Stock Market Downside Scenario Increasingly Likely

The yield curve went from normal in January 2006 to inverted by late 2006. By January 2007, Bill Gross at PIMCO was telling us that unless the Fed lowered short term rates by 150 basis points soon, we’d have significant asset price reductions with problems in real estate and stocks.

Unfortunately, the yield curve only got worse. Short term rates are higher and long term rates are lower. Bill Gross is still sounding warnings. He repeats that either short term rates or asset prices will come down.

Maybe the yield curve has more to due with the recent stock market sell-off than China. China may have been the catalyst, but the yield curve may be the driving force.

The bold blue line is for Jan 2006. The dotted black line is for Jan 2007. The bold red (good color choice don’t you think) line is for today Feb 28, 2007.

Related ETFs: iShares Russell 3000 Index Fund (IWV), SPDRs (SPY), iShares Lehman 20+ Year Treasury Bond Fund (TLT), iShares Lehman 7 - 10 Year Treasury Bond Fund (IEF), iShares Lehman 1 - 3 Year Treasury Bond Fund (SHY)

Comments

[Sr. Pessimist:]

That's right. China was a catalyst. I was thinking that exact same thing yesterday. Here, either you make money cheaper, or the government can't pay back enough on its debts. If you make money cheaper, you make hyperinflation worse. Depreciating the value of the American dollar is already the greatest concern in American macroeconomics, judging by Bernanke's words of inflation being his primary concern resounding in my thoughts. Earnings are below where they should be for stocks to be worth their price. Far below. Either you make money cheaper and easier to come by, or the stocks will continue to underperform, and there will be breathtaking sell-offs any time soon.

2007 Mar 01 01:45 PM