Monday, June 4, 2012

Treasury Yields Now At 200 Year Lows

The 10 year Treasury note is now yielding slightly more than 1.5%.

According to Strategist Michael Hartnett at Merrill Lynch, Treasury yields are now at 200 year lows, breaking the old record set in November 1945.

Despite the record low level of interest rates, there seems little abatement in the appetite for fixed income securities.

Anecdotal evidence further suggests that Wall Street's fixed income community has its most exposure to interest rates this year (i.e., they are betting on a further decline in rates).

Equities, meanwhile, remain unloved and unwanted.  The bullish sentiments that seemed so prevalent just a couple of months ago are now long gone, even though corporate earnings estimates continue to be raised.

Here's how Larry Summers, former US Treasury secretary and Harvard president, described the credit markets this morning:

...consider the remarkable level of interest rates in much of the industrialized world. The U.S. government can borrow in nominal terms at about 0.5 percent for five years, 1.5 percent for 10 years, and 2.5 percent for 30 years. Rates are considerably lower in Germany, and still lower in Japan.

Even more remarkable are the interest rates on inflation-protected bonds. In real terms, the world is prepared to pay the U.S. more than 100 basis points to store its money for five years and more than 50 basis points for 10 years. Maturities would have to reach more than 20 years before the interest rates on indexed bonds becomes positive. Again, real rates are even lower in Germany and Japan. Remarkably, the UK borrowed money last week for 50 years at a real rate of 4 basis points.

(Summers goes on to suggest that governments increase their borrowings and invest in projects that will lead to more job growth.  While this might make economic sense, it seems unlikely that governments will increase deficits at this point in the political cycle, in my opinion.)

Stock markets, meanwhile, continue to get rocked around the market.

Friday's stock market action was ugly in the aftermath of a disappointing jobs report. Global equities have now lost all of the gains achieved in the first quarter of this year, as Nigel Tupper of Merrill Lynch reported on Friday:

In May, the MSCI AC World Index (-9.3%) experienced the 10th worst month on
record (since 1988) as investors focused on the impact of Greece possibly leaving the Euro, the approaching “fiscal cliff” in the US, and weaker economic data from China.

Global equities are now down -0.5% year-to-date.

As is often the case during negative return months, the USA fell the least (-6.4%) while Asia Pac ex-Japan (-10.9%) and Emerging Markets (-11.7%)
underperformed the index. Europe (-13.0%) performed the worst while Japan
(-9.0%) fell in line with global averages.!Xvd!X0ib6L3iZ3gg&__gda__=1338820641_17a2a0e58c8b632c4117b12d2c29d406

Interestingly, Thomas Lee at JP Morgan suggests that the market may have misinterpreted the May payroll figures.

While the headline number for payroll growth was well below expectations (+69K vs. +150K consensus expectations), Mr. Lee argues that the non-adjusted growth in payrolls was much better than perceived.

On a non-seasonally adjusted basis, the U.S. added roughly +800K, which is one of the best reports since 1999.  The culprit, according to Mr. Lee, is the seasonal adjustments that the Labor Department used:

The May change of 800k is one of the best since 1999 for the "establishment"
survey (corporations) and at 732k for the "household" survey is the
BEST since 1999. Think about it…we are talking about the best number
since 1999, yet the May 2012 payrolls figure SEASONALLY
ADJUSTED is one of the worst since 1999.

Still, in a world where investors sell first, and analyze later, it makes little difference whether Mr. Lee's logic is correct.

Warren Buffett famously said that the way to make money in the markets is to "Be greedy when others are fearful, and fearful when others are greedy".

Are we now at one of those times?