550,000), while the latter trailed the consensus (530,000 v. 560,000.) Doesn’t matter. Housing starts are abysmal. There have only been seven months, since the data’s been recorded (1959), when the figures were lower. And the National Association of Home Builders Housing Market Index–essentially builder sentiment–didn’t budged. In general terms, about 16% of builders are optimistic. The average since the 1985 has been, probably not surprisingly, 50%.
- Initial Jobless Claims continued to inch down – 5,000 fewer claims this week than last
- Industrial Production ticked up by 0.1%
- Capacity Utilization ticked up by 0.2% to 75.2% – highest level since Lehman Bros., but still well below the regression of the series (at right). Since we’ve ever more away from manufacturing of goods, capacity has been decreasingly utilized, thus the regression level of about 77.5% is more appropriate than the long-term average of 80%.
- Both the Consumer Price Index and the Producer Price Index are showing very low levels of inflation. On year-over-year core (excluding food and energy) bases CPI is up by just 0.8%, while PPI is up by 1.2%. As the chart below indicates, however, the Federal Reserve appears to have been succesful in ratcheting up expectations of inflation, which is one goal of its quantitative easing program.
The chart below shows the inflation implied in the spread between nominal 5-year Treasuries and 5-year TIPS (Treasury Inflation Protected Securities).
Key Indicators to Watch
Just two, in my opinion
- Personal Income, Spending, and Saving (Thursday) – November
- Initial Jobless Claims (Thursday) – Weekly
- Chicago Fed National Activity Index (Monday) – November
- Q3 GDP (Wednesday) – third incarnation of Q3 GDP
- Existing Home Sales (Wednesday) – November
- Durable Goods Orders (Thursday) – November
- University of Michigan Consumer Confidence (Thursday) – final December
I expect to put out a WR&O next week. If that doesn’t work out, then this will serve as your Merry Christmas greeting.
Graig Stettner, CFA, CMT
Vice President & Portfolio Manager
Tower Private Advisors