Market Update 8 4 11 _ The Heat is On

For those who might be thinking about a quick summer vacation to Memphis, allow me to paint a picture for you.  I park my truck in the underground portion of our parking garage here at the office.  It is a dark and cool place that is well protected from the routine summer threats of tornados and hail.  Yesterday evening I left the office at 6:00 PM and when I turned the key in the ignition, my onboard thermometer read 105 degrees…and it was underground in solid shade all day.  If anyone in a cooler part of the country has a small office that's not being used I'd be happy to sublease it for the next few months.  I know, I know…what could be better than having a bond salesman right there in your own office, right?

Memphis isn't the only place experiencing the heat now-a-days.  The market is taking its share as well lately.  The headlines have been dominated recently by the high-drama and glamour of a political showdown over the debt ceiling and the future of our fiscal trajectory.   This is really good fodder for reporters because you can get lots of hype out of it without really having to understand much of what you're reporting on. 

Given the high profile nature of the debt story there has been an enormous amount of reporting on the topic…much to the detriment of some other newsworthy items that are being pushed to the back burner.  Two of the more significant recent events have been the downward revision of GDP and the declining manufacturing data that we reported on earlier.

Where is the Fed?

The Fed meets next week and I promise you that they are having some prolonged and heated discussions about those two numbers even as I type this.  It is now August 4^th.  Every time the Fed has addressed the state of the economy this year they have had to address the "soft patches" that have prevented us from achieving robust growth.  Each time they describe the negative factors as "transitory"…meaning that these events will be temporary in nature and don't pose a risk to sustained economic growth, and that they expect activity to pick up in the second half.  The longer they stick to this story the better the second half has to be to make up for the first...and given the recent economic data the second half doesn't look like it's gonna be a rock-star.

There has already been a growing choir of voices discussing the potential for QE3.  I'm not in that camp at this point.  If you read the Fed you know that the feelings about QE2 from the start were that it would have only a modest impact at best.  Given that QE2 was expensive and managed to underperform their already low expectations I think it will be difficult to find much support for another round of it. 

That's not to say they won't ever do it…there are a few within the Fed who have already mapped out a course that would lead them to vote for more Quantitaticve Easing…I just think that those members will have an uphill fight against the rest of the FOMC who don't want to throw good money after bad.  It's not hard to find FOMC members who have publicly stated recently that monetary policy can only do so much…at some point the Fed has to be done. 

The Market

Market reaction this week has been like a run-a-way train.  It's almost become a joke around here that the 10-year is up a point every 24 hours.  We are just a few short hours into the trading day and the 10-year is up 3/4's of a point to trade at a 2.52% yield, and the Dow is off 225 points to trade at 11,671. 

What does this mean to investors?  It's tempting to hold our breath and try to wait this rally out…hoping that we can put off some investment decisions until the market comes back.  However it could very well be that when the market finally reverses it could "snap back" to levels lower than where we are now. 

Roughly a week ago the 10-year Treasury traded at a 2.99% yield level…right now it sits at a 2.52%.  Watching the 10-year drop 47 basis points in a week is uncomfortable to say the least.  More worrisome is the fact that the drivers of this rally could push us far lower. 

Some reference points might be helpful here

The low point for the 10-year Treasury in 2010 was 2.38%.  The lowest GDP print we had in 2010 was 2.5%...our most recent print was 0.40%.

The low water mark on the 10-year for this business cycle was 2.04% in December of 2008.  GDP figures in 2008 ranged from 1.3% to -8.9%.  It's also important to note that in November of 2008 the NBER made the "official" declaration that we were in a recession, the markets were falling apart, and there was legitimate concern about a full-fledged depression.   If you really want to review the tone of the market from December of 2008 just go through your old inbox files and pull up the e-mail I sent you back on 12/19/08 titled "Bernanke is Fighting Depression and he's not using Zoloft".  I have it handy if you can't find it so just let me know if you'd like me to e-mail you a copy.

Why does this matter?

The most recent economic data are sliding toward recessionary levels.  They aren't there yet but if they keep mounting up in a recessionary fashion it's easy to believe we could see the 10-year trading somewhere between the "it's almost the end of the world level" of 2.04% from late 2008 and the "we think we're starting to recover" level of 2.38% from 2010. 

I just looked up to see the 10-year just went up over a full point in price on the day…it's now trading at a 2.47%.  The Dow is now off 354 points, and the 2-year Treasury just posted a record low of 27 bps.  Where she stops…nobody knows.  I have to wrap this up and go check on my truck to make sure it's not melting downstairs in the garage.

If you have any questions on this material, or if there is anything I can be doing for you just let me know.

Steve Scaramastro, SVP

800-311-0707