It's A Low, Low, Low, Low Medium-Rate World

by: Barry Ritholtz

I would be remiss in my duties if I failed to point out that this recent run up in yields -- fundamental explanation here -- occurred a few short months after the cover of BusinessWeek declared: It's A Low, Low, Low, Low-Rate World.

Back in November, I was walking by a magazine stand in Grand Central Station when that red cover caught my eye (a lesser hue might have gone unnoticed). It's a fair rule to assume I stop and look at pretty much any magazine cover that is either bright red or has Jessica Biel on the cover.

Jessica_biel_2(As the nearby photo reveals, Jessica Biel in bright red is an automatic).

Since the aforementioned Biel was not on the cover of this particular magazine cover, it led to this post: Uh-Oh: It's A Low, Low, Low, Low-Rate World.

Other folks prefer a more quantifiable basis for announcing their expectations of higher rates in public. Some rely on signs of a inflation, others choose to read the entrails of Fed meetings.

Chartist Michael Kahn, makes The Technical Case for Higher Rates in Barron's Online:

The 30-year Treasury yield has moved above the 5% level to notch a 10-month high and technically, it has already confirmed the end of a 13-year trend of declining interest rates. The benchmark 10-year yield is threatening a breakout of its own, too.

The major trend in interest rates has been down for the past three decades. This generational, or secular, move helped fuel the great bull market in stocks as corporations and equities typically do well when interest rates fall. But as the chart shows, the trendline that guided rates lower is now under attack.

Kahn suggests that it's too soon to "declare a generational rising trend in interest rates". Nonetheless, chartists still note that a major change in the 30-year yield has occurred.


graphic courtesy of Barron's

And Saturday morning, Mike Santoli argues in The 5% Dilemma that "during this bull market of four-plus years, stock indexes have made essentially no upside progress in periods when the 10-year yield has been above 4.75% or so. Stock valuations and M&A deal premiums, in this context, will be crimped at lower rates than we became accustomed to in the prior decade."

However, do not assume that the 5%+ yields means the Bull just rolls over and dies.

"Moving beyond the history lessons, though, there are some encouraging aspects of the markets' action that suggest that this pullback in stocks (partially reversed with Friday's rally) is probably not the Big One, so to speak.

First is the fact that rising rates, which went unnoticed for weeks, have now become overexposed as a news story and a focal point of market commentary. From the headline-commanding comments of Pimco's Bill Gross (risk of 6.5% 10-years within five years) to the popular insistence that higher rates, at last, will bring the buyout boom to its Waterloo, this cacophony hints that stocks are in the process of discounting this story.

The other key sub-surface element to the bond selloff is that it wasn't accompanied by accelerating inflation expectations or carnage in the corporate-bond arena. Market-implied inflation forecasts have remained tame, and corporate-bond yields haven't risen nearly as fast as Treasuries. Corporate-bond spreads still seem too tight to the naked eye, but they have been a good indicator of general economic risk and liquidity for stocks.

Of course, part of this process of stocks' possibly making their peace with 5%-plus rates could well be continued weakness for a few more percent of downside. The first furious one-day rebound, such as Friday's, after such a brutal bout of selling as we saw last week usually can't be fully trusted.

Bulls, in fact, should be hoping this pullback gets deeper and generates a bit more fear than we've seen so far and quiets the chorus of those calling this a "buying opportunity." If the decline is undone in a hurry and a summer melt-up resumes, then we'd again have to start invoking those pesky 1987 analogies."

Well said, and logical. But all I can say is: "Long Live the Magazine Cover Indicator!"

The Technical Case for Higher Rates
Michael Kahn
Barron's, June 6, 2007      

The 5% Dilemma
Mike Santoli
Barron's, June 11, 2007