The recession is destined to continue all through this year and into 2010. Next Friday's employment report for December is projected to decline an additional 500,000, with the official unemployment rate inevitatably rising from last month's 7.2 percent to a cyclical peak of between 10 and 11 percent, probably in 2010. Unfortunately, this official unemployment measure understates the economic pain of those forced by circumstances to take part-time employment or have become so discouraged at the absence of employment opportunities to no longer be counted as actively seeking employment. By such measures the unofficial unemployment rate is already at 13.5 percent. Judging by the rise to 588,000 in intial claims for unemployment benefits in the week of January 24, up from 585,000 the week before, and the large number of announced layoffs, both the worsening unemployment picture and weakening economy will persist for an extended period.
The steep 3.8% plunge in fourth quarter real GDP, versus a 0.5% third quarter decline, reflects a pronounced broadening as well as a deepening in the recession. As bad the decline was, it was not as steep as the 5% to even 7% drop that I and some others feared. But, then there is always the next quarterly report for the current first quarter.
Except for inventories and Federal government spending, virtually all major sectors of the economy were slip sliding away in the fourth quarter. And though inventories rose, the rise was undoubtedly unintended and unwanted and therefore certain to lead to further economic weakness as excessive inventories are trimmed. Without the pervere rise inventories,real GDP would have actually declined 5.1% in the fourth quarter and 1.3% in the third quarter.
The sharply weakening sectors contibuting to the 3.8% reported fourth quarter decline in real GDP include exports, personal consumption spending, and both residential and nonresidential fixed investment. Autos alone accounted for 2% of the 3.8% real GDP drop.
A 19.7% decline in real exports in the fourth quarter, versus a 3.0% rise in the third quarter, underscores the depth of the global recession. At the same time, a 15.7% fourth quarter decline in real imports, a deepening from the 3.5% third quarter decline, attests to the profound worsening of the US recession.
Total real nonresidential fixed investment in the US fell 19.1% in the fourth quarter, versus 1.7% in the third quarter. This the expected response to the broadly based economic weakening in US and foreign business, consumer spending and state and local government spending. Residential fixed investment,which has been in a prolonged decline, accelerated its rate of decent to 23.6% in the fourth quarter, from 16.0% in the third quarter.
Real personal consumption expenditures declined 3.5% in the fourth quarter, a sharp turnaround from a 3.8% third quarter rise. As might be expected, consumer spending in the typically postponable durable goods sector was down steeply, by 22.4% in the fourth quarter, extending the already sharp 14.8% third quarter drop. Of the 3.8% fourth quarter decline in real GDP, the drop in consumer spending accounted for 2.5 percentage points or almost two-thirds of the total.
Perhaps the most significant aspect of the GDP report was the inflation data. The overall GDP deflator, the broadest measure of GDP inflation, edged down 0.1%, crossing the threshold into deflation, a sharp deterioration from 3.9% in the third quarter
Consumers are rebuilding their saving out of disposable income, a typical recession response. In the fourth quarter savings rose close to 3% of disposable income, up from 1.2% in the preceding quarter and a marked increase from the less than zero savings in 2005.
Treasury bond yields rose further this week, on fears of inflation in the wake of the stimulus package and concern that the size of the budget deficit will force Treasury borrowing to outstrip domestic and foreign demand. Despite this development, I would not recommend shorting Treasuries, as some respected analysts recommend. The Fed this week reiterated its warning that it is considering the purchase of long-term Treasuries. Mounting signs of deepening deflation point to lower, not higher bond yields. The weakness of the economy, the prospect of new reasons for panic safe-haven buying of Treasuries some time ahead, including the almost certain failure of additional financial institutions, also point to eventual renewed declines in Treasury bond yields. Bank credit is continuing to tighten for large, medium and small businesses and commercial real estate, a portent of continuing severe economic problems and, over time, a plus for long-term Treasuries. The sharpest January decline in equity prices on record is certainly not a sustained offset to Treasury bonds. This past week gold was one of the few sectors to show price bouyancy. These are not the signs of even a glimmering of hope of recovery on a far distant horizon. Treasury bond yields will decline again and sharply, in at least a retest of their prior lows. That is also the historical cyclical pattern, not only in typical recessions, but well into the first stages of economic recovery. And this is no typical recession. It is, and will continue to be, far, far worse.
Philip Braverman, President
Braverman Economic and Financial Consulting
One Hewitt Square #249
East Northport, New York 11731
Email address: philipbraverman@Gmail.com
Friday, January 30, 2009
Friday, January 23, 2009
The Outlook Darkens
Both recent and coming adverse developments point to the deepest recession, or something worse, since the great depression of the 1930's. That will lead to further declines in equity markets, outright deflation, and renewed declines in Treasury bond yields, contrary to recent trends and the consensus view of so called financial "experts". Indeed, the Fed is considering purchasing Treasury bonds to drive their yields lower. And eventually, the exceptionally wide yield spread between Treasuries and high-to-medium grade corporate and municipal bonds will narrow again. There had been a narrowing in that yield spread that has more recently been partially reversed as the recession deepens and the massive expansion of Government stimulus, both past and proposed, raises misplaced fears of an early resumption of rapid inflation. Unfortunately, the expansion of the money supply and Federal spending is merely partially replacing contracting credit in the private and state and local sectors. In technical terms, that simply means that as the money supply expands there is an equal or more than offsetting decline in the turnover of money (volocity). That not only effectively precludes inflation, but is consistent with deepening deflation, a precurser to lower bond yields.
The economic plunge is continuing to broaden, encompassing sector after sector, with no end in sight. The pronounced deterioration in real estate, both residential and commercial, with which the recession began, is destined to continue. The intense credit crunch persists, undermining all economic sectors. Consumer spending, which has accounted for some 70% of GDP, is now contracting. That contraction is leading to a precipitous drop in business investment and capital spending. Which, in turn, is reinforcing a curtailment of international trade. State and local governments are limiting their spending. With that all encompassing contraction, it is no surprise that initial claims for unemployment benefits reached 589,000 in this past week's report. Expect the unemployment rate to top out between 10% and 11% in 2010. The fourth quarter real GDP report, to be released next Friday, is likely to drop between 5.0% and 7.0%, far worse than the 0.5% decline in the third quarter. Durable goods orders, also out Friday, and leading indicators, reported Monday, will decline further, indicating continuing steep real GDP decline in coming quarters.
The worsening global economic and financial meltdown is simultaneously frightening virtually all markets. This past week gold and oil were among the few market sectors to achieve gains. That suggests renewed inflation fear.
