Here’s my take on a large part of what is going on it the markets now.
- Bond market implied volatility is low. Tony Crescenzi comments about that on the Treasury market, but it is also true of the agency and swap markets. Less true of corporates, because rumored LBOs are making market players jumpy, but spreads are still pretty tight. People are too complacent…
- What did well in the first four quarters of this year? Borrowing from Merrill Lynch, in terms of sectors, it would be utilities and materials, follow by healthcare and energy. In terms of quality, low quality continues to win, which is a function of tight credit spreads. Growth strategies are working — low PEG ratios, small caps, and high ROE are doing well so far in 2007.
- China may take the global economy over the edge. Between tightening interest rates and raising deposit requirements, they are moving to slow their economy. One thing that fights against them is the currency; much stimulus comes from keeping the yuan low.
- One factor that helps to keep oil prices high is the inefficiency of the average state-owned oil company. Venezuela, Iran, and Indonesia are great examples of the damage that can be done by negligent government-sponsored companies tha don’t reinvest enough in their businesses.
- Fascinating to see copper and gold up, Baltic freight up and timber prices down. US housing is damaging timber, but demand outside of the US is driving the rest at the margin.
- Even more amazing is the foreign buying of Treasuries, which proceeds unabated to recycle the shrinking current account deficit.
I have more, but I am tired, and will post more on Monday.
I was intrigued by your mention of TED spreads in your April 30 post. My (limited) understanding of this metric suggests that markets MAY starting to price in an end to the current trajectory of diminishing risk premia and increasing liquidity.
I’d be interested in an expanded view of your thinking on this.
Thanks
As far as China is concerned, yes, it is true China is slowing the economy. With Q1 GDP growth rate in the double digits, and China’s reluctance to increase the interest rate except trying to raise the bank deposit rate to the current of 11% hoping to curb the overheated economy particularly of the Shanghai as well as the Shenzhen stock markets would be considered as warning to the market before Beijing would start increasing the overnight lending rate by perhaps another 27 basis point but given negative interest rate and the signal of persistent inflation, China seems to have no choice but to increase the interest rate but if it is not a heavy-handed one, it would not stop the speculation in the two stock markets.
Regards,
Steven
Hi David! You mention utilities and how well they have been doing this past year. I follow the UTH, IDU and XLU and they are all near or right at 52 week highs. What would derail this trend? Are interest/bond rates the most important factor in utilities? If yes, then how so? Thank you…
Estragon – Yes, you have it right, but as I noted before, swap spreads (which can be construed as forward TED spreads, sorta) are not confirming this. During LTCM, the swap spread curve moved along with the TED spread.
Qomolangma (Steven) – I’m not faulting the Bank of China. They have to do what they have to do. My fear is that they won’t grasp the lagged effects of monetary policy and will overtighten. They are new to this game, and many experienced central banks have made that error frequently.
Paul – Utilities are bond substitutes, with a bit of inflation and profit passthrough from their regulated subsidiaries. At present, bond yields are benign competition, and public utility commissions are not pushing back hard, partly because they see rising energy costs everywhere.