Market Update 9 16 09 _ What is going on in the market

What’s up with the market?

When I look at recent bond market activity I can hear Jerry Seinfeld’s voice in my head asking “WHAT is the DEAL with THAT?” His signature line could be used almost daily in this market. Yesterday a good friend of my summed it up nicely by describing the markets behavior as “schizophrenic”. This morning is a perfect example. When I came in this morning the 30 year was up 21/32’s...a few minutes later it was back to flat…a few more minutes and it was DOWN 21/32’s…and finally a few short minutes after that it was back to flat.

There has been tremendous volatility in the bond market recently, much of which seems counterintuitive. There are days that we get economic data that should cause a huge selloff in Treasuries, yet the market rallies hard driving yields to new lows. It’s very difficult to make sense of the activity. In a way I think this confusion is itself a sign that we’re at the bottom of this cycle. It’s the first time in a long time that the market seems conflicted about what to make of the numbers. Prior to this recent period there was almost a universal agreement that every number we got showed that the recession was still getting worse.

We went through a brief period in May where the clinically optimistic made their bets that recovery was just around the corner. There will always be a rush among some big money managers to be the first one diving back in when the sentiment begins to swing. They need to get those few extra basis points to beat the index and beat the competition. As we moved from the “recession is getting worse every month” mode to the “we seem to be near the bottom” mode there were a lot of people that started placing bets on a “V” shaped recovery. We saw a good bit of this type of activity in May. My opinion on this has been that we’re not going to see a “V” shaped recovery. (The Market Update piece from May 7^th, 2009 reviews the various recovery shapes along with a colorful example…if you can’t find that e-mail let me know and I can resend it).

I’ve been saying for quite some time that even if the bad news tapers off and we find a bottom, it’s not a great thing to stabilize at multi-decade lows of activity. The economy needs people spending money in order to grow. Consumers making purchases keep other people employed doing everything from importing the goods, shipping them, stocking shelves, ringing up the goods etc. There are millions former consumers that are playing a very defensive game right now. Now it’s about staying power. At this point in the business cycle I think the average consumer would rather have $3,000 more in the bank (or less on a credit card) than a 65 inch plasma TV in the living room. In times of uncertainty liquidity is your friend…the consumer gets that now. Many households have been hit directly by unemployment, most others know people that have lost jobs, still others have taken pay cuts to KEEP their jobs (FedEx is a prime example of this…reducing pay for everyone to minimize the number of firings that must be done). This is an episode that the consumer won’t soon forget…fear is a powerful thing.

Given a consumer that is more focused on rebuilding a cash cushion and paying down debt than continuing the spending spree, where will the growth come from? More one-time hits like cash-for-clunkers programs where we pull future consumption into the present using borrowed money? That is exactly the type of game that consumers played for the last several years. This just leads to more leverage, more risk, and slower growth in the future. Econ 101 tells us it’ll take time for this to get better. The consumer needs time to pay off car loans and credit cards and helocs, he needs time to build up a few months worth of cash, and he needs time to get past the concern of losing his job…and don’t get me started on the 401K.

Today’s numbers

Today’s economic data showed inflation in check with CPI numbers generally in line with the estimates. Industrial Production and Capacity Utilization for August were slightly better than expected. I wish I could tell you that the economic data had some effect on today’s activity but if it did it was impossible to discern amid the noise.

Tomorrow we see Housing Starts, Building Permits, Initial Jobless Claims, Continuing Claims, and the Philadelphia Fed Index. These are big numbers that could have a significant impact on Treasury yields. Below I’ve attached a review of today’s economic releases along with tomorrow’s scheduled releases.