The Most Important Economic Chart Of The Year

 A Picture Is Worth A Thousand Words, Analysis & Commentary, Back to the basics, Bond Market, Creditors Caveat, Deflation-Inflation-Stagflation, Devaluation, Economic Analysis Isn't Science, European Union?  No Responses »
Dec 262011
 

courtesy of Spiegel Online:

This chart illustrates the end of euro complacency. Investors once acted as though the euro eliminated not just currency risk but sovereign credit risk. All nations–from Greece to Germany–could borrow at the same low rates. No longer. As the financial crisis enters its fifth year, markets are again distinguishing between strong nations and weak.

I subsequently discovered that I am not alone in choosing this chart. The BBC has a version of this as the first entry in its survey of top graphs of the year (with commentary by Vicky Pryce of FTI Consulting), and Desmond Lachman of the American Enterprise Institute included it in Derek Thompson’s survey of top graphs over at the Atlantic.

P.S. For the United States, I think Brad DeLong is right: behold the shortfall in nominal U.S. GDP.

 

The Most Important Economic Chart Of The Year by Donald Marron

Posted by Brian Schuettler at 10:16 am  

The evidence is building that global growth has stalled. And it’s about to get much worse.

 A Changing Europe, A Growing List Of One Term Presidents, A Picture Is Worth A Thousand Words, A State of Distress, A Time To Repent, Analysis & Commentary, Bond Market, Creditors Caveat, Deflation-Inflation-Stagflation, Deleveraging, Derivatives Reform, Dismal Science-Ignorant Scientists?, Economic Analysis Isn't Science, European Union?, Fiat Currency, Figures don't lie but Liars can figure, Financing Terrorism, Former Economist, Goldman: Underwriter or Undertaker?, Having Fun With Derivatives, History of Finance, How do you dampen the inflation dragon?, If I Only Knew It Was This Easy!, IMF Issues - Discussion, Insolvency, Integrity and Responsibility  No Responses »
Dec 042011
 

I think the most notable development this week was Thursday’s big release of global factory activity surveys. It wasn’t pretty. Overall, the JP Morgan Global Manufacturing PMI dropped for the third straight month and fell below the 50 level — the line of demarcation between growth or contraction in monthly factory activity — for the first time since recession was descending upon us back in early 2008. Scary stuff.

 

Although U.S. activity was buoyant (no doubt a remnant of the sentiment tailwinds enjoyed from the market rally in October), we cannot remain an island of tranquility as Asia and Europe fall into the abyss.

 

Here are the highlights (any reading under 50 indicates a drop in activity):

 

*Brazil PMI: 48.7 vs. 46.5 prior
*Ireland PMI: 48.5 vs. 50.1 prior
*Sweden PMI: 47.6 v. 49 estimated
*Norway PMI: 48.6 vs. 50.2 estimated
*Denmark PMI: 47.7 vs. 43.6 prior
*Poland PMI: 49.5 vs. 51.7 prior
*Spain PMI:  42.8 vs. 43.9 prior
*Swiss PMI: 44.8 vs. 46.6 estimated
*Czech PMI: 48.6 vs. 51.7 prior
*Italy PMI: 44 vs. 42.8 estimated
*France PMI: 47.3 vs. 47.6 estimated
*Germany PMI: 47.9
*Greece PMI: 40.9 vs. 40.5 prior
*South Korea PMI: 47.1 vs. 48 prior
*Taiwan PMI: 43.9 vs. 43.7 prior

 

And, now for the big boys:

 

*Eurozone PMI: 46.4 — lowest reading since recession ended in July 2009
*U.K. PMI: 47.6 vs. 47 estimated — lowest since June 2009
*China PMI: 49 vs. 49.8 estimated — lowest reading since February 2009
*China HSBC PMI: 47.7 vs. 51 prior — 32-month low

 

In addition to signs of economic weakness — which was enough for a Chinese vice finance minster to say the global economy faces a “worse situation” than in 2008 — there was evidence that the financial system remains under severe stress despite the freak out over Wednesday’s move by the Federal Reserve to lower dollar funding costs for foreign banks (which, as I discussed at the time, wasn’t really a game changer). The European Central Bank reported that eurozone banks borrowed nearly €9 billion in overnight emergency cash — up from €2.7 billion earlier this week. Not good.

