The Big Picture: Explaining Yield Curve Inversions
This is a good post by Barry that does more explaining. One thing about this whole issue that is a concern is that it seems like far more people are trying to explain why this inversion (if it happens for real) will be different.
I have been thinking and writing all along that if it does, really, invert it will not be different. I don't find it necessary to spend time figuring why something that is correct 83% of the time will not be correct this time. I'm not that smart.
Proud Member Of
Random Roger
© 2009 | Gadget Theme Blogger Template
Original WPtheme By Blogger Template | Converted By Gadget Lover
| Distributed by eFree Blogger Help
Original WPtheme By Blogger Template | Converted By Gadget Lover
| Distributed by eFree Blogger Help
4 comments:
Roger,
I know you already know what I am about to write but pleas bear with me as too much is being made over the yield curve.
A flat or inverted yield curve is the same every time. In each instance, the investors who make-up this market (primarily huge institutional investors) invest "safe" money in fixed income securities based on their individual projections of future interest rates. If an institution has 5 billion to invest in treasuries for the next five years, should it roll 90 day paper or buy 5 year paper? If the institution believes rates are going to go up, it should buy the short paper. If it believes rates are going down it should buy the long paper.
Institutions which believe rates are headed down and which have the confidence and permission to buy 10 year paper should buy 10 year paper knowing that they can sell at a profit when rates go down. Because treasuries can be margined at 90%, speculators can influence the market with huge but relatively small amounts of capital.
There have been many instances when the curve flattened, inverted or almost inverted when the market was right and when it was wrong. You are correct in your analysis that the market is right most of the time. Interest rates do typically decline soon after the curve inverts.
What we can say about the treasury market right now is that investors in this market, on average, believe interest rates are likely to decline. Since real GNP is economic growth reduced by inflation, we can only guess at how much GNP will slow and how much interest rates will decline. The incredibly good news is that productivity is so strong that it seems that we might escape with only a modest slowing of GNP while seeing extraordinarily low inflation. In recent weeks, head line inflation has raced ahead of core inflation and in weeks to follow it appears that head line inflation will drop well below core.
The problem with the typical analysis is that it stops before the real important point is reached. I can best illustrate with an example. In the fourth quarter of 1994, GNP was flying along at 4.8% even though the FOMC raised rates from 4.5% in August to 5.5% by mid November. Of course the FOMC raised its famous "one more time" in February of 1995.
And remember, in those days the FOMC took out an ax not a hatchet. The increase in November was a .75% increase and the increase in February was another half. Sure enough, the GNP dropped from 4.8 to 1.1 and then to .7. Prognosticators whined and squawked about the falling sky and sat on thier hands afraid to enter the market.
By late 1994, the yield curve was all but inverted; flat as a pancake. The market was forecasting lower interest rates. Sure enough, the bond market rallied and by July the FOMC was forced to lower rates time and time again.
The point for investors to note is that the S&P went down 1.5% during 1994 while the FOMC was raising rates and it went up 34.1% during 1995! Those who focused on the flat yield curve lost a great opportunity to make real money.
This time is not "different". The risk that Greenspan and company is trying to avoid is a price and wage spiral once the capital spending boom develops (there are at least 12 billion dollar plus refineries in construction or in planning stages).
The boom is going to be nice. Investors can play the bonds now if they wish and make decent money if the FOMC continues to jack up rates. However, the smarter move is to invest in stocks. There may or may not be a pull back in the market before the big rally. I do not want to miss it; fully invested and biding my time!
Sell your oil and gold stocks. Not because the prices will fall so much but because this money will miss the 34.1% or whatever of 2006.
"I don't find it necessary to spend time figuring why something that is correct 83% of the time will not be correct this time. I'm not that smart." That is not a statement in which I would take any pride. The details matter.
thanks for the comments. Jack makes great points, no need for the "bear with me...."
I have never called on almost inverted as a call for action. The driver behind my concern is and has always been that lending money is not profitable when the curve is upside down.
All of the bullish arguments I have heard ignore this point. All of the bullish cases for equities assume that the generally positive fundamentals will outweigh my concern. They either will won't but I would love to hear a consise answer to my concern about lending in an upside down curve.
As for the anonymous heckle; fair point. My reply would be that all of this will either cause the market to roll over or it won't. I will take action if the market rolls over (go below its 200 dma). I believe this issue creates a clear path to that happening but I will not start to get defensive until that happens.
I could try to figure out why this time is different but I don't see the point. The market will crack or it won't regardless of any conclusion I make. What better detail than what the market tells us?
You guys can opine on your soap box all day long. The market is sending a clear message right now with gold rallying and the equity markets doing nothing but drifting lower and failing to break out. The market leaders are starting to roll over, and bullish sentiment is at crazy levels. The futures markets are being manipulated up over night then then the market rolls over like Tuesday. HELLO!! We have the worst breadth and sector leadership I have ever seen, and we are historically going into a bearish presidental cycle and the bull cycle is on its last legs historically. The bulls say oh energy prices go down the market should go up, guess what it's not happening. You bulls are hopeless dreamers this market is setting up to correct in a gigantic way and the market is sending this clear message daily. We get great economic news and the market goes down. HELLO!!! It's not the news it's the recation to the news and the reaction says guess what us big boys are selling right to joe public the dumb money.
Post a Comment