RECOUPLING....T-BOND REVIEW (TLT,TBF, XLU)

I've posted a number of charts in the past months that examined the amazing experience we had in 2012 where typical market relationships melted into nothing and became completely useless.  One old notion that treasuries acted inversely to the equity markets was one of these.  In 2012, we witnessed treasuries increasing in value (yields falling) and equities rising, frankly, this isn't normal.

We've speculated as to why this happened, but without fail we always came back to, "Fed manipulation" as the key distorting factor.  Is it really that foreign investors needed safe sovereign holdings and continued to by US bonds without regard for yield?  Maybe.  Was it that Joe 6 Pack was abandoning his fear and rushing headlong into the equity market.  Possibly, with a portion of his holdings.  Each answer may be correct as the Fed's insatiable desire to buy up mortgages and treasuries has artificially suppressed yields and also forced Grandma and pension managers to elect for riskier assets with "new" money in an attempt to make something.  I think this is why our equity leadership has been focused like a laser in dividend paying stocks in defensive sectors.  The average investor doesn't trust this rally and hasn't, so as he holds his nose he buys utilities, consumer staples, and healthcare and shuns small caps and technology.

Don't think utilities have been a safe-haven?  Check this out.  I haven't sold my XLU yet, but is is on the agenda.

As 2013 dawned, we've seen a recoupling of the old relationship in the first few months, and I for one, am very happy.  Yet, as happy as I have been, an odd sense of dread kicked in as the relationship over the last few weeks started to break down.  Perhaps it was Cyprus, or perhaps the huge rally in the first quarter just needed a breather, but bond yields started floating lower, yet the equity markets just continued to press higher and float out in space to new highs.  I 've highlighted the chart of TBF (which is the etf that shorts treasuries which shows the relationships I've been watching).  In this chart, TBF should move in lock-step with the equity market (SPX) which is the black line behind the TBF chart.

A month or so ago I put this chart up and called for a change in direction for the stock market, but it didn't come.  The weakness in TBF suggests that a healthy correction is in store for stock markets.

Don't get too bearish and over extended here, but certainly the chart suggests a bit lower in equity markets.

GOATMUG

Goatmug is an investor that cares about you and your family. Goatmug's Blog - Financial Perspectives From The Mountain Top is a collection of thoughts on our economy and how it impacts the lives of investors and average people. While several specific investments are named in many of his posts, these articles are simply invitations for you to do your own research and reference to these securities does not constitute financial advice. Your situation is complex and unique and you should seek professional assistance with your trading and investing. Please visit Goatmug and share your comments athttp://www.goatmug.blogspot.com/

EURIBOR RATES BEGIN TO RISE ACROSS THE CURVE - CAUSE FOR CONCERN?

I've been in pretty good sync with the market lately and have been trading well.  It seems that for this last cycle or two I've been able to capture rallies and short swoons at the best time.  Even now, I've ridden the last 6% move in the market here and have been quite bullish.  Just as I say those words though, I'm quite certain that we are bumping against the 1130 to 1150 range that has been difficult to exceed.  Call it pervasive bearishness or just the trader's mentality to want to exit when I have profits, but I spent last night and this morning looking for short-term signals that the wheels of the rally could be coming off.  Perhaps this is a hint that something troubling might be coming to slam this rally back down to the lower end of the range (1040).

Please click on the Euribor rates below.  I look at these figures almost every morning and have not seen a consistent move like this in quite a while where every time frame ticks higher (meaning the banks charge each other more to borrow).  Before we put too much stock in this we must marry this with the comments from  the Greeks that say they will not default (when do you trust the Greeks?).  The no-default scenario would obviously be a good thing, so I remain watchful and glad I've got some profits, I'm not selling yet, but am vigilant.

Above is a quick snapshot of the S&P500.  Is there any wonder that I'm watching that 1130 range, it has held for the last several rally attempts, why would it be different this time?

GOATMUG

Summer & Fall Outlook – 7-27-2009

August
In the short run, we will continue to see risk appetites increase and opportunities over the next month or so will be in US equities, commodities, and overseas holdings. The reason for this upward continuation is the belief that things are getting better, despite my view that all the good news has already been priced in.

We’re Not Finished Deflating
As we wind down the summer months, we will witness more asset deflation (contraction of available credit and decline in asset prices). Equity markets could retest recent lows as market participants realize that “green shoots” are not the indication of an end to a recession, but evidence of unparalleled governmental interference and manipulation. Residential foreclosures and falling commercial real estate prices will continue to drag on the ability of banks to recover. Corporate defaults will continue to rise and a consumer led recovery will fail as the market adjusts to the new normal of consumer spending. Interest rates will remain in a trading range in the next year or so and corporate bonds will be a place to obtain opportunistic yields of 4% to 6%. Individual name selection will be tremendously important in this asset class because lower consumer activity will be the death blow to under capitalized firms. In addition, sectors like REITS and financials with commercial real estate exposure will be areas to avoid. We will want to try to keep the maturity of the bonds as short as possible, but take advantage of the return of fear that will push yields back up to extreme levels.

If the US federal government can guide us out of the deflationary cycle, we will be fortunate to enter a period of much greater inflation. In fact, this is the direction that the FED prefers now and is attempting with all of their might. Again, if the FED can break the deflationary cycle by prolific "electronic printing of dollars", deficit spending, and debt issuance it will lead to a significant devaluation of the US dollar. A decline of the dollar will usher in increased commodity prices, and future asset bubbles in other sectors. Investments to consider putting on eighteen to twenty-four months from now will be those that bet the on a US dollar decline; ETFs (exchange traded funds) that invest in the currencies of Canada, Australia, China, and Brazil, investments in food or agricultural production, natural resource companies and commodities, and treasury inflation protection securities. Domestic equity markets in general may go up, but will actually under perform on a relative basis those assets in commodities.

Everyone Sees Inflation - Everyone is usually wrong.
We remain watchful as the results play out in front of us. Although the inflation trade seems logical, we have an current example of deflation in our midst. Japan has existed for almost two decades in a deflationary environment. Interest rates have been at near zero, growth has been absent, and the equity markets languished at points as low at 75% below the market highs. Interest rates have remained low because a large supply of currency has been stuck in banks despite the desire to give money away. Further contributing to this is the "carry trade" where very low interest rates create demand for the YEN. Hedge funds and other Investors then take the borrowed YEN and buy other investments. These investors look to borrow cheaply and profit from the low cost money. The increased value of the YEN creates a difficult operating environment for exporters as their goods and services are priced abnormally high due to demand from speculators. If the deflation trade comes to the US, we can look forward to the carry trade trapping us as well.

While there are many differences between our economies, it is wise to consider that we may be doomed to the same fate. If the inflationist's consensus is wrong, we will have a strong dollar, lower equity markets, commodities will be depressed (more driven by over supply and low demand), and overseas investing will present better growth opportunities. Even though faster growing countries present better prospects for capital appreciation, currency risk will be significant.