With the steepest global yield curve in history it appeared in mid 2009 as though we were going to go on the credit binge to end all credit binges.  We were going to see inflation of eight gazillion percent and gold was headed to $50,000 as we went back to the gold standard.  As we now know that is not what happened. Instead banks bought Treasuries and there has been a massive contraction in lending as borrowing.  Instead of massive amounts of real growth the record steep yield curve instead brought with it a credit contraction that appears to be slowly but steadily sapping the energy from this so-called recovery.

Looking at the global GDP weighted yield curve right now you can see that since April of 2010 long term government rates have been steadily coming down as the short term rates are close to zero percent in many developed nations, which of course make up the bulk of a GDP weighted yield curve.

Global GDP Weighted Yield Curve

What is obvious to us when looking at this chart is that we are in a slow to negative growth environment for the foreseeable future.  We see this in both the economic data as well as in the markets themselves with stocks showing increased volatility and bond yields of all maturities hitting new lows or close to near lows. Until we start to see signs of real growth we expect the curve to continue to flatten, primarily on the long end.   One potential trade to take advantage of declining long bond yields is to either buy the long bond or buy TLT the 20+ year Treasury ETF. While we expect pullbacks and corrections, we expect long term Treasuries to continue to do well as an investment over the coming several months and maybe even the next few years.  Yes, yields are low but they can go lower.

Happy Trading,

Dave@TheMacroTrader.com

Disclaimer-In our model portfolio we are long TLT

Take a $1 trial of The Macro Trader to receive unbiased actionable research.

Bookmarks

While we have been long various risk assets over the past several months we have been very cautious and have had some short positions the entire time.  We have been very defensive due to the plethora of indicators pointing to an economy that at best was going nowhere for the majority of 2010.  The reality is that as time has gone on we have seen more and more indicators deteriorate showing that money for the real economy is tight, employment is worsening, risk assets are overpriced, demand is not there, etc.   This basic outlook has served us well as our newsletter model portfolio has generated positive returns with very low drawdowns so far this year.

Here are two indicators that show that their is a very high likelihood that we are headed for not just a slowdown but a recession.  The two indicators are the PMI and the ECRI WLI growth rate.  As much as the ECRI has been trying to say that they aren’t calling for a recession we and several other analysts find a lot of use in looking at it.  We think that the main reason for some of this controversy is that the folks at ECRI think that Hussman and Rosenberg are using it as a mechanical model and that if it does X then Y will happen.  Instead we are confident that most analysts look at it as another tool in the toolbox, albeit a very good one.  Like inflation, interest rates, industrial production, etc.  it is but a piece in the puzzle. At least that is how we use it.

Looking at the ECRI WLI growth rate and the PMI on the same chart you can see that the WLI tends to lead the PMI by roughly three months.  Not only does it tend to lead but with a few exceptions it does a pretty good job of showing the magnitude of the future move of the PMI.  Looking at the chart right now it appears as though the PMI is headed to a level below 50 and we would not be surprised to see it down to 40.  These levels tend to be not just slowdowns but recessionary.

ECRI WLI Growth and PMI

Happy Trading,

Dave@TheMacroTrader.com

Take a $1 trial of The Macro Trader to receive unbiased actionable research.

Bookmarks