Market Timers or Market Cheaters?

SafeHaven ^ | September 6, 2003 | John Mauldin

[Starwind]

September 06, 2003
Market Timers or Market Cheaters?
by John Mauldin

Given the wide disparity of views about the economy, it is little wonder that the reaction to Greenspans latest speech has been all over the board. That is compounded by the fact that bond price expectations are totally disconnected from Fed expectations. Are the bond market critics just a bunch of whiners (give me back my risk free trade!) or is there substance to their major beef? Who's really in charge here? Can the Fed trump the market? Predictably, I answer the latter question with both yes and no. It all depends upon your time perspective, but timing is everything. There's a lot to cover, of course, so we begin.

But first, while we are speaking of timing, I have to comment on the latest mutual fund scandal uncovered by Elliot Spitzer based on a tip from some (presumably) knowledgeable source. Basically, a hedge fund (Canary Capital Partners) was allowed to buy and sell mutual funds after the market close. Canary was allowed to do so because it was controlled by a mega-wealthy family (the Sterns of Hartz-Mountain) who gave Bank of America a lot of other business.

When Spitzer and/or the SEC went after the investment banks for analyst fraud, IPO scandals, self-dealing, etc., I was not surprised. In fact, I predicted that analysts would be targeted. Everyone knew the whole system did not pass the smell test. WorldCom, Enron and their kin were specific surprises, but certainly these types of scandals were to be expected somewhere at the end of a major bull run which so blatantly rewarded such hubris. In that respect, it was analogous to the end of other bull economies of different eras. Much of our current investment laws came about because of the scandals of the 20's. Human nature changes very slowly, if at all.

But I must confess to being shocked at this latest scandal. And for reasons which go deeper than this one incident.

First off, there is no gray to this violation. It is three feet the other side of the clear black line. There were no attorneys who would tell their clients that this was aggressive but within the guidelines. No counting of the angels on the head of a pin logic by the legal types who tell the client what they want to hear. This was clearly breaking the law.

I can see one guy doing so and getting kick-backs and bribes. But this was evidently sanctioned by management. They had to know that it was career ending, if not jail time, if they got caught. How can a few extra dollars be worth such a catastrophic risk if you get caught? If two people know a secret, it is no longer a secret. Someone was bound to find out.

It is a relatively easy crime to commit. You fax two mutual fund orders (both buy and sell) to the trading firm, they get stamped as coming in before 4 pm or the close of the trading day. At 5 pm, you decide which one you want to keep and throw the other in the paper shredder. (This is in all likelihood what broker Red Bones did for Hillary Clinton with her cattle futures trading. In 15 years of industry watching, I have never met a professional commodities trader with such brilliant trading; at least, not one who could stop after making only $100,000.)

Since most orders for mutual funds are consolidated later in the evening, it is not difficult to get a one or two hour edge. If you know the portfolios of the mutual funds (which the managers might show such large investors), you look to see who is making an earnings announcement after the close, wait for the reaction, and buy or sell based upon the reaction. You might make only a few pennies each trade in "alpha," but you get to do it a lot. It is an advantage of huge dimensions, like betting on a horse race with only a hundred yards to go. Not a slam dunk, but certainly more likely to succeed than betting before the race began.

Were the other investors in the fund robbed? The answer is yes, a percentage point here and there. A small enough difference to allow the human penchant for rationalization to perhaps begin its dark work. Let's set some background.

Market Timers or Market Cheaters?

First, while Spitzer was entirely right nailing these guys, he is wrong when he chose to lump a number of illegal or questionable trading activities in the mutual fund industry under the name of "market timing," citing this as a "banned" investment technique.

There is a clear difference between market cheating and market timing. "Mutual Fund Market Timing is a legal method of trade. In fact, Rule 3a4 of the Investment Company Act contemplates the timing of portfolios of mutual funds. This rule allows for baskets of mutual funds to be traded similarly - without this rule Registered Investment Advisors could not market time those baskets. The Securities and Exchange Commission's Form ADV requires Investment Advisors to check the boxes describing their investment approach. "Market Timing" is one of those boxes. There are thousands of managers who practice "Market Timing". Over the years the SEC has audited thousands of managers who practice one or more forms of "Market Timing." (CMG and Steve Blumenthal).

