Bond yields will panic stock markets soon enough
The high-point of Davos unreality this last week was Tim Geithner pointing out that the US economy “is not in a boom”. He didn’t go on to say “and it’s not heading for double-dip”, because he can’t speak with quite the same certainty on that subject. As veteran Sloggers will know only too well, my view remains that there cannot be a double dip, because such recovery as there was happened thanks to taxpayers and the Treasury. And the same is true in the UK: there has only ever been a natural decline, delayed briefly by Canutist stimulators.
Judging by media posts from the world’s temporary economic brain-centre, there’s been a slightly hysterical atmosphere at Davos all week. The last time this sort of thing happened was the Berlin outburst of 1945. This took place in the Reichschancellery bunker; it involved a lot of champagne and suicide, along with much self-delusion on the subject of miracle weapons which might save the occupants from Gotterdammerung.
Outside the other-world of Davos in 2011, there are no miracle weapons: here too there is only the inexorable progess of globally financed mercantilism towards its end-game. Those with any levers left to pull know full well that they are bunkered: what they lack is the right shape of iron to lift them out of it.
Once again I’m left writing in the tone of those sandwich men who used to walk up and down when we were kids, advertising ‘The end of the World is Nigh’. What makes it worse is that the bloke walking in between the boards can also be heard muttering, ‘and those in the know agree with me’. This combination of doom and conspiracy theory never sounds terribly credible.
But in point of fact, it’s neither. There is no doom at the inevitable end of this current cycle of species economic development – at least, not for most people. And there is no conspiracy: just the usual super-optimists trying to aquire immortality through money.
The only problem we face, as ever, is denial of the impossibility of that aim. The natural equity boom faded towards the end of 2000, and by 2004 required correction. Unfortunately, so many piglets at the trough wanted it to be The New Paradigm, Alan Greenspan was persuaded to keep lots of liquidity pouring into the US economy – and to hell with the deficit. From 2002 onwards, New Labour took the same view.
When the endlessly inflating credit boom was about to burst in 2007, the major Governments were hastily summoned (like some Monty Pythonic Bicycle Repair Man) to rub talc and elastic glue all over the bursting inner-tube….and then in the end, buy the bike. But three years further down a very bumpy road, the gears are giving up and the rider’s eun out of p0cket money.
Reading most of our ‘leading’ business journalists at the moment, you could be forgiven for thinking that the failing bike was a brand new 750 Kawasaki just waiting to be unleashed onto the growth highways of endlessly fruitful capitalism. Yesterday I listened to Money Box on Radio Four, and heard two smoothly lackadaisical soothsayers talking about ‘a recovering housing market now that the interest rates have remained the same’ and ’2011 may well be a 15% growth year for equities’. It was as though no global deficits, no Chinese overheating, no American QE2, no eurozone meltdown and no doubled UK national debt existed.
But they do, and they aren’t going away. Last week, the Portuguese bond auction was hyped into being a huge vote of confidence. In fact it was a scramble for a scarce amount of free money, so generous were the terms and get-out clauses being offered to investors. Anyone who thinks the EU or the ECB could afford too many of those needs to go back to primary school and resit 11+ maths.
The month before, we were treated to more smoke and mirrors as the UK Government hailed a growth in manufacturing – omitting to point out that the growth areas represented just 5.5% of the economy. Last Wednesday, an early release from the US Fed actually referred to US growth ‘roaring away at last’, until it was hastily withdrawn and replaced by Bernanke saying it was ‘not bad’. The truth is that the growth wasn’t in the export area, although US exports did grow….from a base that would require until roughly 2037 in order to generate a recovery.
But as I say, there won’t be doom – just an acceleration of events some time soon, and then a destitute global economy in which nobody has any money to either supply things to refine, or refine them for export, or import the finished product. Then and only then will some people (although by no means all) realise that all the confident No Alternative talk about decisive markets, big bangs, deregulation and globalised banking we’ve heard for nigh on 25 years was all lightweight bollocks floating up into a stratosphere of thin air.
When that happens, there will be a big conference somewhere, and as the debtor nations have better nuclear weapons than the creditors, debts will be written off in exchange for something dreamed up by smooth-suited spivs….and the whole rodeo will start all over again. Which government institutions, political Parties and economic theories remain intact by then remains to be seen.