 

Other signs of strain could be seen in the way German 12-month bill yields dropped below zero on Wednesday as European investors were willing to pay Berlin for the luxury of lending it money. The motivation is that, if you’re holding a big wad of euros, German short-term debt is one of the few “sure bets” left out there. It’s a sign of extreme risk aversion and fear.

 

Of course, the epicenter for all this is Europe.

 

Adding to concerns were comments this week from new ECB chief Mario Draghi that while downside risks to the economic outlook have increased, he cannot ride to Europe’s rescue by engaging in unmitigated money printing and bond buying; instead, it must adhere to its founding principles, including an inability to engage in monetary financing of government debts (exactly what the likes of Italy would love right now).

 

Draghi’s comments were akin to yelling “fire” in a crowded theater before announcing all the fire extinguishers are empty. Whoops.

According to the team at Capital Economics, based in London, the eurozone economy is on track to contract by 1% next year and by 2.5% in 2013, with risks to the downside for both forecasts. Recession will only deepen the budget deficits at the center of the eurozone debt crisis. The only way out is growth. And the only way the likes of Greece, Portugal, and Italy can restore growth is via massive currency depreciation and domestic inflation — something that’s not going to happen as long as they’re in the eurozone.

 

Sure, there will be distractions like Wednesday’s move by the Fed or additional stimulus measures out of places like China and Brazil. That’s just how the market gods like it. All the better to keep the masses confused and complacent as the fundamentals just get worse and worse.

 

To put it differently: When you look around the theater, everyone’s still focused on center stage blissfully unaware what’s happening around them. Turn around. The balcony level is in flames.

The Economy Is About To Get A Lot Worse – Anthony Mirhaydari, MSNBC

 

Posted by Brian Schuettler at 9:57 am  

Prepare For Europe Collapse Before New Year

 A Changing Europe, A Moral Question - Not A Political One, Back to the basics, Bond Market, CDOs, Collateral Damage, Coming Social Unrest, Consumption Ran the Old Economy, Decapitalization, Deflation-Inflation-Stagflation, Deleveraging, Devaluation, Dismal Science-Ignorant Scientists?, Economic Analysis Isn't Science, European Union?, Fiat Currency, Financing Terrorism, Having Fun With Derivatives, History of Finance, IMF Issues - Discussion, Insolvency, Integrity and Responsibility, It starts with a foundation, IT'S ALL ABOUT POWER AND MONEY, It's the Tribes, It's Your Turn to Cry FOR ME, Let's Call What It Is - DEPRESSION, No Bank Is Indispensable, PANDEMIC, Patience is a virtue...Delusion is a vice, Pig-Headed Economic Policy May Still Lead to Disaster, PIIGS Default?, Political Chaos, Read and Weep Entries, Smaller Can Be Better, Strategizing Suppy Chain Links, Subsidiarity, The Big Fat Greek Question, The Consequences of Greed, The Currency Wars Officially Begin, The Financial Elite, The Global Economy, The Importance of Strategic Planning, The Intrusion of UNLAWFUL Authority, The Judeo-Christian Political Coalition, The Suffering Poor, The Ticking Euro Bomb, This self-serving arbitrariness, Time For A New Third Party, Unemployment Catastrophe, Unindicted Co-Conspiritors, Unintended Consequences, Wage Deflation, Watch The China Market, We Are All Cooked, We Need Open Derivative Models  No Responses »
Nov 122011
 

It’s official: The European Financial Stability Facility (EFSF) plan announced at the EU summit on October 27th is essentially dead prior to arrival.

As a consequence, Angela Merkel and Nicolas Sarkozy appear to be betraying signs of throwing in the towel on the Euro project as it exists today. They appear to be actively contemplating ways to engineer an orderly breakup of the Euro.

As financial market participants gets wind of their intentions – albeit tentative – expect financial markets to accelerate the unfolding of events. The entire Euro edifice could collapse before the New Year.

EFSF Chief: The Insurance Plan Is Dead Prior To Arrival

When the Chief of the EFSF is pessimistic about the capacity of the EFSF to be leveraged to an extent that is adequate to the task at hand, then you might as well kiss the whole thing goodbye.