"Agree or disagree as to its benefits vs. a buy and hold strategy, market timing has never been banned. To the contrary, for many years, hundreds of investment firms have successfully served the investing public utilizing market timing strategies. There is absolutely no relationship between the strategies employed by these investment firms (who are registered with, supervised by and conduct their investment management business in accordance with the rules promulgated by the SEC and state regulatory authorities) and the example cited by Mr. Spitzer. To draw such an inference is both irresponsible and a disservice to the investing public." (Thomas Giachetti, attorney)

There are lots of hedge funds which do mutual fund timing. Many of them use the so-called "International trade." In essence, you see where the US market is closing and then buy or sell international funds, knowing that there is a statistical correlation between the US market today and foreign markets tomorrow. Given the recent so-so track records of most of these funds, it is a lot harder to do than it sounds.

As an aside, the mutual fund families know who these hedge funds are and allow such trades, for a variety of reasons. However, if as Spitzer alleges, they state in their prospectus they do not allow such practices and then let some violate their written policy, then throw the book at them.

I called around to some of my hedge fund friends to get their take on this. All but one had never heard of anyone getting after hour trades. One attorney tells me he was approached by a fund who was offered such an after hours trading deal in return for moving business to the service provider. After the attorney convinced both the fund and the provider that this was as illegal as hell, the offer was withdrawn.

But the concern I have is that this offer was made in the first place (most likely by what is known as a prime broker), presumably (only my guess) under competitive pressures to match other such offers. If this was a one time deal, I might shrug it off. But I fear it is not. As Dennis Gartman frequently points out, when you see one cockroach on the kitchen floor, there are another hundred in the baseboards.

Spitzer and/or the SEC are unlikely to catch this illegal trade by looking at mutual fund records. Vanguard or another mutual fund family just get a list of consolidated trades sent to them at the end of the day. The crime was committed at the service provider or broker level that consolidates the trades. It will take some good (some @#$@% very good) forensic accounting teams to catch this. I hope they nail them to their trading desks. Banning them from the industry should only be a start.

Trust, But Verify

Interesting reaction to the Greenspan speech and my analysis. Bob Prechter (of Elliot Wave Theory fame) wrote to say, "I concur with you on every point." David Tice of the Prudent Bear Fund also said he liked the analysis, as did many others. However, Paul McCulley of Pimco sent me his analysis, politely noting that he disagreed a bit with me.

Then Jim Bianco writes, "Last Friday Greenspan spoke in Jackson Hole in what we termed his worst speech since becoming Fed chairman in 1987. What made it so bad, in our opinion, was its unbridled arrogance. Essentially Greenspan said there are two outcomes to monetary policy (1) the Fed is right or, (2) the market doesn't understand and further transparency/ communication is necessary. Where is the option 'the Fed is wrong?' (or, the market does understand monetary policy but thinks it is wrong?) This is often the case.

"While this arrogance is bad enough, Greenspan then went on to defend the Fed's 'make it up as we go along' approach to monetary policy by rejecting any kind of guidelines or rules. So the Fed's never wrong and doesn't need any guidelines. Scary."

Bianco points out the Fed policy is in direct contradiction of what the market is saying. The bond futures market tells us short term rates are going to rise in our not too distant future. The TIPS market says inflation is going to rise, even as the Fed says further disinflation is a risk. Today and yesterday Fed governors were out in force, telling us they intend to keep rates low for a considerable period of time. Who wins this debate and why?

First, let me state outright that the collective wisdom of a million investors is not any more prescient, nor is it any more accurate, than is that of 12 men sitting around a Fed board room 8 times a year. Both make guesses, educated as they may be, about the future. To think either group possesses some true grip on the future is patently silly. Greenspan admitted as much last week, and we only have to look at the results of the investment markets to see how accurate the average investor is. 95% of futures investors, as an example, lose money over time. I can go on with many examples. This is not to say that 12 men should supercede, manipulate or over-ride the market. It is that the market is neither right or wrong when it forecasts (guesses) the future. It simply is what it is. To make it into more than that deifies collective wisdom, which does not even come up to the level of psychic, let alone demi-god status.