The equity market sold off on expectations of further steep corporate earnings declines, dividend cuts, mounting financial losses and additional investor selling in the wake of the massive deleveraging process and withdrawal of investor funds. The $50 billion Madoff "Ponzi scheme" loss intensified fears of other hidden problems still to be uncovered.
The GE report of a 44% drop in earnings focused market attention on the company's decision to maintain their $13.5 billion payout and still try to maintain their AAA rating. Concern that the GE dividend would yet be cut to preserve the rating, precipitated a steep drop in the stock, while concern that the AAA rating would be lost hurt their bonds. If there is a choice to be made, it will be to cut the dividend and retain the bonds AAA rating.
The corporate, municipal and Treasury bond markets all retreated this week on a myriad of concerns. The prospect of massive US stimulus spending raised fears not only of inflation but that Treasury borrowing will skyrocket so steeply that foreign investors may become reticent to continue their buying of US Treasury debt. Furthermore, the global nature of the economic plunge raises expectations that the major foreign buyers of US debt will be forced to divert their available funds to stimulate their own economies. Treasury Secretary designate Geithner's harsh criticism this week of China, the largest purchaser of US debt, did nothing to allay those market fears. However, the realty is that it is in the best interest of China and other nations to continue investing in US Treasuries.
Financial institutions stocks and bonds were particularly hard hit by concerns that the next step in their bailout would include nationalization, which would put shareholders at risk of a complete loss and even potentially raise questions over the status of bondholders. Despite seeming assurances from Treasury Secretary designate Geither in his confirmation testimony that the intent is to perserve the private status of the financial system, his references to a sharing of losses by shareholders and bondholders (but not by depositors) still leaves many questions unanswered. The realty is that the Federal government is beginning to exert a degree of control that borders on nationalization for financial firms that ostensibly remain independent. For banks, that in the opinion of the Government are at risk of bankruptcy, nationalization is the temporary solution so that the assets can be sold and deposits protected. That power and threat is not lost on top bank executives, some of whom this past week agreed to "voluntarily" pass up 2008 bonuses. Bondholders in major institutions are likely to continue protected.
The focus of government support for the financial system is shifting toward some means of encouraging lending, which thus far has been grossly deficient. Indeed, the heart of the credit crisis is the swing in the pendulum from injudicious or even irresponsibe over-optimistic speculative lending to essentially a lending freeze. Even responsible credit-worthy borrowers, who have never been delinquent, have had their credit lines cut and their loans called. The reason is that many lenders are themselves overwhelmed with unrealized losses on their large holdings of toxic mortgage-backed debt instruments for which there is a less than fully functioning market. Despite the lack of a true market for this distressed debt, banks and other institutions that hold the paper must place a value on these assets even if that involves mere guesses and establishes huge losses. Indeed, full adherence to what is called the "mark-to-market" requirement would wipe out all the capital for all too many financial institutions forcing them into bankruptcy. This "mark-to-market" requirement merely means that banks and other financial institutions "mark" or value their assets at current market prices, even when they have no intention of selling these depressed assets at current distressed prices. As I have suggested before, that senseless mark-to-market requirement should be at least temporarily suspended for the duration of the emergency.
There is at least a hope that in time (undoubtedly years)the market value of the depressed mortgage-backed and other assets will rise materially in value, thereby solving the problem for the individual financial institution and for the financial system. To take advantage of that hope and help the banks, it is proposed that the government set up a special institution (such as another Reconstruction Finance Corporation)to buy those distressed assets from the beleagured banks, thereby giving them a renewed ability to lend. The major problem is in setting an equitable price that is high enough to benefit a bank, without precipitating its bankruptcy, and still low enough to give taxpayers a chance to recoup much of their investment. Though it would have been more responsible to have prevented the speculative lending in the first place, this approach holds some promise of mitgating the credit crunch. However, it is no panacea. The recession will still deepen and extend into 2010.
Philip Braverman, President
Braverman Economic and Financial consulting
One Hewitt Square, #249
East Northport, New York 11731
Email Address: philipbraverman@Gmail.com
The economic plunge is continuing to broaden, encompassing sector after sector, with no end in sight. The pronounced deterioration in real estate, both residential and commercial, with which the recession began, is destined to continue. The intense credit crunch persists, undermining all economic sectors. Consumer spending, which has accounted for some 70% of GDP, is now contracting. That contraction is leading to a precipitous drop in business investment and capital spending. Which, in turn, is reinforcing a curtailment of international trade. State and local governments are limiting their spending. With that all encompassing contraction, it is no surprise that initial claims for unemployment benefits reached 589,000 in this past week's report. Expect the unemployment rate to top out between 10% and 11% in 2010. The fourth quarter real GDP report, to be released next Friday, is likely to drop between 5.0% and 7.0%, far worse than the 0.5% decline in the third quarter. Durable goods orders, also out Friday, and leading indicators, reported Monday, will decline further, indicating continuing steep real GDP decline in coming quarters.
The worsening global economic and financial meltdown is simultaneously frightening virtually all markets. This past week gold and oil were among the few market sectors to achieve gains. That suggests renewed inflation fear.
The equity market sold off on expectations of further steep corporate earnings declines, dividend cuts, mounting financial losses and additional investor selling in the wake of the massive deleveraging process and withdrawal of investor funds. The $50 billion Madoff "Ponzi scheme" loss intensified fears of other hidden problems still to be uncovered.
The GE report of a 44% drop in earnings focused market attention on the company's decision to maintain their $13.5 billion payout and still try to maintain their AAA rating. Concern that the GE dividend would yet be cut to preserve the rating, precipitated a steep drop in the stock, while concern that the AAA rating would be lost hurt their bonds. If there is a choice to be made, it will be to cut the dividend and retain the bonds AAA rating.
The corporate, municipal and Treasury bond markets all retreated this week on a myriad of concerns. The prospect of massive US stimulus spending raised fears not only of inflation but that Treasury borrowing will skyrocket so steeply that foreign investors may become reticent to continue their buying of US Treasury debt. Furthermore, the global nature of the economic plunge raises expectations that the major foreign buyers of US debt will be forced to divert their available funds to stimulate their own economies. Treasury Secretary designate Geithner's harsh criticism this week of China, the largest purchaser of US debt, did nothing to allay those market fears. However, the realty is that it is in the best interest of China and other nations to continue investing in US Treasuries.