In a little noted article in Thursday’s FT, Klaus Regling, head of the EFSF essentially admitted that the plan agreed upon at the EU summit on October summit to use the EFSF as collateral for a first-loss insurance scheme is essentially dead.

As I predicted would occur in an article of mine several weeks ago entitled “Europe’s Inane Idea: Fake Brady Bonds,” the EFSF chief has acknowledged that there is no interest on the part of investors to purchase PIIGS bonds with a first-loss guarantee of only 20%.

Regling believes that a first-loss guarantee of 30% may be required to garner any interest.

Personally, I have serious doubts that there would be sufficient interest. Any issuance that actually requires a 30% loss guarantee in order to be viable simply has an implicit default risk profile that will be unable to garner sponsorship of sufficient size.

Since there are only about 250 billion euros available for the EFSF first-loss insurance scheme, that means that, even assuming 30% were sufficient, the mechanism would only be adequate to cover about 800 billion euros worth of debt issuance by Italy and Spain — and any other euro area country that needed funding.

It has been estimated that roughly two trillion euros of funding are needed to simply merely meet projected roll-over and fresh financing needs through mid 2013. Therefore, the 800 billion projection is totally insufficient to the task at hand.

If $800 billion in guarantees are all that Europe can come up with, Europe would probably better off wasting precious resources on this scheme at all.

That is why the EFSF first-loss guarantee proposal seems to be dead on arrival. The plan is totally insufficient, and therefore is unlikely to be implemented at all.

I believe that this realization is thoroughly discouraging the Eurocrats that are charged with structuring the EFSF insurance facility and selling it to investors. These Eurocrats are relaying their pessimism back to Merkel and Sarkozy in real time. This in turn, is prompting Merkel and Sarkozy to begin to contemplate “exit strategies.”

Imminent Fiasco

Because Merkel and Sarkozy are unwilling or are unable to support the only viable option available to them that is to fund bond purchases via the ECB, they appear to be engaging in preliminary speculations regarding a possible exit plan. The problem is that there is no viable exit plan that would not entail a total economic and financial disaster.

It will be impossible for Merkel, Sarkozy and other European leaders to prepare an exit strategy without their intentions being leaked to the press. Financial markets will therefore unravel any and all plans that they contemplate before they can even commit them to paper.

As soon as markets realize that the original EFSF scheme is being abandoned and that the entire Euro project will be restructured, the Euro will be crushed, the European banking system will become insolvent and global financial markets will freeze up.

Merkozy Musings

Sarkozy is already openly musing about a “two-speed” Europe. He envisions a group of countries that will quickly move towards tight fiscal and economic integration and another group of countries that will remain fiscally and monetarily independent.

Sarkozy has stated that he believes that a tight federation is impossible for a large group of economically, politically and culturally disparate countries. The implication is that the group of 16 nations that currently comprise the Euro is probably too large to be manageable.

At the same time, Merkel is already dreaming about a “New Europe.” Exactly what Germany’s Chancellor means by this is ambiguous. However, it is clear that Merkel has in mind much tighter fiscal and economic integration. In this regard Merkel must know that several current Euro members may be unable or unwilling to join in such a tight federation.

The problem with Sarkozy’s and Merkel’s musings is that they are completely irrelevant and even counterproductive to the current task at hand. The issues that they are touching on were issues that needed to have been resolved at the inception of the Euro. At this point, the question is how the damage can best be undone, not to debate what should have been.

Conclusion

Merkel and Sarkozy will soon learn that an orderly break-up of the Euro is not possible. Even the slightest hint that a breakup is being contemplated will cause a global financial disturbance that is so great that any perceived benefits of a break-up will be completely overwhelmed by the costs that will be imposed by the market.

Prepare For Europe Collapse Before New Year by James A. Kostohryz


Posted by Brian Schuettler at 10:58 am  

The Risks Lurking in Treasury Bonds

 Bond Market, U.S. Treasuries  No Responses »
Sep 142011
 

How’s this for an investment opportunity: a guaranteed yield of 3.2 percent, with an enormous potential downside. As risky as that sounds, millions of investors are moving money into Treasury bonds as a “safe haven.” In early September, the yield on the 30-year Treasury bond sank to a new low of 3.2 percent, while the 10-year note fell to 1.9 percent. If the inflation rate stays anywhere close to its current modest 3.6 percent pace, long-term investors will be guaranteed to lose money after factoring in inflation’s toll.