Jobs, Growth and Spirals

"It seems to me that, with inflation already low, disinflation risk will remain a concern for some time," said Fed Governor and intellectual force Ben Bernanke in New York. From the AFP summary: "He agreed with private forecasters that the US economy will grow quickly through next year as business investment improves but that growth probably won't be accompanied by any significant hiring. Because growth without new jobs will not reduce idle capacity in the economy, inflation rates are likely to fall to even lower levels. The Fed and private economists have expressed concern that weak prices could eventually lead to a crippling deflationary spiral." (AFP)

Depending upon which speech you read, the Fed is committed to keeping rates low for a "considerable" or "significant" period of time. "If we convey a sense we're serious about not raising rates, the market will see an arbitrage opportunity and interest rate will start to fall," said Bernanke.

Fool Me Once, Shame on You

The old line is "Fool me once, shame on you. Fool me twice, shame on me." The bond market feels betrayed as Greenspan and the Fed meeting announcements did not follow through on the rhetoric that rates would remain low because the Fed was prepared to resort to unconventional methods. Now, the Fed governors are trying once again to talk interest rates down, but without the use of the word "unconventional."

So far, the bond futures market does not believe Bernanke and his fellow governors. The Eurodollar Deposit swap predicts the Fed will raise rates by at least 175 basis points in the next 18 months, and over 100 basis points in the last half of 2004. Or maybe they think that what the Fed means by "considerable" is 6 months.

The bond market thinks the economy is going to be so strong, or inflation will come back so quickly, that the Fed will be forced to raise rates, even in the months running up to a presidential election.

Or, there is one other possibility, which I find more reasonable and appealing.

Paul McCulley makes the argument today on Pimco's web site that it is precisely the lack of Fed clarity that is causing the bond market to price in rate hikes. It is "risk premium." Because the bond vigilantes don't know what the Fed is going to do, they have to hedge and make a bet that to the casual observer (me) doesn't make sense. (You should read both his and Bill Gross's latest excellent columns at www.pimco.com.)

McCulley argues for "constrained discretion" on the part of the Fed. By that he is not arguing that the Fed should not have discretion to make decisions and even to change its mind as the facts change. But these decisions should be constrained (limited) by a set policy which everyone understands. Quote:

"...since the passage of the Full Employment and Balanced Growth Act of 1978 (commonly known as the Humphrey Hawkins Act), the Fed's operational autonomy has been under an enabling umbrella directing the Fed "to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates."

"...If PIMCO's Investment Committee were given the (intellectual only!) challenge of carrying out the Fed's legislated mandate, the first thing we would ask would be: How do you define "maximum, stable and moderate?"

"We would want to know what those adjectives mean, so that we could establish a benchmark for performance. We would also want to know the relative weights that we should put on the three objectives, on both a static and dynamic basis. Put differently, we would want to know the accepted deviation from target for all three of the objectives, so that we could use our fancy-dancy quantitative models to develop both an optimization framework and a risk-management framework. And finally, we would want to know the guidelines regarding which tools, with what horsepower, we could use in pursuing the objectives.

"We would treat the assignment as one of 'constrained discretion.' And once the terms of the portfolio management assignment were agreed, we would negotiate a communication strategy with the client, so as to minimize the chance for 'surprises' on either side. Yes, that's how we'd go about it. We would want flexibility in the day-to-day management of the assignment, but we would also want the terms of that flexibility to be well understood, all in the context of well-defined goals, objectives and reporting requirements."

