Good Evening: Today the U.S. capital markets continued the slow healing process that began on November 21. Stocks and commodities rose while the dollar and Treasurys fell, a combination of outcomes rarely seen since last July. Even the VIX tailed off, so the seemingly placid activity surrounding today’s market action may have been more than just random noise. More importantly, however, the question of just how we will finance this whole mess is finally being raised over at the Treasury Department. Many options will be considered, but in my opiniion, we’ll need to start thinking long term when pondering next year’s approach to debt issuance.
Stock markets around the world seemed to take no notice overnight of yesterday’s correction to stock prices in New York. Asian stock markets were particularly peppy, and our index futures responded by rallying prior to this morning’s open. A drop back to earth in this week’s report of mortgage purchase applications didn’t dent the rally, and stocks opened with gains of approximately 1%.. The major averages then took a breather following the release of the latest inventory figures. Inventories shrank by what looked to be an impressive 1.1%, but since sales fell by an even more impressive 4.1%, the inventories to sales ratio actually rose to a 20 month high (see Merrill’s take below).
Underneath the surface, some weakness in the dollar and some strength in various commodities put a nice bid into the commodity-related equities (see below). Financial stocks sat out the advance (the KBW bank index fell 1%), but energy and mining names rose by 5% to 15%. The newfound zest for energy, metals, and mining plays (infrastructure stocks were also firm) helped push the major averages to their best levels of the day by lunchtime. An afternoon swoon carried the indexes back toward the unchanged mark, but a rally in the final hour of trading left the averages up between 0.8% (Dow) and 2.3% (Russell 2000). Treasurys retreated in fairly quiet trading, and yields rose between 1 and 4 bps across the coupon curve. The dollar fell 0.5%, which was just enough to encourage the aforementioned buying (or shortcovering?) in commodities. A 4% pop in gold led the way, but crude oil, grains, and base metals were also nicely higher. The CRB finished the session with a gain of 2.6%.
We’ve seen plenty of advances in commodity prices since July, but all of them have rather quickly been rebuffed. Perhaps it will be the same with today’s rally, but the one asset class that has consistently been sought this year has been Treasury obligations. If “First, do no harm” is the cry of the physician, then the 2008 parallel in portfolio management might be similar: “First, seek safety — without regard to yield”. To a generation accustomed to double digit returns on capital, forsaking yield in the name of assuring a return of that capital is a tough transition to make. It’s been tough even for grizzled veterans who foresaw many of the problems now buffeting the global economy. PIMCO’s Bill Gross is one such manager, and he publicly expressed his regret today for not owning the big winner of 2008 (see below). Confession complete, Mr. Gross also says he’s sticking to his end of 2007 view that Treasurys offer little, if any, value at these levels. With all due respect to Merrill’s David Rosenberg, who’s been correctly bullish as Treasury yields approach Japan-like levels, I agree with Mr. Gross.
In addition to the Lilliputian-sized yields now on offer, perhaps another reason to avoid Treasurys can be inferred by reading the final article below. The Treasury Department announced today that it is considering “novel approaches” to the future issuance of U.S. government debt. Is it a pure coincidence that Gold perked up so much on the same day this statement hit the tape? Merrill Lynch discusses a few of the options open to the Treasury in their piece you see at the bottom of the page, but there is no escaping the fact that the U.S. will likely issue $2 Trillion in new securities in 2009. The math surrounding the large and compounding amount of interest our nation will be forking over in future years is daunting, and it will take novel approaches indeed to get all the paper out the door.
Let’s hope President-elect Obama’s Treasury Department resists the urge to issue T-Bills, despite the microscopic current cost of doing so. Such a program would subject our nation to rollover risk in future years, and those who yesterday sought to actually pay Uncle Sam for the privilege of holding their capital while riding out the current storm won’t be there (at least not on the same terms) once the storm finally passes. No, the novel thing to do would be to issue as much long dated paper as the markets will stand. Locking in the lowest long term rates in more than five decades is the cheapest bill we can hand future generations. Issue 50 year bonds, even 100 year obligations if need be. Just let investors seeking safety, duration, etc. flock in droves to these low yields. Let them, at some point in the future, feel the opposite form of regret that Bill Gross is feeling right now. It may sound silly in this environment, but at some point investors will come to scorn Treasurys almost as much as they do subprime mortgages today.
— Jack McHugh