And that’s only scratching the surface of the risks.

Continue:

Posted by Brian Schuettler at 12:19 pm  

Bond Blow-Out?

 Bond Market  No Responses »
Feb 262011
 

Yields on triple A-rated 10-year munis reached a 24-month high of 3.46 percent in mid-January, according to The Bond Buyer. Many states and cities seem to think that they can wait out the high-yield environment.

This could be a dangerous game. It has the potential to result in a pent-up demand for credit. If yields remain elevated for long enough, borrowers could find themselves forced to come to market when everyone else is also trying to sell bonds. This surge would likely push down prices and raise yields even further.

We’ve heard this kind of talk about “temporary market dislocations” before—back when the market for mortgage-backed securities began to fall apart in 2007 and 2008. There was lots of confident talk back then, about market prices not reflecting fundamentals and too much risk being priced into mortgage bonds. As it turned out, market prices were accurately reflecting the climb in mortgage delinquencies and decline in revenue streams from the bonds.

A far less benign explanation for the decline of issuance could be that the muni market is freezing up. We’ve now seen month after month of outflows from muni funds, forcing funds to sell bonds to pay off exiting investors. It’s very likely that some of the decline of issuance results from advice from bankers, who fear they cannot sell the bonds at yields attractive to the borrowers.

The mortgage-backed security market froze up in a similar way prior to the finance crisis. The decline of private label mortgage backed securities that began in mid-2006. That decline, as it turned out, anticipated a huge jump in mortgage defaults.

It might make sense to take another look at the effect of the BAB-Build America Bond programs. Instead of seeing the end of the program as an explanation for this decline, I can look at the beginning of the program as an artificial boost to the market. Without BAB, the evidence of trouble in the muni market may have been apparent even earlier.

I don’t think that the muni market is transparent enough to allow for accurate forecasting—which is why I’m not predicting a surge of defaults. But I do think it makes sense to watch for potential warning signs in the market—and the dramatic drop in issuance could well be flashing: DANGER AHEAD.

The Muni Bond Market Signals Danger Ahead
- John Carney, CNBC

Posted by Brian Schuettler at 11:40 am  

Collapse?

 A Shareholder-Not Just a "Stakeholder", A State of Distress, Bond Market, Coup d'etat in America, Creditors Caveat, Deflation-Inflation-Stagflation, The American Financial Oligarchy, The Bear Facts, The Democrats Blew It Again, The Intrusion of UNLAWFUL Authority, The Obama OMG magic factory, The Suffering Poor  No Responses »
Aug 152010
 

Taleb Says Government Bonds to Collapse, Avoid Stocks – Bloomberg

Nassim Nicholas Taleb, who warned that unforeseen events can roil markets in “The Black Swan,” said he is “betting on the collapse of government bonds” and that investors should avoid stocks.

“I’m very pessimistic,” he said at the Discovery Invest Leadership Summit in Johannesburg today. “By staying in cash or hedging against inflation, you won’t regret it in two years.”

Treasuries have rallied amid speculation the global economic recovery is faltering, driving yields on two-year notes to a record low of 0.4892 percent today. The Federal Reserve yesterday reversed plans to exit from monetary stimulus and decided to keep its bond holdings level to support an economic recovery it described as weaker than anticipated. The Standard & Poor’s 500 Index retreated 16 percent between April 23 and July 2, the biggest slump during the bull market.

The financial system is riskier than it was before the 2008 crisis that led the U.S. economy to the worst contraction since the Great Depression, Taleb said.

Posted by Brian Schuettler at 4:35 pm  

Deflation worries

 Bond Market, Deflation-Inflation-Stagflation  No Responses »
Aug 152010
 

Back to Worrying about Worse-Case Scenarios – Tom Petruno, LA Times

The fear pushing government bond yields sharply lower isn’t about whether the world is facing just a temporary economic slowdown. Rather, it’s dread of a downturn that would set off a deflationary spiral.