Then McCulley gets down to his critical points:

"Mr. Greenspan would not be comfortable with the PIMCO style. He has long argued for maximum flexibility for the Fed, with minimum quantification of the Fed's goals. In a nutshell, Mr. Greenspan's management style is best described as 'trust me' - sometimes known as 'constructive ambiguity.'... Greenspan disagrees [with specified policies], when it comes to carrying out his job mission. His definitions of the Fed goals are what his gut says they are, but what he cannot bring his lips to say, subject to change when he has an undisclosed stomach ache. Broadly speaking, such a paradigm has worked for him, with both inflation and unemployment relatively low. Such a paradigm is not, however, an institutional framework for monetary policy management; rather, it is a maestro-digm."

"To be sure, the FOMC has told us that it will remain accommodative for a 'considerable period. But the FOMC has not told us either its definition of price stability or full employment. Therefore, the markets cannot reliably predict the length of a 'considerable period.' Accordingly, the fixed income market is "buying insurance" against uncertainty as to the Fed's intentions by pricing in some 200 basis points of Fed tightening next year...If Mr. Greenspan ever wanted evidence of the cost of his infectious hubris, he need not look any further than the money market futures market, as displayed on the cover. Unconstrained discretion, as Mr. Greenspan advocates, is not a free good, because it raises risk premiums for uncertainty about monetary policy, acting as a headwind to the FOMC's accommodative will."

The Fed and Greenspan have been given a free ride for quite a long time. As long as things were going well, who wanted to rock the boat, other than some bond traders and a few Austrian (economist) curmudgeons?

Why is Greenspan resisting such a reasonable guy like McCulley's request for transparency? Why is he saying "trust me" is a better policy than understandable parameters? And why, if the economy is growing so well, is the Fed telling us that rates will remain low for a "considerable" period of time?

Let's look at some uncomfortable long-term facts facing the Fed.

First, they must clearly mistrust that the current economic growth spurt that is forecasted has "legs." In my opinion, I believe if they thought that for one minute the economy was going to grow on its own at 5% real growth for the next 18 months, I cannot imagine they would not begin to raise rates, if for no other reason than to have some room to lower them the next recession.

Why mistrust this growth? Because much of the growth is from stimulus that is not lasting. This growth is caused by (1) Bush's tax rebates, which are clearly kicking in (Wal-Mart's sales are up 5-6% year over year), (2) a huge government deficit spending (more than half the GDP growth last quarter was government [mostly defense] related) and, (3) massive mortgage refinancing which was done in the second quarter which produced a huge amount of spendable cash, which is now being spent.

But where are the jobs, as I have been writing about for months? With productivity at 6% plus (a number about which I think there is reason to doubt), you would need somewhat more than 5% growth to produce jobs. A jobless recovery is not sustainable, and the Fed knows it.

Greg Weldon slices and dices the numbers from today's ugly jobs report. (www.macro-strategies.com) Employment is down 113,000 since June. Unemployment is down 453,000. That means 340,000 of those formerly classified as unemployed have now dropped out of the labor force. Part-time employment is down 200,000 in the month of August. Thus, the "lower" unemployment rate does not reflect any real growth in jobs, but statistical games.

He does an analysis of the breakdown by sector and sex and comes up with this conclusion: "Bottom line ... there is one macro-conclusion of significance to be gleaned from today's labor market input: 'second income jobs,' many of them part-time jobs, held primarily by women, are being eliminated."

The Fed is all too aware that even as GDP was revised upward for the 2nd quarter, that housing investment was cut by half from the first quarter, and this before rates began to rise.

Thus it comes as no surprise the Fed governor's are out and about, trying to talk rates down. It is apparent to me they feel the recovery is fragile and thus are willing to risk a return of inflation.

In talking today with one of the smartest analysts I know, Rob Arnott, he notes a concern that Ben Bernanke seems to be backing away from his former hard line of price stability. Is he saying that we are now targeting 2-4% inflation? From this, Arnott infers that the Fed won't raise rates until real inflation of more than 2-3% develops.

Japan and China say: Go Away

GM, Ford and Chrysler watch their domestic auto sales drop year over year by a respective -8.2%, -27.7% and -28.6%(!) as sales for Nissan and Toyota rise by over 17%. Thus, it must be frustrating in Detroit to see Snow rebuffed in Tokyo, when even as he was talking about letting the market set the exchange rates, the Bank of Japan was massively intervening again and again to force the yen lower, making Japanese automakers more competitive.

