This morning, following very weak retail sales and an Empire State index that showed a negative forward looking orders component, US 10-years have been exceptionally well bid, with yields making new lows at 1.44%.
Click to enlargeThe last time yields got this low was early June, when the Dow (DIA) and S&P 500 (SPY) were making their 2012 lows. The divergence over the past several weeks cannot possibly be sustained; either treasuries or equities will sell-off significantly.
The collapse in yields is largely a result of the now persistent meme, "flight to safety." With gold not being bid very well as European implosion fears have escalated over the past several months, there are very few assets that the market has deemed safe-havens. The main beneficiaries of the capital reallocation have been:
- US treasuries
- German bunds
- US dollar
- Highly rated municipals and corporates
- Some US dividend paying stocks
I don't attribute very much of the price action in treasuries to hopes of further QE from the Fed. With each new Fed minutes or meeting that goes without promises of easing, treasury prices have often risen in response to flights from equities and precious metals, in conjunction with dollar strength. Of course, there is a definite ceiling on rates considering the Fed's ability and will to purchase treasuries directly.
Meanwhile, equities are failing to adequately discount both earnings and European (which of course translates to earnings) risk into prices as a consequence of ultra-easy monetary policy. The accepted term for this now is "The Bernanke Put," though as David Einhorn has explained, the put really only exists in the treasury market. By ensuring that the prices of treasuries will always rise, investors have desperately held on to their treasury holdings.
Similar to the Greenspan Put, Bernanke's version will not be able to hold a sustained floor under equity prices. With each new LSAP program from the Fed, the impact on the equity markets, and ultimately the economy, has been increasingly muted. We can see this overseas as well, given the ECB's famously brief success with its LTRO program.
Markets are failing to react to new injections of liquidity, which to me, implies they are about to come to terms with the structural issues that were supposed to have been mitigated by now.
US treasuries are foretelling of very stagnant, if not negative, US growth. Additionally, yields reflect undeniable skepticism relative to equities. I believe this is because pricing in bond markets is far more efficient than it is in equity markets, since the information for individual companies often lags by several months, and takes far longer to price into equities.
I should note that the above chart comparing yields and equities in no way implies a drop of 30% in the stock market. Rather, it reflects the economic reality that the bond market is seeing, and that the equity market is ignoring.
Disclosure: I am short SPY via longer-dated puts.