Financial topics

[Higgenbotham]

The graph you showed is interesting because it indicates we should see an approximately 30 year trend toward lower PE ratios from here, so it's going to be a very long time before stocks are cheap. Seems like it won't be until this crop of Prophets and Nomads are completely out of the picture.

An so perhaps a long time before a real crash?

World is really complex and short-term (1 year) prevision are difficult to make.

I would guess not long to a crash, but a long time to great value. Like the crash was in 1929 and great values were in 1942 or 1949. A mini crash in 1974 and great values in 1982. That type of thing.

But I am starting to see your scenario develop for this year. It looks like a mini replay of 2007. In order to maximize the pain for all concerned, the S&P could take out the November low ever so slightly in March or April to get the bears excited. Then it could come back up as QE2 continues and maybe even slightly exceed the high we may be putting in here to get the bulls excited. Then drop from there. That process would be similar to July to October 2007. How does that sound? It's some combination of our two scenarios.

Also, I can see the case for great values in 10-15 years instead of 30. Guess it depends on whether the slope to get there is steeper than in the past or if it drags out longer because these bubbles were so extreme. I like the idea of seeing a long period of time, say from 2022 to 2035 where nobody gives a hoot about stocks and they sit at low very PEs in mirror relationship to the very high PEs that existed from say 1998 until 2011.

[OLD1953]

Don't forget, there is a built in assumption in investment strategy, that the company won't go bankrupt or default. Same for governments. When those assumptions are challenged, as by a large number of sudden bankruptcies or a number of defaults, the value of investments plummets to a bottom where those willing to assume some risk will invest. Over time, as nobody defaults for an extended period, the value of investments climb off that bottom, until the default part of the cycle begins again. We've avoided the default part of the cycle by extreme government action, but it is doubtful that we will continue to avoid it much longer. If we do , we will create an economy with high risk, but all risk assumed by taxpayers. Few will vote to continue such a system forever, and we'd have to have a dictatorship to keep it going for very long.

[vincecate]

The 30 year treasury is now at 4.74%. If the current trend continues (which I think it will) it will soon be the highest it has been in 3 years. Many people believe that the Fed sets interest rates and that the Fed will keep them low. When we start getting articles about how the 30 year bonds are at the highest interest rate in over 3 years, or longer, there will be many people with cognitive dissonance. That stock E/P ratios should track bond yields and many people with this uncomfortable feeling that the Bernanke Put is like the Tooth Fairy is what I think will trigger the crash.

http://finance.yahoo.com/bonds/composite_bond_rates
http://www.fxstreet.com/rates-charts/bond-yield/
http://en.wikipedia.org/wiki/Cognitive_dissonance

[Higgenbotham]

The 30 year treasury is now at 4.74%. If the current trend continues (which I think it will) it will soon be the highest it has been in 3 years. Many people believe that the Fed sets interest rates and that the Fed will keep them low. When we start getting articles about how the 30 year bonds are at the highest interest rate in over 3 years, or longer, there will be many people with cognitive dissonance. That stock E/P ratios should track bond yields and many people with this uncomfortable feeling that the Bernanke Put is like the Tooth Fairy is what I think will trigger the crash.

http://finance.yahoo.com/bonds/composite_bond_rates
http://www.fxstreet.com/rates-charts/bond-yield/
http://en.wikipedia.org/wiki/Cognitive_dissonance

Looks like you're right on. The stock market has gotten into serious trouble at least twice when the 30 year approached this level - May 2008 and May 2010.

Bernanke addressed reporters for the second time yesterday. The first time was February 19, 2009 when it was also painfully obvious things weren't going so well. Now just one day later bonds have fallen through a support level. I think you brought up a key point - a consensus has to be building that QE2 did not achieve its objective of lowering interest rates and has led to unanticipated problems (like food riots and cotton shortages and...).

[John]

Vince and Higgie, I don't understand.

Isn't it true that QE2 targeted 10 year bonds, leaving
30 year bonds on their own?

And isn't QE2 keeping 10 year bond yields down?

John

[vincecate]

Vince and Higgie, I don't understand.

Isn't it true that QE2 targeted 10 year bonds, leaving
30 year bonds on their own?

And isn't QE2 keeping 10 year bond yields down?

Cognitive dissonance.

Look at the chart below. Along with 30 year yields it also has 5 year and 10 year. They are all going up since QE2. The increases in the 5 year and 10 year are more dramatic (like 1% to 2% and 2.5% to 3.5%). Printing money and buying bonds can lower interest rates in the short term, but long term printing money causes inflation which causes interest rates to go up. With QE2 the Fed went long term and is clearly failing to lower interest rates. When the 30 year crosses 5% it will be the highest in 3 years, when it crosses 5.5% it will be the highest in 9 years (second graph below). At this point it will be painfully obvious. Cognitive dissonance will hit. When the public finally sees that the Fed does not really control interest rates but the market does, then the stock market will crash.

Then again John, I have March puts on the S&P 500 and maybe I am just talking my book. We will see.

http://www.fxstreet.com/rates-charts/bond-yield/

[jdcpapa]

I need to get a clarification on this issue. Please correct me. The Fed is keeping the prime rate at 0%-.25%. The stated rate for the 10 year bond is approximately 2.58%. The fed and the market are buying (bidding down) 10 year bonds at auction at lower than face value resulting in yields in excess of 3.5%. How does that result in an increase in interest rates? There is no increase in interest rates but there is an increase in yields which traditionally goes to risk. It seems to me that the fed is playing both ends against the middle by fixing the prime and bidding higher yields and not increasing interest rates. Thanks.

[vincecate]

I need to get a clarification on this issue. Please correct me. The Fed is keeping the prime rate at 0%-.25%. The stated rate for the 10 year bond is approximately 2.58%. The fed and the market are buying (bidding down) 10 year bonds at auction at lower than face value resulting in yields in excess of 3.5%. How does that result in an increase in interest rates? There is no increase in interest rates but there is an increase in yields which traditionally goes to risk.

The stated interest rate on the bond does not change every day. However, what investors really care about is the effective yield they are getting taking into account the current price and the payout on the bond. This is the real market interest rate. The interest rate in the previous graphs was the real market interest rate, not the stated interest rate on the bonds.

When the Fed with their $100 billion per month jump in the market they do impact market interest rates. It is just that eventually printing money has a dark side.

[jdcpapa]

I am not a student of the fed. So let me get this staight. The fed announces QE2 then prints money and sets the market rate at auction (buys its' bonds at a discount). The fed controls the printer and the auction house? So can it be said that the fed is intentionally increasing the market rate? On the issue of the fed and money printing is it true that the unknown variable is how much money the fed has on its' books to begin with? Regards,

[vincecate]

I am not a student of the fed. So let me get this staight. The fed announces QE2 then prints money and sets the market rate at auction (buys its' bonds at a discount). The fed controls the printer and the auction house? So can it be said that the fed is intentionally increasing the market rate? On the issue of the fed and money printing is it true that the unknown variable is how much money the fed has on its' books to begin with? Regards,

On the very short term the Fed is able to set the market rate. But on longer term, like 5 year, 10 year, 30 year, they are just another bidder in the market. When they bid up the price of bonds they are lowering the effective interest rate, not increasing it. But since they are buying with newly printed money, and people know that, it is not really like when other people buy bonds. New money devalues existing money, so you don't want to lock your money up for 10 years when the Fed is doing much of this, so it can drive rates up.

Note that lower interest rates means pension funds make less money and so go bankrupt faster. When pension funds go bankrupt the government will have to support more people, which will be more money printing.