China said, "We will allow the yuan to rise when we decide it is in our own best interests and not a moment sooner."

This competitive currency devaluation cannot go on forever, and Bill Gross of Pimco points out quite succinctly what I have been writing for a long time:

"...In turn the hundreds of billions that the Japanese and other Asian countries have been buying in order to keep their currencies competitive with the Chinese Yuan (Renminbi) and the U.S. dollar will be subject to a sanity check as well. The currency/bonds/stocks of a reflating economy engaged in guns and butter, Hummer and Hummvee spending of near historical proportions are bad investments. Sooner, perhaps later, our Asian creditors will wake up and smell the coffee. Perhaps their java will take the form of dollar or Treasury Note sales. Perhaps the aroma will resemble a revaluation of the Yuan and then the Yen. Either way we pay the price: higher import costs, a cutback in spending on cheap foreign goods, rising inflation, perhaps chaotic financial markets, a lower standard of living. Mark these words well for what they're worth (not much some will say): China holds the keys to our kingdom, and our Hummers. Their willingness to buy our bonds, their philosophy of fixing their currency to the U.S. dollar will one day be tested. And should their patience be found wanting, all of their neighboring Asian China wannabes will move in near unison. Reflation's second round will have begun, U.S. interest rates will rise, our goods in the malls and the showrooms will be less affordable, and the process of national belt tightening and increased savings will have begun."

The Fed is between the devil and the deep blue sea. If the trade imbalance keeps at current levels, then foreign holding of US bonds will rise dramatically. At low interest rates, this is not a huge drag on the economy. But what if rates rise and we start having to send $100 billion or $200 billion to foreign bond holders which would only add to our trade deficit? Can the Fed really allow rates to rise prior to a drop in the trade deficit?

What's a central banker to do? The above problems if allowed to develop before the recovery is clearly established will mean a recession and deflation. Thus, the Fed must feel, as evidenced by their policies, that they have to do everything possible to get an economy to grow its way out of the problem, even if it means a little inflation.

And there is the disconnect. The bond market can see exactly what I have described. Inflation will ultimately mean higher rates. The Fed does not think we can afford higher rates, which might possibly choke off a fragile recovery.

Thus, just as Volker caused a recession to bring down inflation, the Fed is willing to risk inflation to try and avoid the scenario Gross describes.

Do you think the Fed governors do not see the same imbalances that Gross and a hundred other analysts, including yours truly, see? However, rather than acquiescing to the decline of our "hegemonic rule" as Gross terms it, it is ingrained within a central banker's DNA to at least attempt to fight the tides of said decline.

And thus, to establish a "reasonable" set of policies such as McCulley asks for would mean the Fed may to all too soon feel forced to abandon them in order to deal with the potential crisis resulting from today's imbalances. Such a reversal has the potential for creating far more havoc than the current environment of "guess what Greenspan is feeling today." Since the exact nature of the potential crisis is unknown, how can you set a proper course? Better, says Greenspan, to allow them ultimate flexibility than adopting polices. Trust me.

And maybe there won't be a crisis and we do grow ourselves out of the problems, at least for awhile. The current economic growth is very for real, at least for the next 6-9 months. What if oil then comes down in price? Rates drop again? Jobs pick up and the economy gets on sound footing. A new round of technology investment ensues. There are lots of good things that can happen in the short term on the road to balancing the twin deficits. If you are a central banker, you are counting on them.

At the end of the day, it does not matter whether McCulley, Mises or Greenspan is right. Greenspan is going to win this debate, as he holds the cards until someone takes them away. Rates will stay low until the recovery is on a sound footing and producing jobs or inflation is truly back. We will know when that moment is when he tells us. And therefore risk premiums are going to stay high.

[...snip...]

