On my risk watch is the potential for a sovereign debt crisis originating in Europe. The debt-to-GDP ratios are staggering, entitlements are unmanageable and unemployment is high. The economic chasm between the northern haves and the southern have nots is blatantly clear. The people have had enough. The UK exit is the start not the finish.
All of this dysfunctionality wrapped together in incomplete and growingly divided political structure. The surprise capitulation reeks of desperation by the elites to hold it all together. So we step forward and watch with keen interest.
Last Friday morning the 10-year Treasury Note touched 1.38% overnight. As I write, it is yielding 1.43%. The 30-Year Treasury Bond is yielding 2.22%. Why? Bonds are rallying globally as the UK vote to leave the European Union raises speculation that the decision will curb economic growth. Money is escaping to the Treasury market.
Take a look at the following chart. It shows the year-to-date down move in the 10-Year yield from 2.25% to 1.43%. At the start of the year, few Wall Street analysts and none of the Fed officials, were predicting declining rates. Again, a big miss. What we’re seeing is that growth remains subdued and debt continues to have a choke hold on the global economy.
To this end, I have been on record saying that interest rates will remain lower for longer. I certainly didn’t expect a drop of 75 bps in six short months. Remember back in December that the Fed had just raised the Fed funds rate by 25 bps and the call was for three to four more rate increases in 2016.
The Zweig Bond Model has kept me correctly positioned, invested in long term high quality bonds. It is a Trade Signals model which is largely based on trend analysis. It continues to remain bullish on high quality bonds. Not perfect, no guarantees, but it has kept us in the right spots over the last few years. I’ll change course when the model signals higher rates.
As we begin the second half of the year, my outlook remains unchanged. This is what I wrote on December 31:
2016 Outlook: neutral on equities and neutral on fixed income. Nothing exciting there, but like the Fed, I’ll hedge and say it is “data dependent.” Following are the significant risks I see:
- Global Recession – Likely underway
- U.S. Recession – Possible in 2016. Probable in 2017. The largest market declines come during periods of economic recession.
- High-yield bond defaults – Rising in 2016, peaking in 2017 (tactically trade HY)
- European sovereign debt crisis – The EU banks are loaded up on that debt (shorting EU banks or buying out-of-the-money put options may be a good equity hedge).
- Emerging Market dollar denominated debt crisis
- Watch the Fed, ECB, JCB and Chinese central bankers
- Tax and structural reform would be a positive for the markets, but unlikely in 2016
Further, I currently believe the Fed is unlikely to raise rates this year and it is believed more central bank stimulus lies in our immediate future. The risk on mood seems to have returned. It is tied to the prospects for more central bank QE but the deeper implications remain. The Fed remains “Data Dependent.” The market appears to remain “Fed Dependent.” For now…
Next week, we’ll take a look at June month-end data on valuations, forward returns and I’ll share with you my favorite recession probability charts.
Excerpted from “On My Radar” by Steve Blumenthal | For the rest of the story, charts, analysis, and market outlook see On My Radar: Data Dependent – Fed Dependent.
The current opinions and forecasts expressed herein are solely those of Steve Blumenthal and are subject to change. They do not represent the opinions of CMG. CMGs trading strategies are quantitative and may hold a position that at any given time does not reflect Steve’s forecasts. Steve’s opinions and forecasts may not actually come to pass. Information on this site should not be used as a recommendation to buy or sell any investment product or strategy.
