Adam Katz has a completely different analysis of the slope of the yield curve than the guys at Bespoke Investment Group. Adam’s article at Seeking Alpha lists the following as possible explanations for the steep yield curve:
- Pressure on the front end of the yield curve - This was caused by safehaven buying and repatriation by Americans of foreign investments looking for a place to park their cash and earn a little yield. There is also the (not so small) issue of margin calls. As the markets came crashing down and as hedge funds fell into the loop of selling to cover margin calls causing further price drops and further margin calls, the need to raise cash as collateral increased. As far as margin goes, treasuries are considered to be as good as cash. What we have seen is a stampede into treasuries by large investors and managers in order to maintain their margin levels and earn some yield in the process (as opposed to posting cash).
- Long end over supplied - And supply is expected to increase. As the U.S debt increases and the yearly budget deficits grow, the government is expected to try to fund the costs of current and future bailouts with longer dated maturities. They are trying to avoid what is already a big issue in the corporate world - rolling short term debt. With yields under 5% and being dragged lower by Fed rate cuts, it’s a great time for the government to fund its long term liabilities. That being said, rates can’t go much lower and once the Fed runs out of ammo, we may see the long maturity rates move up.
- Foreign governments may be forced to sell or may voluntarily diversify - Taking cue from Warren Buffett, government debt is expensive right now (rates are low). Some countries may find it necessary to sell their treasuries to raise cash for local stimulus, while others may be looking to diversify at a time of a strong dollar and attractive exit prices. Others, such as China, may be looking to add less long term treasuries to a portfolio already centered on U.S. debt.
- Risks exist to both the sovereign rating of the U.S. and the stability of the currency - In my opinion, the biggest factor driving the steepness of the yield curve is the financial health of America’s balance sheet. Although many are searching for ANY yield right now, as small as it may be, they are looking at the front end of the curve as further down the line carries increasing risks.
It will be interesting to look back in a year to determine which, if either, analysis (i.e. Adam’s or Bespoke’s) was accurate.
The great analysts at Bespoke have this article at Seeking Alpha in which they discuss the current slope of the yield curve and what it may be a precursor for.
The difference in the yields between the 10-Year and 3-Month US Treasuries is currently 375 basis points and that is near a 10 year high. Quoting from Bespoke’s article, while an inverted yield curve has been a reliable precursor of impending economic weakness, steeply sloped yield curves have historically been a sign that the market is anticipating strength in the economy (as was the case in 2002 and 2003).
I am neither an economist nor a financial analyst so I do not consider myself qualified to present economic forecasts based on the slope of the yield curve but I do find its steep slope to be interesting.
FJP
With further declines in the Canadian and US markets again this past week, the S&P/TSX composite index is down 38.0% and the Nasdaq is down 36.6% since the ETF2X timers advised us to get out of the stock market in mid-June. There has been no change in the ETF2X timers so you should stay in cash, short term bond ETF’s or be short the market. Personally I would not initiate a short position in the market at this point.
In my own portfolios, my Canadian holding is the iShares Canadian Short Bond Index ETF (XSB) and my US holding is the iShares 7-10 Year Lehman Treasury Bond ETF (IEF).
You can view updated performance tables and equity curves for the Canadian and US ETF2X models here and here.
There was a good article in the Globe and Mail yesterday by Tom Bradley. Essentially, the message was that when choosing mutual funds to invest in you should look for fund managers that have a significant portion of their personal investments in the funds they manage. I don’t own any mutual funds but I like the message as it can be expanded to other facets of investing. For example, if you want to follow the stock recommendations of a fellow investor and consider Tom’s message to be important then you should consider joining Covestor. Most of the top rated investors have blogs and you can follow their trades to determine if they follow their own recommendations. Admittedly I have a bias here as I am a member of Covestor.
FJP
If you have an interest in seasonal investing, you may want to watch this video from BNN’s interview of Brooke Thackray on November 10. I haven’t backtested Brooke’s ideas yet so I can’t say whether there are exploitable seasonal patterns in the stock market which can be built into an investor’s trading plan.
FJP
Both the US and Canadian ETF2X timers told us to get out of the market in mid-June. Out of curiosity I prepared the table below as I wanted to see how the various stock markets and relevant ETF’s have performed.
Dividends have been included in the above results.
PSQ, RWM, SH and DOG are single exposure contra ETF’s designed to move one times the relevant index daily in the opposite direction. QID, UWM, SSO, DDM and HXD are double exposure contra ETF’s designed to move two times the relevant index daily in the opposite direction.
I can’t say I suggested that you buy contra ETF’s in June as I normally don’t try to short the market. As time goes by and my models build a more substantial history I may revisit this policy but for now I just suggest that you get out of the market and go to a money market ETF or short term bond ETF when the ETF2X timer signals that it is time to get out of the market.
The Nasdaq responds best to the US version of the ETF2X timer so it is no surprise to me that QID has had the highest return. Note that the return on the double exposure contra ETF’s is less than two times the return on the corresponding single exposure contra ETF’s. In the case of QID and HXD, both of these are up more than two times the underlying index.
On a different matter, some of you had trouble reading the screen shot from Covestor in my post several days ago. I’ll try again with the following which illustrates that I am currently ranked #39 based on absolute return over the past three months.
Covestor doesn’t provide information on the number of investors that I am ranked against but I think it is fair to say that there are thousands of others that I am competing against to be in the Top 100.