Financial institutions stocks and bonds were particularly hard hit by concerns that the next step in their bailout would include nationalization, which would put shareholders at risk of a complete loss and even potentially raise questions over the status of bondholders. Despite seeming assurances from Treasury Secretary designate Geither in his confirmation testimony that the intent is to perserve the private status of the financial system, his references to a sharing of losses by shareholders and bondholders (but not by depositors) still leaves many questions unanswered. The realty is that the Federal government is beginning to exert a degree of control that borders on nationalization for financial firms that ostensibly remain independent. For banks, that in the opinion of the Government are at risk of bankruptcy, nationalization is the temporary solution so that the assets can be sold and deposits protected. That power and threat is not lost on top bank executives, some of whom this past week agreed to "voluntarily" pass up 2008 bonuses. Bondholders in major institutions are likely to continue protected.
The focus of government support for the financial system is shifting toward some means of encouraging lending, which thus far has been grossly deficient. Indeed, the heart of the credit crisis is the swing in the pendulum from injudicious or even irresponsibe over-optimistic speculative lending to essentially a lending freeze. Even responsible credit-worthy borrowers, who have never been delinquent, have had their credit lines cut and their loans called. The reason is that many lenders are themselves overwhelmed with unrealized losses on their large holdings of toxic mortgage-backed debt instruments for which there is a less than fully functioning market. Despite the lack of a true market for this distressed debt, banks and other institutions that hold the paper must place a value on these assets even if that involves mere guesses and establishes huge losses. Indeed, full adherence to what is called the "mark-to-market" requirement would wipe out all the capital for all too many financial institutions forcing them into bankruptcy. This "mark-to-market" requirement merely means that banks and other financial institutions "mark" or value their assets at current market prices, even when they have no intention of selling these depressed assets at current distressed prices. As I have suggested before, that senseless mark-to-market requirement should be at least temporarily suspended for the duration of the emergency.
There is at least a hope that in time (undoubtedly years)the market value of the depressed mortgage-backed and other assets will rise materially in value, thereby solving the problem for the individual financial institution and for the financial system. To take advantage of that hope and help the banks, it is proposed that the government set up a special institution (such as another Reconstruction Finance Corporation)to buy those distressed assets from the beleagured banks, thereby giving them a renewed ability to lend. The major problem is in setting an equitable price that is high enough to benefit a bank, without precipitating its bankruptcy, and still low enough to give taxpayers a chance to recoup much of their investment. Though it would have been more responsible to have prevented the speculative lending in the first place, this approach holds some promise of mitgating the credit crunch. However, it is no panacea. The recession will still deepen and extend into 2010.
Philip Braverman, President
Braverman Economic and Financial consulting
One Hewitt Square, #249
East Northport, New York 11731
Email Address: philipbraverman@Gmail.com
Friday, January 16, 2009
Deep recession and deflation point to still lower bond yields and equity prices
The stock market rallied modestly on Friday, with enough enthusiasm left over to leave the futures market predicting a positive equity market opening on Tuesday, after the Monday Reverend Martin Luther King holiday. A potential cause for this latest equity market improvement was overconfidence that new intiatives planned by the Obama Administration will prove effective in restructuring still deteriorating banks sufficiently to encourage them to eventually lend, a necessary prerequisite to economic recovery. But, this new rally will not endure. Like those that preceded it this cycle, this rally too will be completely reversed, with new equity market cyclical lows still a likely prospect. The reason: there is still too much financial and economic pain ahead.
The Friday shift into equities also somewhat boosted Treasury bond yields. That reflected an investor shift from Treasuries, as well as concerns that the massive size of the projected Federal lending would ultimately raise Treasury borrowing costs and reignite inflation. Despite growing market concerns over those risks, Treasury yields are not only likely to stay low, new lowd in Treasury bond yields are still likely to established in coming quarters and maintained for an extended period. That prospect is likely to be a response to renewed safe-haven buying amidst new signs of financial distress, steep economic declines and outright deflation.
Fourth quarter real GDP, to be released on a preliminary basis late this month, is likely to plunge an horrendous 6% or more. A decline of that frightening magnitude would be one of the steepest ever. That points to significant further depressants for the equity market. A precipitous drop in corporate profits and accompanying sharp cuts in dividends are to be expected in the wake of such a deep drop in real GDP, especially considering that the three series tend to move in unison. This prospect is all the more significant at this juncture since actual and anticipated declines in corporate profits typically lead stock prices lower. That pattern is likely to be powerfully reinforced by a decline in capital investment, a further sharp rise in unemployment and a retreat in consumer spending.
Among the most significant factors contributing to a likely further downtrend in bond yields will be the coming transition from disinflation (which is a progressive slowing in the rate of inflation)to outright deflation (which is a sustained fall in prices). In Friday's report,consumer price inflation for December was down 1.0% from November and up a mere 0.1% from December 2007. This 0.1% year-over-year comparison is now at the very threshold of deflation, after having been up just under 6% earlier this year. The current inflation pace is already well under the prior recession cyclical lows of just above 1% reached in 2002. But, the current downdraft in inflation will almost certainly carry prices into clear deflation territory over coming months. Real wages and salaries, after deducting this slim inflation pace, are now down almost 4% from a year ago, an indication of pronounced consumer financial distress and a portent of further consumer spending cuts.
Despite the diappearance of inflation and prospect of deflation there is still a wide yield disparity between low Treasury yields and the much higher yields on all other debt instruments. The primary reason is the percieved risk of corporate issuers default. This default risk and exceptionally wide yield spread will inevitably narrow as the worst of the recession takes its toll and the first signs of recovery are discerned. While that transition lies well ahead, it is not too early take advantage of the already narrowing yield spread on the bonds of likely corporate survivors. The ratings of investment grade corporate bonds range from AAA, the best rating implying the least risk, through AA,A and BBB,the low end of investment grade ratings with presumably more risk of default. As an example, the AAA rating of GE capital suggests its risk of default, despite substantial problems, is modest.
Nevertheless, there were rumors this week that the coming GE quarterly earnings report will be disappointing due to far more corporate borrowers late or delinquent in their payments to the firm than anticipated. That has led to speculation that GE would be in jeopardy of being downgraded from AAA to AA unless they choose to trim their dividends. It is by means clear that the rumors and speculation are true. But, even if they are, GE bonds would still remain attractive at current yield levels. ,
But, which GE bonds should you consider. Though many prefer relatively short-term maturities, five years to at most ten years, so they can be held to maturity if necessary. I prefer longer-term maturities because they typically offer higher yields to maturity and significantly more capital appreciation if, as expected, bond yields trend lower. But you should emphasize those issues that can be most readily sold when the appropriate time comes. Choose a large original issue, that is noncallable with a relatively high coupon that is not already being sold at a premium price above par(above $1,000 per bond). A bond of a large original issue is slightly easier to sell because it is better known, easier to price and therefore thought to have greater liquidity. A noncallable bond will appreciate much more in price as interest rates decline because it cannot be called (repaid)by the issuer. The market typically has a preference for bonds with higher coupons as long as they are not sold at a premium price(a price above its par price or maturity redemption value).