Your seeing lots of opportunity analyst,

John Mauldin
Frontlinethoughts.com

John Mauldin is president of Millennium Wave Advisors, LLC, a registered investment advisor. All material presented herein is believed to be reliable but we cannot attest to its accuracy. Investment recommendations may change and readers are urged to check with their investment counselors before making any investment decisions. Opinions expressed in these reports may change without prior notice. John Mauldin and/or the staff at Thoughts from the Frontline may or may not have investments in any funds cited above. Mauldin can be reached at 800-829-7273.

Copyright © 2003 John Mauldin. All Rights Reserved

« Opinions expressed at SafeHaven are those of the individual authors and do not necessarily represent the opinion of SafeHaven or its management. »

[Starwind]

Fyi...

[Starwind]

Further elaboration on Greenspan's ambiguous policy as we were discussing on Monetary Policy under Uncertainty, if you're interested.

[Starwind]

FWIW, some qualitative commentary as opposed to numbers.

Let's look at some uncomfortable long-term facts facing the Fed.

First, they must clearly mistrust that the current economic growth spurt that is forecasted has "legs." In my opinion, I believe if they thought that for one minute the economy was going to grow on its own at 5% real growth for the next 18 months, I cannot imagine they would not begin to raise rates, if for no other reason than to have some room to lower them the next recession.

Why mistrust this growth? Because much of the growth is from stimulus that is not lasting. This growth is caused by (1) Bush's tax rebates, which are clearly kicking in (Wal-Mart's sales are up 5-6% year over year), (2) a huge government deficit spending (more than half the GDP growth last quarter was government [mostly defense] related) and, (3) massive mortgage refinancing which was done in the second quarter which produced a huge amount of spendable cash, which is now being spent.

[Free Vulcan]

slef-ping

[kitkat]

BUMP

[arete]

He has long argued for maximum flexibility for the Fed, with minimum quantification of the Fed's goals. In a nutshell, Mr. Greenspan's management style is best described as 'trust me' - sometimes known as 'constructive ambiguity.'... Greenspan disagrees [with specified policies], when it comes to carrying out his job mission. His definitions of the Fed goals are what his gut says they are, but what he cannot bring his lips to say, subject to change when he has an undisclosed stomach ache.

I have been saying for months that the FED has been actively following an unstated policy of releasing misinformation, conflicting opinions, and intentionally vague statements designed specifically to keep the markets and traders confused and guessing. I can only assume that with the economy so weak and dependent on the flim flam of borrow and spend new era structured finance, the debt bubble must be expontially inflated and having bond traders get a clear understanding and sense of the coming inflationary train would raise rates and limit the ability of the central planners to further stimulate the artificially induced recovery. It always comes down to "inflate or die".

Richard W.

[Always Right]

A conspiracy and a bubble all in the same post....I am impressed....

[arete]

Just in case you didn't read the article --

"And thus, to establish a "reasonable" set of policies such as McCulley asks for would mean the Fed may to all too soon feel forced to abandon them in order to deal with the potential crisis resulting from today's imbalances. Such a reversal has the potential for creating far more havoc than the current environment of "guess what Greenspan is feeling today." Since the exact nature of the potential crisis is unknown, how can you set a proper course? Better, says Greenspan, to allow them ultimate flexibility than adopting polices. Trust me."

Richard W.

[raybbr]

I have been saying that the stock market has been a scam for years. It is a closed business that relies on guesses and misinformation from companies. There is no way to verify company forecasts so the manipulation of the stock market goes on and on.

[Starwind]

A conspiracy and a bubble all in the same post....I am impressed....

Greenspan has made statements calculated to hopefully induce traders to respond as they have previously, to suit Greenspan's unspoken and vague policy. Greenspan's own words (Monetary Policy under Uncertainty):

For such judgment, we policymakers, rather than relying solely on the specific linkages expressed in our formal models, have tended to draw from broader, though less mathematically precise, hypotheses of how the world works. For example, inference of how market participants might respond to a monetary policy initiative may need to reference past behavior during a period only roughly comparable to the current situation.

Greenspan's intent was to encourage the stock market to go up because a recovery was in place, yet encourage bond yields (interest rates) to remain low, ignoring the inflation that normally comes with recovery.

