The New Conundrum?

Daily State of the Markets 
Tuesday Morning – August 24, 2010  

Alan Greenspan once referred to the action in the bond market as a conundrum. I won’t bore you with the details, but in June 2005, the then-Chairman of the Federal Reserve voiced his concern about the way the long bond was acting and several of his colleagues were publically puzzled by the action as well. My point this morning is that although things are very different now on many fronts, there may be a new conundrum developing in the bond market.

Yes, I recognize that it is late summer and the height of the vacation season on Wall Street. As such, the game is more than a little thin these days. But, to hear the talking heads tell it, the message from the bond market is easy to comprehend and not exactly encouraging.

As I’ve mentioned a time or twenty lately, the stock market appears to be following bond yields around like a little puppy dog. So, with bond yields in the U.S. finishing within a whisker (0.005% to be exact) of the lows of the day and German bund yields actually hitting new lows, it wasn’t terribly surprising to see our stock market get hit with sell programs into the close.

However, the reasoning behind the moving parts here is a bit of a conundrum (well, to me, anyway). We are told by the folks on T.V. (who are always completely sure they are correct), that the decline in bond yields is a clear sign the economy is in trouble. These guys tell us – again, with absolute certainty – that the message is simple: Prepare for Armageddon II. They point to the widening CDS spreads in Europe and the risk of default in Greece as Exhibits A and B in their arguments and then bring it home with talk of a double-dip recession.

But in spite to the pending doom-and-gloom, I’m going to opine that there just might be a another side of this thing. You see, the Financial Times reported in a recent article that, according to Greenwich and Associates, Hedge Funds now account for 20% of all trading volumes in the U.S. Treasury Market, which, is up just a smidge from the 3% level seen in 2009. Yep, that’s right; Hedge Funds and the “momentum trade” just might be one of the reasons that bond yields keep falling (even when there is no news). In short, there just might be too many dollars might be chasing too few bonds.

Yes, we understand that the hedgies may be buying bonds in order to de-risk their portfolios. But then again, one thing that hedge funds are REALLY good at is identifying and then exacerbating a trend (anyone recall tech in 1999 or commodities/oil in 2008?). So, with bonds being the ONLY thing working in the financial markets these days, it is little wonder that the boys on Wall Street are bombing into bonds. After all, if you leverage these things up 20-30 times, the returns aren’t half bad.

Can I be accused of rationalizing a bit here? Perhaps. But there are often many ways to look at a topic in the stock market game, so I wanted to bring this idea to your attention.

Getting back to the matter at hand, it was mildly disturbing to see stocks fall in response to good news. One might have expected the M&A activity and the decent data out of the Chicago Fed National Activity Index (which gave no hint of recession) to lend the bulls a hand. But, with bond yields falling and the guys programming their computers to have the machines to sell stocks when yields decline (see the conundrum?), well, it is easy to see why stocks lost a little ground on Monday.

Turning to this morning… It’s all about the bonds again this morning. With no economic news to work with before the bell gloom-and-doom appears to be the mood of the market as bond yields are plunging to new lows. A conundrum or just an old fashioned panic? Stay tuned.

On the economic front… We’ll get reports on Existing Homes Sales and the Richmond Fed Index at 10:00 am eastern.

Finally, remember that there is more to life than increasing its pace…

Pre-Game Indicators

Here are the important indicators we review each morning before the opening bell…

• Major Foreign Markets:
  • Australia: -0.94%
  • Shanghai: +0.41%
  • Hong Kong: -1.10%
  • Japan: -1.33%
  • France: -1.70%
  • Germany: -1.16%
  • London: -1.31%

   

• Crude Oil Futures: – $1.21 to $71.89
• Gold: – $15.20 to $1213.30
• Dollar: higher against Yen, Euro and Pound
• 10-Year Bond Yield: Currently trading lower at 2.520%

   

• Stocks Futures Ahead of Open in U.S. (relative to fair value): 
  • S&P 500: -12.91
  • Dow Jones Industrial Average: -110
  • NASDAQ Composite: -22.2  

Wall Street Research Summary

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