A comparison of the features of some similar longer-term GE Capital issues can help make some of these distinctions clearer so that they can be more readily applied in choosing between other bonds that you may be offered. In my opinion, last weeks GE Capital offering of a 6.875% issue maturing January 10, 2039, priced to yield 7%, may be somewhat more attractive than some other near comparable maturity GE Capital issues even if they were offered at identical yields. This seems true even though this 30-year issue is a longer maturity than the 6.75% coupon of 2032 and the 7.5% coupon issue of 2035. The reasons are that while the 6.75% of 2032 is also a large issue,it is technically callable, but with a "make whole call" that richly rewards the buyer against call. However many potential buyers do not understand this feature. The 7.5% GE capital bond of 2035 is a smaller issue and at current prices it is sold at a premium. These attributes are considered to slightly outweigh the benefit of the one feature that this issue has that the other two issues lack. This issue is guaranteed by GE(the parent company), as well as backed by GE Capital, the financial arm of GE. But the two companies are thought to be so interwined as to make the extra guarantee less relevent than it may seem.
Philip Braverman,President
Braverman Economic and Financial Consulting
One Hewitt Square #249
East Northport, New York 11731
Email Address: philipbraverman@Gmail.com
The Friday shift into equities also somewhat boosted Treasury bond yields. That reflected an investor shift from Treasuries, as well as concerns that the massive size of the projected Federal lending would ultimately raise Treasury borrowing costs and reignite inflation. Despite growing market concerns over those risks, Treasury yields are not only likely to stay low, new lowd in Treasury bond yields are still likely to established in coming quarters and maintained for an extended period. That prospect is likely to be a response to renewed safe-haven buying amidst new signs of financial distress, steep economic declines and outright deflation.
Fourth quarter real GDP, to be released on a preliminary basis late this month, is likely to plunge an horrendous 6% or more. A decline of that frightening magnitude would be one of the steepest ever. That points to significant further depressants for the equity market. A precipitous drop in corporate profits and accompanying sharp cuts in dividends are to be expected in the wake of such a deep drop in real GDP, especially considering that the three series tend to move in unison. This prospect is all the more significant at this juncture since actual and anticipated declines in corporate profits typically lead stock prices lower. That pattern is likely to be powerfully reinforced by a decline in capital investment, a further sharp rise in unemployment and a retreat in consumer spending.
Among the most significant factors contributing to a likely further downtrend in bond yields will be the coming transition from disinflation (which is a progressive slowing in the rate of inflation)to outright deflation (which is a sustained fall in prices). In Friday's report,consumer price inflation for December was down 1.0% from November and up a mere 0.1% from December 2007. This 0.1% year-over-year comparison is now at the very threshold of deflation, after having been up just under 6% earlier this year. The current inflation pace is already well under the prior recession cyclical lows of just above 1% reached in 2002. But, the current downdraft in inflation will almost certainly carry prices into clear deflation territory over coming months. Real wages and salaries, after deducting this slim inflation pace, are now down almost 4% from a year ago, an indication of pronounced consumer financial distress and a portent of further consumer spending cuts.
Despite the diappearance of inflation and prospect of deflation there is still a wide yield disparity between low Treasury yields and the much higher yields on all other debt instruments. The primary reason is the percieved risk of corporate issuers default. This default risk and exceptionally wide yield spread will inevitably narrow as the worst of the recession takes its toll and the first signs of recovery are discerned. While that transition lies well ahead, it is not too early take advantage of the already narrowing yield spread on the bonds of likely corporate survivors. The ratings of investment grade corporate bonds range from AAA, the best rating implying the least risk, through AA,A and BBB,the low end of investment grade ratings with presumably more risk of default. As an example, the AAA rating of GE capital suggests its risk of default, despite substantial problems, is modest.
Nevertheless, there were rumors this week that the coming GE quarterly earnings report will be disappointing due to far more corporate borrowers late or delinquent in their payments to the firm than anticipated. That has led to speculation that GE would be in jeopardy of being downgraded from AAA to AA unless they choose to trim their dividends. It is by means clear that the rumors and speculation are true. But, even if they are, GE bonds would still remain attractive at current yield levels. ,
But, which GE bonds should you consider. Though many prefer relatively short-term maturities, five years to at most ten years, so they can be held to maturity if necessary. I prefer longer-term maturities because they typically offer higher yields to maturity and significantly more capital appreciation if, as expected, bond yields trend lower. But you should emphasize those issues that can be most readily sold when the appropriate time comes. Choose a large original issue, that is noncallable with a relatively high coupon that is not already being sold at a premium price above par(above $1,000 per bond). A bond of a large original issue is slightly easier to sell because it is better known, easier to price and therefore thought to have greater liquidity. A noncallable bond will appreciate much more in price as interest rates decline because it cannot be called (repaid)by the issuer. The market typically has a preference for bonds with higher coupons as long as they are not sold at a premium price(a price above its par price or maturity redemption value).
A comparison of the features of some similar longer-term GE Capital issues can help make some of these distinctions clearer so that they can be more readily applied in choosing between other bonds that you may be offered. In my opinion, last weeks GE Capital offering of a 6.875% issue maturing January 10, 2039, priced to yield 7%, may be somewhat more attractive than some other near comparable maturity GE Capital issues even if they were offered at identical yields. This seems true even though this 30-year issue is a longer maturity than the 6.75% coupon of 2032 and the 7.5% coupon issue of 2035. The reasons are that while the 6.75% of 2032 is also a large issue,it is technically callable, but with a "make whole call" that richly rewards the buyer against call. However many potential buyers do not understand this feature. The 7.5% GE capital bond of 2035 is a smaller issue and at current prices it is sold at a premium. These attributes are considered to slightly outweigh the benefit of the one feature that this issue has that the other two issues lack. This issue is guaranteed by GE(the parent company), as well as backed by GE Capital, the financial arm of GE. But the two companies are thought to be so interwined as to make the extra guarantee less relevent than it may seem.
