Friday, August 02, 2013

Are US Stocks Markets in a Wile E. Coyote Moment?

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US stocks soared to fresh record highs! Again mostly based on the market’s Pavlovian response to central bank stimulus and partly to selective focus on economic data
 
Markets tend to rise during central bank meetings (see New York Fed Study here) as a conditioned response to central bank guarantees.

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This euphoria ironically comes amidst soaring yields of 30 year UST bonds which is at a two year high

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Yields of 10 year notes also spiked approximating the recent highs which are also at 2 year highs.

In the recent past, US stocks have risen in the backdrop of DECLINING yields of US Treasuries

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And rising stocks and rising yields seem as a replay of 2006-2007.

The market’s Pavlovian response to central banking steroids signifies as expectations of extended zero bound rates or prolonged low interest environment.

But the bond markets has been saying otherwise.

Will this time be different?

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Another headwind. Oil prices has also surged and is now at $107+ per bbl (WTIC). 

As I recently pointed out, each time WTIC passed the $100 mark, US stocks eventually succumbed to substantial corrections (green oval). Another this time is different?

Rising bond yields, oil prices, producers prices and stock markets are manifestation of the advanced (maturity ) phase of the US inflationary boom.

The incompatibility of the forces behind rising stocks and high oil/bond yields also means one of these two has been wrong…unless this time is different, where water flows uphill.

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The impact of rising yields is on leverage. Rising yields which means higher interest rate extrapolates to higher cost of debt servicing.

The build up margin debt in the US stock markets seem to also mimic record stocks and replicates the 2000 and 2007 episode.

This means that the rate of increase of stock market returns should be greater than the rate of increase in interest rates, otherwise the wheels come off.

So yield chasing in the stock market has now transformed into a Minsky’s Ponzi finance—which relies on continued ascent of asset prices to maintain unsustainable debt levels.

Wile Coyote continues to chase the elusive Road Runner and he may just be running off the cliff.

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And another thing, how do you think rising yields or higher interest rates will affect government debt of developed economies?  This time is different?
Don’t worry, be happy

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