Posted by Brian Schuettler at 4:29 pm  

Fixed-Income Pros Fear ‘Bond Fund Bubble’

 Bond Market, Investment Portfolios, Investment Strategies  No Responses »
May 012010
 

overlooking risks in equities, bonds

Given the events of the past three years, individual investors’ preference for bonds is understandable. Cash in money markets currently offers miniscule returns, while the U.S. stock market’s perils became all too clear in 2008 and early 2009. According to TrimTabs, $11.9 billion has been pulled from U.S. equity funds in the last 12 months, even as the S&P 500, the broad stock market index, rose 76 percent since Mar. 9, 2009.

“Before 2008, people were not really recognizing the risk in equity markets,” says Eric Meermann, financial planner and portfolio manager at Palisades Hudson Financial Group in Scarsdale, N.Y.

Now, many may not recognize the risk in bond markets. “We foresee a rising interest rate environment, and investors need to be aware of the risks associated with that,” says Ron Florance, director of asset allocation and strategy at Wells Fargo Private Bank (WFC).

Bonds vary widely but there are two main types of risk embedded in all fixed income products: credit risk and interest rate risk. Credit risk is the risk that a bond issuer will not be able to pay, a possibility with which investors in Greece’s government debt are currently contending. Interest rate risk is the possibility that—because of Federal Reserve action, a stronger economy, or fears of inflation—rates could rise.

Fixed-Income Pros Fear ‘Bond Fund Bubble’ – Ben Steverman, BusinessWeek

Posted by Brian Schuettler at 12:21 pm  

Capital Needed!

 Bond Market, Cash Is King!  No Responses »
Oct 172009
 

Ismail Dalla and Heiko Hesse note that as the financial crisis has curtailed the ability of borrowers in emerging markets to find funds abroad, they have turned to raising capital in domestic markets. Local-currency bond markets had already grown tremendously since the crises of the 1990s. Dalla and Hesse say that deepening local-currency bond markets should now be a top priority for emerging economies. See Rapidly Growing Local-Currency Bond Markets Offer a Viable Alternative Funding Source for Emerging-Market Issuers.

Posted by Brian Schuettler at 8:10 am  

Investment Future

 401(k) Issues, Analysis & Commentary, Back to the basics, Bond Market, Devaluation, Dollar Musings, Figures don't lie but Liars can figure, Investment Portfolios  No Responses »
Oct 102009
 

The Future of Investing
FT writers join major world figures in examining the implications of the credit crunch on our investment system.

Posted by Brian Schuettler at 9:42 am  

Bond Bears do a dump

 Bond Market, Monetary Policy - Discussion  No Responses »
Aug 252009
 
Bond Bears Dumping Two-Year Treasuries Defy Fed Rate History
Bloomberg
… simply because there’s no inflation,” said Michael Cheah, who manages $2 billion in bonds at SunAmerica Asset Management in Jersey City, New Jersey. …
Posted by Brian Schuettler at 10:16 am  

Chrysler Mows Down Debtholders’ Claims in Court

 Bond Market, Collateral Damage, Creditors Caveat  No Responses »
Jun 112009
 

June 5 (Bloomberg) — Today was supposed to be the day that Chrysler LLC sold itself to Fiat and embarked on a new, government-designed chance at survival. Instead, its lawyers are arguing in a federal appeals court this afternoon to please, please let the sale go through.

It probably will. No matter what the law says, it’s hard to picture a three-judge appellate panel throwing itself into the path of a speeding train carrying the futures of Chrysler and General Motors Corp. and, with them, a segment of the ailing U.S. economy.

However messy, derailment is what the law seems to demand. But that’s not what these judges are likely to order.

“Circumstances have conspired to force them to find a way to approve the sale,” says Daniel Glosband, a bankruptcy lawyer with Goodwin Procter in Boston.

The package the White House hammered together to convert big, old, dying Chrysler into a smaller, healthier car company looks a lot like a massive violation of bankruptcy law. A few dissident creditors, namely three Indiana pension funds that banded together, remain defiant enough to say so.