Philip Braverman,President
Braverman Economic and Financial Consulting
One Hewitt Square #249
East Northport, New York 11731
Email Address: philipbraverman@Gmail.com
Saturday, January 10, 2009
Surge in unemployment heightens concerns over investment safety
The economy is in far worse shape than even some of the dubious but bleak official economic reports suggest. And there is no cyclical economic bottom in sight any time soon, despite Washington efforts and promises to throw ever more money at the problems.
One rarely reported measure of unemployment, which includes those only marginally employed, is already at 13.5% and likely to go far higher. Even the official widely followed unemployment rate will top 10% this year or next. It is no wonder that consumer confidence measures are establishing new lows. The Conference Board consumer confidence index at 38 in December, is down 15% from 44.7 in November and 58.1% from 90.6 a year ago. That points to a continued drop in consumer spending. There is certainly no prospective sales relief any time soon for the beleagured automobile manufacturers. Domestic auto units sold in December, even with major promotions, were down 32% from a year ago, virtually identical to the 33% plunge for imported auto units sold.
Housing is still far from bottoming out. Expect another 20% nationwide home price drop from here, as well as a continued surge in home mortgage defaults and foreclosures. Commercial real estate is certainly not immune. Office, store and apartment rents are also headed lower. The US has too much retail store space and too much office space. The deleveraging process will take a heavy toll in a further contraction of the financial sector and retailing.
The index of leading indicators will undoubtedly continue well under year ago levels, thereby month by month forcasting a continued recession for at least another six months ahead at a minumum. But, other longer-lead measures suggest the recession will persist right through 2009 into 2010.
Corporate profits will continue to slump. The S&P 500 index earnings per share now looks likely to be cut to or under $50 from some $100 or more last year. That, and the almost certain cuts in dividends that will be produced, is likely to be a strong catalyst for sharply lower equity prices ahead, including a retest of last November lows and quite likely the establishment of new even lower cyclical lows. The Dow Jones Industrials are now up just 15% above its November low. But, the Dow, S&P 500 and Nasdaq Composite are now down for this year to date, considered an ominous portent, given the market belief that a January rise increases the odds of a rise for the year and a January drop a decline for the year.
With all the forgoing it is only reasonable to anticipate that the various measures of inflation will soon be pointing to deflation. The December CPI,to be reported next Friday, should be down 1%. This follows the November consumer price index, which was down 1.7% from October and up just 1.0% from a year earlier. November finished producer prices were unchanged from a year earlier but are likely to be down in the next report. The JOC(Journal of Commerce)-ECRI industrial price index as of January 9 was down a precipitous 41% from a year ago, clearly flashing an outright deflation signal. Most commodity prices, with the notable exception of gold and possibly oil, are likely to continue weak with the persistent global recession. That in turn points to lower market interest rates, especially bond yields which rise with rising inflation expectations and decline with slowing inflation or outright deflation expectations. Indeed, the primary force keeping nonTreasury bond yields high is market concern over the potential for corporate and municipal default, termed "default risk", not inflation.
Similarly, the prime near-term reason for gold purchases is the potential for financial disarray, not inflation. The deep recession in India eliminates much of that country's traditional buying support for gold. But, persistant panic sentiment elsewhere, sufficient to create a shortage of gold vault space, keeps gold prices buoyant. But, some years ahead, perhaps five years, inflation concerns will return with a vengence and on a sustained basis. Until then gold holdings should be viewed as precautionary, despite increased deflation prospects which normally argues against gold.
The official BLS (Bureau of Labor Statistics) unemployment rate spiked up 0.4 percentage points to 7.2% for December from 6.8% in November. Nonfarm payrolls were reported to have plunged 524,000 in December alone, following a revised 584,000 drop in November and a deeper than originally reported drop in October. According to the BLS, The country has now lost a total of 2.6 million jobs in 2008, the largest drop since 1945. As horrendous as the December employment report is, there had been market concerns that the official report would be even worse. That even more dire expectation for the Friday BLS employment report was generated by a revamped ADP estimate, released on Wednesday,that private nonfarm private payrolls(excluding government employment) plummeted 693,000 in December. The disparity between the two series suggests either or both that the BLS report understates the actual loss of jobs and that there will be further steep job losses in the months ahead. A BLS understatement of nonfarm payroll job losses is also suggested by the frightening 806,000 December decline in employment reported in the BLS household survey, which is believed to be the far more reliable series in recession. Also, nonfarm payrolls continue to be irresponsibly inflated by the BLS, by 70,000 in December, to reflect the jobs the BLS merely assumes are being created by companies they do not sample. That inappropriately trims the nonfarm payroll loss by an equal number. The monthly pattern of downward revisions to nonfarm payrolls also indicates an unrelenting understatement of job losses in nonfarm payrolls.
What should you do with this information? It suggests that you should remain cautious,particularly in commiting new funds to equities. Shun them or to the extent possible, limit equity investments to high dividend,low price-earnings ratios (9 or less)in recession-proof companies. Instead of equities, emphasize safety, such as highly-rated debt instruments.
Despite last week's Barrons article urging readers to sell Treasuries, I still believe Treasury bonds and Treasury zero-coupon strips not only have value but offer a strong potential for capital gains. The peak Treasury coupon bond yield (at the apex of the maturity yield curve)at the market close on Friday was 3.43%, on the the 5.5% coupon Treasury bond scheduled to mature August 15,2028 and priced at 129.375 per $100 face value. Because almost all Treasury bonds can not be called by the government prior to maturity, the premium paid above par ($100 face value), will not be lost until maturity or if the bond is sold prior to maturity at less than you pay for it. However, because the bond is not callable, if Treasury market yields decline, as the economy weakens further and deflation risks escalate, as I expect, the market price on this and other Treasury bonds will rise further.
The peak Treasury zero coupon yield last Friday was 3.77% on the strip with a May 15,2023 maturity priced at $58.56 per $!00 at maturity. Even if Treasury market yields were not to decline over the next year, the market price on this zero strip would still rise as the the strip moves closer to maturity and the yields decline quarter by quarter along the yield curve. One year from now, under the circumstances I described, the price on the May 15, 2023 stip would rise to at least $61.06 per $100 face value, or a price rise of 4.3%. Of course, if market yields decline, as I expect, the profit on the May 15, 2023 strip would be larger.
This past week there was a long-term GE bond offering to yield some 7%. That is an excellent yield for a AAA rated issue reflecting excessive default risk.
There has already been a lessening in the near panic perceived default risk of late last year, as measured by the large yield spreads over comparable Treasury maturity yields. But there will be more of a decline in that yield spread and percieved default risk still to be realized. That suggests considering somewhat lesser credits as well if adequatly compensated in yield.