In the meantime, all one can do is sit back and ponder what will set off the decisive panic. And to this end, last week I spent three riveting (but depressing) hours talking to Full Circle, a hugely successful and prescient UK-based wealth management company. They manage the meagre remainder of my wealth, and while you have to be patient with them at times, over the long term they spectacularly outperform most rivals.
One Full Circle obsession with which I agree wholeheartedly is that concerning the relationsip between US bonds and the Stock Market. If nothing else, it defines the exact area wherein there is room for jockeying by the Bernankes of this world.
This is how it works: you can’t have the Stock Market and bond yields going in the same direction. A rising stock market = confidence = not much reason for governments to need to borrow money = not much risk in buying government debt = low yields for investors in government debt. It’s safe and certain, but it’s not exciting.
Now take a stock market at peak…even though anyone with over 30% of the brain intact can discern that economic performance suggests it shouldn’t be at that peak. And take a Government so deep in debt, it needs to borrow all the time to keep the show on the road. Yields on that debt are going to rise.
Let’s now for the sake of argument say we’re talking about the US here – because let’s face it guys, we are. And then observe that right now, both the stock market and the bond yields are rising. This can’t continue for long. Not only that, dyed-in-the-wool professionals have what the market calls ‘signals’. As in, buy and sell signals in readiness for that moment when the ”two rising opposites’ thing becomes untenable.
They further have classic products and numbers that trigger these signals. In this instance, it’s the 30-Year US Bond Certificate…and the point when its yield rises to 5%.
As of now, this yield figure is kind of wobbling laterally at 4.53%. But in recent months, it has been rising steadily.
Hitting 5% will have two effects on the big movers in the US stock market. First, it will tell them that there is more to be gained in Government securities. But second, it will suggest to them that if there’s that little confidence in America’s ability to repay debt, then the Stock Market is woefully overpriced. And they’ll be right.
The Stock Market will fall – quite a big early drop – and hit the Dollar’s value. This will in theory reduce the debt and help US exports. Sadly, the market fall will in turn reduce confidence in the US….and cause debt (bond) yields to rise still further. That will inflate the Fed’s debt, because the payback becomes still more expensive. It will also cause more investors to pile into bonds.
At this point, Bernanke is screwed whatever he does. The stock market is falling and thus there is less investment money going into the recovery of US growth. If he whacks in QE3, that increases the debt and raises bond yields – and causes a further stock market fall. If he does nothing, the growth figures suck and so the market falls anyway.
Except that this isn’t quite how it happens. The element I’ve left out here is speed of panic.
Markets recognise end-game moments so quickly now, the very technology to hand accelerates the response. Effectively, if the 30-Year bond yield ups a couple of decimals at any given time (to the point where it is at or exceeds 5%) and then moves just a point or two higher still, the Dow will fall off a cliff. As will the FTSE, and every other major market in the world. Because the assumption of the Masters of the Universe will be that the crazily inflated Dow level has been found out, tested, failed, flunked – or whatever other term you wish to apply.
The FTSE level we’d be talking about in this scenario would be around 2,500*. But if credit-rating confidence in the US and UK repayment ability were to be further eroded by more poor growth figures, the debt yields would go bezerk. Neither country would be able to attract new debt bond purchases at all. They would enter that quicksand in which Greece and Ireland are already sinking, and Portugal must soon tread.
I’m a conservative investor: I try only to bet on sure things, and I’m more than happy to be out early rather than in the nick of time. I’ve been out of the Stock Market for the best part of a year, if only because the plunge I describe could’ve happened at any time – and it’s a mug’s game trying to get it dead right. Compared to some, I lost potential gains in 2010.
But I have piled into gold, and its fall by $80 I can only see as great good fortune, in that the anxieties of others allow me to buy even more of it. And when the stock markets collapse, I will use the gains made in metals to buy solid shares that have been caught up in the panic – and thus grossly undervalued. Believe me, by the close of 2012 this tortoise will be miles ahead of the hare-brained believers in rising stock markets and small downward property market corrections.
* People I mention this figure to fall about laughing. Well, in 2005 I bet an employee at the London Stock Exchange that by the close of 2008 the FTSE would be at 3500 (It was then at 6,200). I lost the bet by just ten days.