The Chrysler plan “seeks to extinguish the property rights of secured lenders, trampling the most fundamental of creditor rights in disregard of over 100 years of bankruptcy jurisprudence,” the funds argued in bankruptcy court papers.

Their share is tiny, to be sure. Out of $6.9 billion in senior secured loans, the Indiana funds have $42 million. They paid 43 cents on the dollar, and would get roughly 29 cents after the sale.

The Gall

What galls them is that the United Auto Workers’ retiree health care trust fund, the most prominent of the unsecured creditors, would own 55 percent of the new company and get a $4.5 billion note for its $10.5 billion unsecured claim.

Putting unsecured creditors ahead of secured lenders isn’t how bankruptcy law is supposed to work.

Plus, the government has no business giving Chrysler money meant only for financial institutions under the Troubled Asset Relief Program, the funds say.

They say the sale is really reorganization in disguise, which is illegal under bankruptcy law. By claiming it’s a sale, Chrysler avoids months of court scrutiny and legal wrangling over how much to give each creditor. They slip past rules that reorganization requires.

“If there ever was a stealth reorganization plan, this is it,” David Skeel, law professor the University of Pennsylvania, told Bloomberg Radio.

Heated Debate

It looks like a sub rosa reorganization to me, too, but bankruptcy experts hotly debate the point in blogs and in news interviews.

U.S. Bankruptcy Judge Arthur Gonzalez this week declared it a bona fide sale, a fair deal for creditors and the best possible result under dire circumstances.

As for using TARP funds to save a car company, Gonzalez didn’t rule on that, saying the Indiana funds had no legal authority to raise the issue in the first place.

It would have been almost impossible for him to turn down the Chrysler-Fiat deal. If you think the Second Circuit Court of Appeals feels pressure to give Chrysler what it wants, imagine the stress on a sole bankruptcy judge.

The Obama administration decided Chrysler and, behind it, General Motors, are too American to fail, no matter how poorly they’ve been run. It’s pumped billions into the companies while structuring this quick sale and dragging most secured creditors into agreement. If the sale doesn’t go through this very minute, or at least by June 15, Fiat can walk away, leaving liquidation as the only option, Chrysler and its partners in the deal declare.

Contrived Emergency

But the urgency is largely self-inflicted. The government, as financier-in-chief, created the emergency in fashioning the sale the way it did.

It’s a common tactic for debtors to declare themselves in imminent danger of total demise while demanding a rushed sale to avoid reorganization, says Glosband, the Boston bankruptcy lawyer. Judges usually see through it.

If Chrysler gets away with it, and he predicts it will, the precedent will ripple through bankruptcy courts for years to come.

“It basically circumvents the bankruptcy code provisions that deal with how you address the rights of all the different constituencies in the case,” says Glosband.

Those rules are there to make the process fair. But in this case, the Obama administration played the lead role in figuring out who gets what, and providing the finances to make it work before the matter ever got to court.

Fast Moving

After today’s argument in New York, the Second Circuit judges could rule as soon as this weekend. That’s extraordinary speed for a federal appellate court.

“If Chrysler wins,” says Stephen Lubben, bankruptcy law professor at Seton Hall University, “it takes the wind out of a lot of objections likely to be filed with GM.”

Lubben considers that a fine result, as he believes the Chrysler sale’s legit.

But those who argue Chrysler can’t win if the courts follow law worry that when judges let big cases bend the rules, they erode the rule of law for everyone.

(Ann Woolner is a columnist for Bloomberg News. The opinions expressed are her own.)

Chrysler Speeds Past Legal Limits to Live – Ann Woolner, Bloomberg

Posted by Brian Schuettler at 4:28 am  

The trillion dollar question: China or America?

 A State of Distress, Bond Market, China and the Treasuries - A Dependency Relationship, Death of the Dollar  No Responses »
Jun 022009
 

Who is going to come out of the economic crisis stronger and with the whip hand – China or America, asks Niall Ferguson.