Philip Braverman, President
Braverman Economic and Financial Consulting
One Hewitt Square #249
East Northport, New York 11731
Email address: philipbraverman@Gmail.com
One rarely reported measure of unemployment, which includes those only marginally employed, is already at 13.5% and likely to go far higher. Even the official widely followed unemployment rate will top 10% this year or next. It is no wonder that consumer confidence measures are establishing new lows. The Conference Board consumer confidence index at 38 in December, is down 15% from 44.7 in November and 58.1% from 90.6 a year ago. That points to a continued drop in consumer spending. There is certainly no prospective sales relief any time soon for the beleagured automobile manufacturers. Domestic auto units sold in December, even with major promotions, were down 32% from a year ago, virtually identical to the 33% plunge for imported auto units sold.
Housing is still far from bottoming out. Expect another 20% nationwide home price drop from here, as well as a continued surge in home mortgage defaults and foreclosures. Commercial real estate is certainly not immune. Office, store and apartment rents are also headed lower. The US has too much retail store space and too much office space. The deleveraging process will take a heavy toll in a further contraction of the financial sector and retailing.
The index of leading indicators will undoubtedly continue well under year ago levels, thereby month by month forcasting a continued recession for at least another six months ahead at a minumum. But, other longer-lead measures suggest the recession will persist right through 2009 into 2010.
Corporate profits will continue to slump. The S&P 500 index earnings per share now looks likely to be cut to or under $50 from some $100 or more last year. That, and the almost certain cuts in dividends that will be produced, is likely to be a strong catalyst for sharply lower equity prices ahead, including a retest of last November lows and quite likely the establishment of new even lower cyclical lows. The Dow Jones Industrials are now up just 15% above its November low. But, the Dow, S&P 500 and Nasdaq Composite are now down for this year to date, considered an ominous portent, given the market belief that a January rise increases the odds of a rise for the year and a January drop a decline for the year.
With all the forgoing it is only reasonable to anticipate that the various measures of inflation will soon be pointing to deflation. The December CPI,to be reported next Friday, should be down 1%. This follows the November consumer price index, which was down 1.7% from October and up just 1.0% from a year earlier. November finished producer prices were unchanged from a year earlier but are likely to be down in the next report. The JOC(Journal of Commerce)-ECRI industrial price index as of January 9 was down a precipitous 41% from a year ago, clearly flashing an outright deflation signal. Most commodity prices, with the notable exception of gold and possibly oil, are likely to continue weak with the persistent global recession. That in turn points to lower market interest rates, especially bond yields which rise with rising inflation expectations and decline with slowing inflation or outright deflation expectations. Indeed, the primary force keeping nonTreasury bond yields high is market concern over the potential for corporate and municipal default, termed "default risk", not inflation.
Similarly, the prime near-term reason for gold purchases is the potential for financial disarray, not inflation. The deep recession in India eliminates much of that country's traditional buying support for gold. But, persistant panic sentiment elsewhere, sufficient to create a shortage of gold vault space, keeps gold prices buoyant. But, some years ahead, perhaps five years, inflation concerns will return with a vengence and on a sustained basis. Until then gold holdings should be viewed as precautionary, despite increased deflation prospects which normally argues against gold.
The official BLS (Bureau of Labor Statistics) unemployment rate spiked up 0.4 percentage points to 7.2% for December from 6.8% in November. Nonfarm payrolls were reported to have plunged 524,000 in December alone, following a revised 584,000 drop in November and a deeper than originally reported drop in October. According to the BLS, The country has now lost a total of 2.6 million jobs in 2008, the largest drop since 1945. As horrendous as the December employment report is, there had been market concerns that the official report would be even worse. That even more dire expectation for the Friday BLS employment report was generated by a revamped ADP estimate, released on Wednesday,that private nonfarm private payrolls(excluding government employment) plummeted 693,000 in December. The disparity between the two series suggests either or both that the BLS report understates the actual loss of jobs and that there will be further steep job losses in the months ahead. A BLS understatement of nonfarm payroll job losses is also suggested by the frightening 806,000 December decline in employment reported in the BLS household survey, which is believed to be the far more reliable series in recession. Also, nonfarm payrolls continue to be irresponsibly inflated by the BLS, by 70,000 in December, to reflect the jobs the BLS merely assumes are being created by companies they do not sample. That inappropriately trims the nonfarm payroll loss by an equal number. The monthly pattern of downward revisions to nonfarm payrolls also indicates an unrelenting understatement of job losses in nonfarm payrolls.
What should you do with this information? It suggests that you should remain cautious,particularly in commiting new funds to equities. Shun them or to the extent possible, limit equity investments to high dividend,low price-earnings ratios (9 or less)in recession-proof companies. Instead of equities, emphasize safety, such as highly-rated debt instruments.
Despite last week's Barrons article urging readers to sell Treasuries, I still believe Treasury bonds and Treasury zero-coupon strips not only have value but offer a strong potential for capital gains. The peak Treasury coupon bond yield (at the apex of the maturity yield curve)at the market close on Friday was 3.43%, on the the 5.5% coupon Treasury bond scheduled to mature August 15,2028 and priced at 129.375 per $100 face value. Because almost all Treasury bonds can not be called by the government prior to maturity, the premium paid above par ($100 face value), will not be lost until maturity or if the bond is sold prior to maturity at less than you pay for it. However, because the bond is not callable, if Treasury market yields decline, as the economy weakens further and deflation risks escalate, as I expect, the market price on this and other Treasury bonds will rise further.
The peak Treasury zero coupon yield last Friday was 3.77% on the strip with a May 15,2023 maturity priced at $58.56 per $!00 at maturity. Even if Treasury market yields were not to decline over the next year, the market price on this zero strip would still rise as the the strip moves closer to maturity and the yields decline quarter by quarter along the yield curve. One year from now, under the circumstances I described, the price on the May 15, 2023 stip would rise to at least $61.06 per $100 face value, or a price rise of 4.3%. Of course, if market yields decline, as I expect, the profit on the May 15, 2023 strip would be larger.
This past week there was a long-term GE bond offering to yield some 7%. That is an excellent yield for a AAA rated issue reflecting excessive default risk.
There has already been a lessening in the near panic perceived default risk of late last year, as measured by the large yield spreads over comparable Treasury maturity yields. But there will be more of a decline in that yield spread and percieved default risk still to be realized. That suggests considering somewhat lesser credits as well if adequatly compensated in yield.
