Jan. 30 (Bloomberg) – The U.S. economy shrank the most in the fourth quarter since 1982 as consumer spending recorded the worst slide in the postwar era, a trajectory that’s likely to continue in coming months.
When one reads that the U.S. economy contracted at the fastest pace since 1982 and that there is no end in sight… it is hard not to be bearish with regard to the equity markets. On the other hand we couldn’t help but feel that we had seen this once before- only in reverse. To explain we will include a snippet from an L.A. Times article dated March 30, 2000, “The red-hot U.S. economy, powered by heavy spending by consumers and the federal government, was roaring ahead at an annual rate of 7.3% in the final three months of 1999, the fastest growth rate in nearly 16 years.“
Our point today revolves around the bond market.
One of the most bizarre things that we had ever seen in the markets occurred in January of 2000. With the U.S. economy smokin’ through the fourth quarter of 1999 and still a few months away from the March peak for the Nasdaq Composite Index the long end of the U.S. Treasury market began to lift in price. In other words in response to the hottest pace of economic activity in 16 years… long-term interest rates declined.
Many wrote off the strength in the bond market as purely ‘technical’ in response to plans to limit future auction of 30-year securities but month after month the price of the 30-year T-Bond futures moved higher.
It was only months or, perhaps, quarters later that the seemingly inexplicable action in the long end of the Treasury market began to make sense. The bond market began to lift in price in early 2000 because economic activity was beginning to slow. The bond market continued to rise in price because… economic activity continued to slow.
The chartbelow compares the Nasdaq Composite Index with the U.S. 30-year T-Bond futures from the spring of 1999 through 2000. The chart shows that after making a low in January of 2000 the trend for long-term Treasury prices turned upwards. The chart also shows that the bond market was rising in price a few months before the Nasdaq reached its ‘bubble’ peak, as much as 8 or 9 months before significant cyclical price weakness showed up in the fourth quarter of 1999, and a full year ahead of the first rate cut by the Fed in January of 2001.
It has been our experience that the one market that we always regret arguing with is long-term Treasuries. We are, more or less, hard-wired into thinking that this is our view and therefore this is the way the bond market should be trending instead of working hard to ‘listen’ to what the bond market is saying and adjusting our views accordingly.
The point is that if one paid attention to economic news reports in 2000 there was no way in the world that rising bond prices made sense. If one looked at the near-vertical trend for cyclical asset prices through the first quarter of 2000 there was absolutely no way that one could rationalize the idea that interest rates should be falling. In the fullness of time, however, if one actually took a few minutes to think about it the pivot upwards in the long end of the Treasury market was a powerful indicator that economic growth was slowing. It was, upon further reflection, the one thing that truly told anyone who was paying attention that the rising trend for asset prices was approaching its conclusion. It was months ahead of asset prices, quarters ahead of most economists, a year ahead of the Federal Reserve, and probably even further ahead of most investors. The upward pivot in the TBond futures in January of 2000 made no sense if one argued with it and made perfect sense to those who accepted that new trends begin at those points in time when they are least expected.
Equity/Bond Markets
We used the entirety of today’s first page to make a somewhat simple point. The argument is… don’t argue with the bond market. From our point of view it usually makes better sense to accept what the bond market is ‘saying’ than to argue with what it is doing. If the bond market is strong and rising then it usually means that economic growth is slowing and when it is weak and falling one can be reasonably sure that future economic news will surprise to the upside.
The next step is to put this into some sort of present-day context.Below we compare the U.S. 30-year T-Bond futures from July of 1999 through August of 2000 with the TBonds from July of 2008 to the present day.
The point is that bond prices fell through the month of January. We admit that bond prices have declined from rather lofty levels and that this doesn’t even begin to become interesting until the TBonds dive well below their 200-day moving average line (red line on chart) but… even so… our curiosity is now well and truly piqued.
In 2000 the bond market rose even as U.S. GDP rose at the fastest pace in 16 years. In 2009 the bond market declined even as GDP fell as the fastest pace since 1982. We will argue that falling bond prices and rising interest rates today make about as much sense as rising bond prices and falling interest rates did in the first quarter of 2000.
To extend the argument we have to take a rather large ‘leap’. The idea would be that bond prices peaked at the end of 2008 and are now in a falling trend. Since it will be weeks if not months or quarters before this becomes absolute clear we would caution that the entire argument- while compelling- is still somewhat theoretical.
So… in theory… if the trend for long-term Treasury prices peaked in December and turned lower on a sustained basis at the start of this year how will this impact the other markets? Good question.
The first thing the TBonds would have to do is break below the 200-day e.m.a. line (i.e. go sub-123). After that the TBonds would have to hold below the moving average line so that the 50-day e.m.a. crosses down through the 200-day. Why? Because the ‘cross’ is typically a significant technical event. To explain notice that in 2000 the moving average lines ‘crossed’ to the upside in late March and this marked the peak for the Nasdaq.
If the TBonds continue to decline and move well below 123 and if the moving averages ‘cross’ so that the 50-day (blue-green line on chart) moves below the 200-day (red line) then this should mark the bottom for at least a number of the major cyclical asset markets.
A second chart-based argument from 2000 goes something like this. There was a second cyclical asset price peak that occurred in August of that year. This price peak coincided with the TBond futures breaking above the April highs. We have argued, for example, that a trend becomes ‘set’ when the moving averages have crossed, prices have moved back towards the moving averages, and then new extremes are made. In other words it would be technically significant and very equity markets bullish if the TBonds were to decline to a low this quarter so that the moving averages crossed, rallied upwards for some length of time, and then broke to new lows. All things considered that may well prove to be the best time to get seriously positive with regard to the equity markets.