He knew that typically bond traders would drop prices (yields rise) if they believed what Greenspan told the stock traders that the economy was recovering, and he knew that stock traders would not bid stock prices up if they believed what Greenspan told the bond traders, that deflation was a real danger to a recovery.

So he was deliberately vague to both groups, trying to get both bonds and stock prices to go up together - which they typically don't.

I presume you don't need any proof of the debt bubble?

[imawit]

My take. You're both right but there is an interesting lull that I see.

No one referenced in the article or Mauldin himself has an inkling nor guess as to what will really happen. So I looked at this as the lull before the next move/storm to hit. In doing so, there are two possibilities, advance or decline. Now I'm not a doom and gloomer and certainly least wish for the doom to occur. I see a downtrend coming as the best guess and the best scenario would be the uptrend Mauldin mentions that could last for 6-9 months. There are tooo many tight rope acts that must remain in place.

And maybe there won't be a crisis and we do grow ourselves out of the problems, at least for awhile. The current economic growth is very for real, at least for the next 6-9 months.

This scenario could happen, nothing negates it entirely. Certainly the majority either blindly or with hope (knowing the truth) do wish to see this happen. Right now it looks like it will but every thirty days will be a whew and catch a breath, things are going OK.

There are those problems lurking in the shadows; they are not being addressed nor are they being handled; if anything they seem to get bigger and nastier; they are also being fueled by both fiscal & monetary policies as are the good times.

[Starwind]

Nor did Mauldin mention the amouint of new debt coming to market. I've mentioned this before and IIRC you agreed only moderately.

I don't track the bond markets typically, just recently. But it seems to me record supplies of Treasury, GSE, and corporate paper are coming to market and the recent demand (lower bid-to-cover) indicates satiation unless prices fall (yields rise), irrespective of what the economy or stock market may do.

Have your views on the supply/demand of bonds crystallized any, and if so, do you see yields rising or falling - based soley on supply/demand?

[imawit]

What, now you want me to come out of Polyanaland, Camelot ?

I found it very interesting to see how the King Arthurs in earlier years (and certainly now also (the aluding to of Sir G's "unbridled arrogance") and the "Full Employment and Balanced Growth Act of 1978") reflect the demigodery and out and out foolish emporer syndromes of our wonderful leaders then and now. Ok. So let's get to the facts.

First, crystalization is not the proper adjective. I'm a fundamentals guy (reason for my allusion to Polyanaland). Second, the need for financing, if you will, bonds is actually an unnatural market force. I say this meaning that the US Treasuries bond market is manmade/governmentmade. There are no economic forces that drive this up or down, just extant policy at any given moment. Therefore this area and force can either be a great hindrance or accomodation to true market forces at any given economic moment. In the long run it is always a hindrance, the government never makes a profit by which it can pay down debt.

With this in mind I feel one has to look at the corporate and government bonds separately; see what each is doing and being driven by separately; and then combine both forces as a function of how the market will treat bonds. Currently there still is no market for corporate bonds other than speculation with playing the trends (a technical study in market forces). Utilization of corporate facilities/factories is still down and concurrent with that so is expansion (nonexistent), job creation (nonexistent) and the need for corporate bond expansion/creation (actually also nonexistent). What we are actually seeing in corporate land is restructuring of debt. As interest rates rise this will come to an end if it hasn’t already. This does not mean that the technical side will change any though but I don’t look to analyze that arena, I don’t speculate in bonds. I don’t believe you do either or that the majority of the readers/posters here do either. That’s another world altogether. However, I do feel and as you rightly open the question to me that, one must keep an eye on what’s happening here because this market arena has great effect and great information as to how the economy is doing, envisioned as doing and is being affected or going to be affected by what happens here.