Philip Braverman, President
Braverman Economic and Financial Consulting
One Hewitt Square #249
East Northport, New York 11731
Email address: philipbraverman@Gmail.com
Friday, January 2, 2009
Look for new cyclical lows in Treasury yields and equity market prices
On Friday, the first day of 2009, the equity market rallied broadly, with the Dow up 2.9% or 258 points, while Treasury yields rose sharply (the 10-year yield surged to 2.42% from 2.25% the day before, and 2.07% just a few days prior). This seeming cyclical turn-around in equity prices and Treasury yields is mistakenly seen by many observers as potentially setting the stage for far more of the same over coming weeks and possibly even months. But as I warned in the report before last, just like the inevitable additional bouts of misguided optimism to come, this turn-of-the year market euphoria will prove to be only temporary. For those nimble enough, it may be possible to shift investment horses back and forth in midstream without getting trampled, But that may take extraordinary investment attention, acumen and dexterity.
A reversal of the primary market trends of 2008 is virtually certain to prove unsustainable in the midst of the still rapidly deepening and extremely severe and prolonged recession that is still to come. There is far more pronounced economic and financial pain ahead that will spur a reinvigorated panic flight to the safety of Treasuries and a renewed selloff in equities. Look for S&P 500 profits to weaken to between $50 to at most $60 a share, well under market expectations. That will mandate significant cuts in dividends. A realistic and quite likely optimistic 10 times price-earnings ratio implies a price index low in at least the area of 600, well under the Friday 931.80 level. In order to put this forecast in proper perspective, it is worth noting that under similar circumstances in comparable cycles the S&P 500 price-earnings ratio hit cyclical lows well within the single digit area.
A plunge in the latest Institute for Supply Management gauge of manufacturing activity ahead portends perhaps the worst slide in this still key sector in the last sixty years, which is as far back as the data go and a much deeper recession. The overall ISM index fell to a level not seen since June 1980, when the economy was plummeting into the worst and most prolonged double-barreled recession of the post World War Two era. But, new manufacturing orders, an advance indicater of future manufacturing activity, seems to be forcasting an even worse recession than 1980-82, perhaps in some respects reminicent of that of the late 1930's. The December employment report, to be released next Friday, is likely to be the worst thus far this recession, reinforcing expectations of a double-digit high in the unemployment rate.
The flare-up of hostilities in the middle-east raises far-fetched concerns over a new oil embargo and a consequent new spike in oil prices and other commodity prices. The potential inflationary consequences of that exagerated prospect, especially in light of the Fed's massive expansion of credit is seen by some as another potentially inflationary factor seemingly justifying a rise in Treasury yields. My response to these concerns is that they are utter "nonsense".
While it is true that a rise in inflation expectations and Treasury yields go hand in hand, a spike in inflation any time soon is as likely as a snowstorm in midsummer. Iran is the primary backer of Hamas. Thus, a defeat of Hamas in Gaza by Israel would weaken Iran's clout in the region. That would be privately welcomed by the Arab oil producers, who see Iran as a major threat to their stability and possibly the survival of their regimes. Moreover, the Arab oil producers recognize that a defeat of Hamas is a necessary precondition and perhaps the only viable avenue to the establishment of a separate Palestinian state. Under these circumstances there is little or no reasonable basis for an Arab oil producer embargo. Inflation is dead for this cycle even with Fed efforts to resserect it.
The Fed is attempting to engineer a low Federal funds rate and Treasury yield environment in an attempt to move institutions to lend and invest in riskier investments. The Fed has indicated an intention to buy Treasuries if necessary to achieve their objectives. The Fed is also attempting to use its low interest rate policy to weaken the dollar, which will both spur exports and encourage other central banks to defensively adopt an equally agressive easing policy. Since those initial-step objectives have not yet been achieved, let alone as yet borne fruit, it is clearly premature to expect a sustained market sell-off in Treasuries. If necessary, the Fed will prevent it. But it should not even require Fed intervention considering that as the global recession worsens, deflation will take a firmer grip in reality and expectations. And with that development more clearly recognized, the drive to lower Treasury yields wil be reinforced.
The unsustainability of a rally in equities and sell-off in Treasuries at this time seems all the more likely the given that these developments are typical in recessions, especially prolonged ones. This time, hopes of an early economic recovery were born of merely the turn of the calendar into a new year, a new President and major stimulative initiatives already in place, with more promised. There were other premature speculations, intended to ride a snap-back reversal of the downtrend in equity prices and Treasury yields, both earlier this recession and in earlier recessions. Like each of those, this bout of misplaced enthusiasm will also run its course, and be completely reversed. That, for example was the classic experience in 1933. In anticipation of the inauguration of President elect Franklin Roosevelt, the Treasury bond market sold off sharply at the beginning of the year, only to subsequently completely reverse itself and reach new yield lows.
Though it would not matter if I were alone in my view for this year, I would still hold to them because past experience amply supports them. But, there are others who share my views. Nevertheless, these views are contrary to consensus expectations (including some forecasters I normally hold in high regard), that the Treasury rally is just another bubble ready to immediately burst, if it is not already doing so, that equity prices are still dramatically oversold (though they are up from their lows), and inflation is about to reasert itself in the form of sharply rising commodity prices.
There are some forecasters who go so far as to recommend shorting Treasuries. The latest issue of Barron's includes a major, cover-featured, article on Treasuries by Andrew Bary, headlined "Get out now". It cites Mohamed El-Erian, chief investment officer of Pimco, the largest bond fund manager, who recommends immediately selling Treasuries. Of course he and his firm have been arguing against buying Treasuries almost all the way down in yield. In sharp contrast, Lacy Hunt, of the highly successful Van Hoisington Treasury bond fund which was up some 40% last year, holds to his expectations (and mine) of new lows in Treasury bond yields ahead and another outstanding gain for his fund this year. Similarly, David Rosenberg, the noted Merrill Lynch economist, expects the 10-year yield to hit a cyclical low of 1.5% this year, down from 2.42% on Friday, a view I share. In Japan, which preceded us on the road to deflation and a protracted on-again off-again recession, the yields on JGB's, their Treasuries, fell to 0.75% lows. Thus, a forecast of a 1.5% US Treasury 10-year yield should be seen as merely a cautious forecast.
As I have indicated previously, it is also appropriate to invest in high-grade corporates (with perhaps the best risk reward trade off in bonds of banks and others partnered with the US Treasury) and municipals that offer exceptionally high yields because of an exagerated default risk. When the economy eventually recovers, that default risk will evaporate, while inflation concerns will remain tame for an extended period. There are already signs of improvement in those debt sectors. But, there is far more price improvement to come. Perhaps one third of hedge funds will go out of business this year, with pronounced financial strains also showing in credit card issuers, insurance companies, and other mortgage paper holders. That outlook forshadows renewed panic sales of assets to stave off bankruptcy and meet claims and withdrawls. That suggests even better investment opportunities may lie ahead.
