Tuesday, August 10, 2010

Treasury Yields Continue to Fall

In the latest battle over who does a better job of forecasting market movements, bonds are nearing a strong signal that a bear market for stocks is right around the bend.  Since hitting its most recent high yield of 4.01% on April 5, the 10-year Treasury bond has slid nearly 1.20 percentage points, a metric that signaled in 1990, 2000 and 2007 that a steep drop in stocks was only two months away, according to research from Gluskin Sheff strategist David Rosenberg.

With the 10-year yield at 2.82% in early Tuesday trading and the bond market still red-hot despite continued predictions of its demise, the big bear indicator is looming large.  "Declines of this magnitude very often presage the onset of bear markets and recessions," Rosenberg says.  "Typically, equities and then economists are late to the game...What is key to note is that the bond market is the tail that wags the stock market's dog—it leads."

Whether the bond market again is foretelling a bear market—a 20% drop in stocks from the most recent high—is part of a long-running debate over who does a better job forecasting—stock or bond investors.  Conventional wisdom is that bond investors tend to be more conservative and thus less influenced by fear and greed. That's cited as the reason by some that the bond market does a better job of getting the economy right.  "With all due respect to the stocks guys, the bond guys, when it comes to the economy, tend to sniff things out a little earlier and eventually get things right," says Mike Larson, analyst at Weiss Research. "Bond yield levels have given you key insight into what's going on in the economy. The verdict in my mind is pretty unmistakable."
The concern over what bond market movements portend for the economy come as Wall Street awaits word from the Federal Reserve on what its plans are to juice the economy. The FOMC meets Tuesday to discuss rates and possible future quantitative easing measures, though some think the central bank has become less an influence after three years of aggressive policy moves.

In the meantime, economic signs, particularly in employment and consumer and business sentiment, are progressively weakening, indicating that if deflation is not on the horizon, then strong economic growth is unlikely either.

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