Who Emerges With Whip Hand? China or U.S.? – Niall Ferguson, Telegraph

Posted by Brian Schuettler at 4:00 am  

The Required Yield Theory of Asset Valuation

 Back to the basics, Bond Market, Investment Portfolios  No Responses »
May 252009
 

Is the Required Yield Theory better than the Fed Model? (CXO Advisory Group)

What aggregate return thresholds are critical to investors in deciding whether to accept or reject equity and bonds for investment portfolios? In their December 2008 paper entitled “A Required Yield Theory of Stock Market Valuation and Treasury Yield Determination”, Christophe Faugère and Julian Van Erlach argue that investors first require that U.S. stocks and bonds in aggregate prospectively provide a real after-tax earnings yield directly related to real long-term GDP per capita growth. Investors then decide between stocks and bonds based on the better after-tax real return. Applying this Required Yield Theory (RYT) to quarterly data over the period 1953-2006, they find that:

  • Real, after-tax Treasury and S&P 500 forward earnings yields reliably revert to positive means. For stocks, the mean yield is very close to the long-run average real GDP per capita annual growth rate (2.24% during 1929-2001 and 2.03% during 1929-2006).
  • The equity risk premium derives mostly from business cycle risk, as measured by the growth in book value of equity per share (productivity growth). Inflation risk and fear-based risk have only transient, secondary impacts on the premium. The equity premium is always positive or zero relative to long-term Treasuries, but may be negative relative to short-term Treasuries when short-term productivity outpaces medium-term and long-term trends.
  • Periods when the after-tax 30-year Treasury bond yield is below the nominal required yield indicate that a fear-based premium is present.
  • Using quarterly data, the RYT Model fits the S&P 500 forward earnings yield with adjusted R-squared statistics of 88% over 1953-2006 and 94% over 1978-2006, about 19% better than the fit provided by the Fed Model (see chart below). Transient deviations from the model arise from: (1) economic, productivity or policy shocks that impact the equity risk premium; (2) shocks to earnings, productivity or inflation forecasts; and, (3) short-term noise trading.
  • Treasury yields are a function of short-tem productivity growth relative to its long-term trend. The RYT Model fits the yields on 1-year, 10-year and 30-year Treasuries with adjusted R-squared statistics over 66%.
  • Using the difference between long-term and short-term growth in aggregate book value per share, the RYT Model largely explains the spreads in yields between long-term and short-term Treasuries (term spread), with adjusted R-squared statistics over 58%. The model successfully generates 10 of 12 yield curve inversions over the sample period.
  • RYT partially validates the Fed Model since both the S&P 500 forward earnings yield and the 10-year Treasury yield both derive from the required yield (long-term real U.S. GDP per capita growth)
Posted by Brian Schuettler at 5:24 am  

Muni Rising

 Bond Market, MUNIs  No Responses »
May 232009
 

Muni bonds are back to pre-crisis levels. (TraderFeed)

In a low interest rate environment, those tax-free yields have looked attractive to retail investors and, amidst hopes of economic stabilization, investors have been willing to move away from Treasuries and into munis.

Posted by Brian Schuettler at 5:26 am  

Bond Bailout

 Bond Market  No Responses »
Mar 312009
 
“You’re ticked off about the bank bailouts. You think somebody–other than you and your fellow taxpayers–needs to pay. Let’s try to work out who that somebody ought to be. … Which leaves … the folks who loaned the banks money. The banks’ creditors have been the clearest beneficiaries of the bailouts–leaving them with the wherewithal to contribute. … But banks also borrow on wholesale markets, mainly by issuing bonds. About $2.6 trillion of bank funding in the US, 20% of the total, comes from such debt securities, according to the FDIC. … It may be too much to ask small depositors to monitor the risks at the banks where they out their money and pay for getting it wrong. But these bond buyers are pros. … If Citi’s $486 billion in wholesale debt were converted into common shares–admittedly a pretty extreme situation–the company’s balance-sheet woes would evaporate”, my emphasis, Justin Fox at Time, 23 March 2009.


Until bondholders have the right to inspect banks’ books, there is no meaningful way they can monitor the banks activities. However, I agree bondholders should have taken a haircut on their bonds as opposed to taxpayers bailing out the banks. Why would converting Citigroup’s $486 billion in debt into common stock be “a pretty extreme situation”? That’s what happens in bankruptcy courts every day.

Posted by Brian Schuettler at 4:54 am  
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