Philip Braverman, President
Braverman Economic and Financial Consulting
One Hewitt Square #249
East Northport, New York 11731
Email address:philipbraverman@gmail.com
A reversal of the primary market trends of 2008 is virtually certain to prove unsustainable in the midst of the still rapidly deepening and extremely severe and prolonged recession that is still to come. There is far more pronounced economic and financial pain ahead that will spur a reinvigorated panic flight to the safety of Treasuries and a renewed selloff in equities. Look for S&P 500 profits to weaken to between $50 to at most $60 a share, well under market expectations. That will mandate significant cuts in dividends. A realistic and quite likely optimistic 10 times price-earnings ratio implies a price index low in at least the area of 600, well under the Friday 931.80 level. In order to put this forecast in proper perspective, it is worth noting that under similar circumstances in comparable cycles the S&P 500 price-earnings ratio hit cyclical lows well within the single digit area.
A plunge in the latest Institute for Supply Management gauge of manufacturing activity ahead portends perhaps the worst slide in this still key sector in the last sixty years, which is as far back as the data go and a much deeper recession. The overall ISM index fell to a level not seen since June 1980, when the economy was plummeting into the worst and most prolonged double-barreled recession of the post World War Two era. But, new manufacturing orders, an advance indicater of future manufacturing activity, seems to be forcasting an even worse recession than 1980-82, perhaps in some respects reminicent of that of the late 1930's. The December employment report, to be released next Friday, is likely to be the worst thus far this recession, reinforcing expectations of a double-digit high in the unemployment rate.
The flare-up of hostilities in the middle-east raises far-fetched concerns over a new oil embargo and a consequent new spike in oil prices and other commodity prices. The potential inflationary consequences of that exagerated prospect, especially in light of the Fed's massive expansion of credit is seen by some as another potentially inflationary factor seemingly justifying a rise in Treasury yields. My response to these concerns is that they are utter "nonsense".
While it is true that a rise in inflation expectations and Treasury yields go hand in hand, a spike in inflation any time soon is as likely as a snowstorm in midsummer. Iran is the primary backer of Hamas. Thus, a defeat of Hamas in Gaza by Israel would weaken Iran's clout in the region. That would be privately welcomed by the Arab oil producers, who see Iran as a major threat to their stability and possibly the survival of their regimes. Moreover, the Arab oil producers recognize that a defeat of Hamas is a necessary precondition and perhaps the only viable avenue to the establishment of a separate Palestinian state. Under these circumstances there is little or no reasonable basis for an Arab oil producer embargo. Inflation is dead for this cycle even with Fed efforts to resserect it.
The Fed is attempting to engineer a low Federal funds rate and Treasury yield environment in an attempt to move institutions to lend and invest in riskier investments. The Fed has indicated an intention to buy Treasuries if necessary to achieve their objectives. The Fed is also attempting to use its low interest rate policy to weaken the dollar, which will both spur exports and encourage other central banks to defensively adopt an equally agressive easing policy. Since those initial-step objectives have not yet been achieved, let alone as yet borne fruit, it is clearly premature to expect a sustained market sell-off in Treasuries. If necessary, the Fed will prevent it. But it should not even require Fed intervention considering that as the global recession worsens, deflation will take a firmer grip in reality and expectations. And with that development more clearly recognized, the drive to lower Treasury yields wil be reinforced.
The unsustainability of a rally in equities and sell-off in Treasuries at this time seems all the more likely the given that these developments are typical in recessions, especially prolonged ones. This time, hopes of an early economic recovery were born of merely the turn of the calendar into a new year, a new President and major stimulative initiatives already in place, with more promised. There were other premature speculations, intended to ride a snap-back reversal of the downtrend in equity prices and Treasury yields, both earlier this recession and in earlier recessions. Like each of those, this bout of misplaced enthusiasm will also run its course, and be completely reversed. That, for example was the classic experience in 1933. In anticipation of the inauguration of President elect Franklin Roosevelt, the Treasury bond market sold off sharply at the beginning of the year, only to subsequently completely reverse itself and reach new yield lows.
Though it would not matter if I were alone in my view for this year, I would still hold to them because past experience amply supports them. But, there are others who share my views. Nevertheless, these views are contrary to consensus expectations (including some forecasters I normally hold in high regard), that the Treasury rally is just another bubble ready to immediately burst, if it is not already doing so, that equity prices are still dramatically oversold (though they are up from their lows), and inflation is about to reasert itself in the form of sharply rising commodity prices.
There are some forecasters who go so far as to recommend shorting Treasuries. The latest issue of Barron's includes a major, cover-featured, article on Treasuries by Andrew Bary, headlined "Get out now". It cites Mohamed El-Erian, chief investment officer of Pimco, the largest bond fund manager, who recommends immediately selling Treasuries. Of course he and his firm have been arguing against buying Treasuries almost all the way down in yield. In sharp contrast, Lacy Hunt, of the highly successful Van Hoisington Treasury bond fund which was up some 40% last year, holds to his expectations (and mine) of new lows in Treasury bond yields ahead and another outstanding gain for his fund this year. Similarly, David Rosenberg, the noted Merrill Lynch economist, expects the 10-year yield to hit a cyclical low of 1.5% this year, down from 2.42% on Friday, a view I share. In Japan, which preceded us on the road to deflation and a protracted on-again off-again recession, the yields on JGB's, their Treasuries, fell to 0.75% lows. Thus, a forecast of a 1.5% US Treasury 10-year yield should be seen as merely a cautious forecast.
As I have indicated previously, it is also appropriate to invest in high-grade corporates (with perhaps the best risk reward trade off in bonds of banks and others partnered with the US Treasury) and municipals that offer exceptionally high yields because of an exagerated default risk. When the economy eventually recovers, that default risk will evaporate, while inflation concerns will remain tame for an extended period. There are already signs of improvement in those debt sectors. But, there is far more price improvement to come. Perhaps one third of hedge funds will go out of business this year, with pronounced financial strains also showing in credit card issuers, insurance companies, and other mortgage paper holders. That outlook forshadows renewed panic sales of assets to stave off bankruptcy and meet claims and withdrawls. That suggests even better investment opportunities may lie ahead.
Philip Braverman, President
Braverman Economic and Financial Consulting
One Hewitt Square #249
East Northport, New York 11731
Email address:philipbraverman@gmail.com
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