Well I've given you what’s happening with corporate bonds, it’s very simple if you’re not an investor/speculator with such. Government bonds is another question altogether. There are so many effects and players that it is a real challenge to get a bridle on it and control it and much harder to get a feel as to what’s happening and what will happen. Corporate bonds rates have risen (and only brought down because of market pressure from government bonds) and so has corporate financing rates (funding is practically nonexistent so who cares about rates but under these conditions you'd have to put actual rates at sky high levels). Only because the spread was too out of whack have the yields/rates come down and brought forth the grand opportunity to restructure (a la GM’s new bond issue). This tells you that the upward pressure in corporate bonds is still there and really never subsided. Look at what corporate financing has done over this period, nothing, it’s still nonexistent.

I know this is probably getting quite long but the answer to government bonds, fundamentally is very quick and simple as in corporate bonds but no one is stating it. The more that are created and put to market (and don’t forget, it’s against a specific and quantifiable collateral (if you will) the taxpayer and his ability to service and payoff the debt (which never happens and never will) the more the risk involved. Or the less confidence and therefore the higher the risk and the higher the rate. Now add to this the inflation it causes and that’s another factor for higher risk and higher rates. And then add to this the fact that the issuance of new debt and government bonds is in the offing and with no end in sight. This is a 3rd factor that pushes up rates/yields. Fourthly and now I ask you, how certain and confident are you that the economy is expanding and if you think it truly is then is it expanding by a high enough rate (which it isn’t at this time) to assuage, mitigate and nullify the risk and bolster confidence in bonds and what they represent. Then fifthly, and this is the hidden 800lb gorilla (they own 40% or more of bonds now and must be counted on the buy that portion or more for a successful issue) how are these foreign governments/central banks going to see all of this with respect to their motives and intentions. My (obviously educated and fundamentals rooted) guess is rates will go up. But then there is Japan who has been using its trade payments money to buy dollars and bonds no matter what just so their Yen stays low against the dollar.

Just hope Japan, the #2 economy doesn't wake up and realize they can be #1 with a stronger yen and owning 10% or better of the #2 economy, the US. Should their Imperial tendencies become reawakened, nothing could stop them. They are the biggest economic force in Asia still and are in fact the largest exporter and investor to China at the moment and to all of Asia. (something that no one is telling you either)

[Tauzero]

Good piece.

bttt

[imawit]

ps: the only reason rates fell in the first place was the FED controlled rate going down (which is now stopped and for the foreseeable future; only an increase seems logical), FED jawboning (which has now been found to be baloney) and the Japanese buying dollars and bonds to keep their Yen weak and exports up (very succesful action). The first two factors are now missing and the 3rd ... well Japan now has a new problem; lots of trade payments cash and further drowning of their Yen will degrade the value of that cash and also hurt their improving economy.

Let's see if the price of Japanese cars start to rise. They have conquered the US car market at this point. And I do mean conquered. If Ford, GM and ChryslerDaimler go for a counter attack, all 3 will go bankrupt because they'll have to give no interest, no payments for 12 months and cash away with each car (don't forget pension plans funding in this money giveaway). Take a look at car sales shares per manufacturer.

[arete]

Maybe a little less "crystalization" next time please. Didn't understand what you were talking about (over my head) so I am glad that you can to a conclusion -- higher yields (?) in which case I agree with you. Way too much supply plus the risk premium.

Richard W.

[imawit]

Maybe a little less "crystalization" next time please

Wellllll, I dunno bout that. Maybe a few more words and some more examples would have made it more clear.

[lelio]

You fax two mutual fund orders (both buy and sell) to the trading firm, they get stamped as coming in before 4 pm or the close of the trading day. At 5 pm, you decide which one you want to keep and throw the other in the paper shredder. (This is in all likelihood what broker Red Bones did for Hillary Clinton with her cattle futures trading.

We should start a trend and label this "The Hillary Maneuver." Has a mountaining ring to it as well (and we all know Hillary was named of Edmund, right?)

[lelio]

Just hope Japan, the #2 economy doesn't wake up and realize they can be #1 with a stronger yen and owning 10% or better of the #2 economy, the US.

Interesting point. And coinkydinkyly I just picked up a Zen Buddhism book. Can't remember if that's Chinese or Japanese. Anyway its all a bunch of riddles. Perhaps Greenspan's been taking cues from it.