The return of the 30-year Treasury bond to the capital markets raises a compelling question: while we understand why it is being sold, what drives investors to buy it?
This Treasury bond, which has not been issued for over four and a half years, made a triumphant comeback. The demand from buyers indicates strong confidence in what is essentially government debt, with a principal that won’t be returned until 2036. According to Bloomberg News, the bidding was so competitive that the yield fell to 4.53%, marking a record low for a 30-year Treasury bond.
Global liquidity is abundant, and central bank reserves are no exception. According to IMF data, international reserves at central banks climbed by 2.5% over the year ending December 2005, reaching record levels.
So where is all this liquidity heading? A significant portion is likely being invested in dollars. Recently, the U.S. Dollar has strengthened again, supporting the idea that central banks are continuing to allocate their reserves to the primary reserve currency. The somber outlook for the dollar observed in January has shifted, with the U.S. Dollar Index rising 2.6% since the sell-off on January 23.
The yield curve has once again inverted, igniting concerns that an impending recession may be on the horizon. Current yields show the 10-year Treasury at 4.56%, below the 2-year’s 4.61%. This inversion is particularly striking given last week’s economic releases, which suggested that the economy is experiencing healthy growth, despite a surprising dip in the initial estimate for fourth-quarter GDP.
Recent earnings projections are facing significant downward revisions, according to Michael Krause of AltaVista Independent Research, which specializes in fundamental analysis of exchange-traded funds (ETFs). His latest report indicates a trend of “sustained and accelerating revisions to the downside” for 2006 forecasts across seven of nine sectors. This decline is unprecedented as it marks the fastest descent since monitoring began in July 2005.
Krause’s findings arise amid ongoing debates about whether the economy is poised for a slowdown. The mixed signals from recent economic reports have Wall Street buzzing about potential outcomes for the stock market. To shed light on these trends, we interviewed Krause by email…
In your latest research report, you mention “sustained and accelerating revisions to the downside.” Could you elaborate on this trend? Is the earnings cycle shifting?
We still anticipate that S&P 500 earnings will rise this year. What has changed is the declining expectations compared to the past two years, when revisions were consistently positive, even excluding the impact of energy earnings, which are well recognized.
The graph below illustrates the trend in 2006 earnings estimates since last July. Estimates rose through November but have started to decline. Moreover, estimates that remained stable throughout last summer have begun to weaken faster recently.
Historically, trends in estimate revisions tend to persist, which suggests the current downward trend could continue. After two years of underestimating corporate earnings strength, Wall Street analysts may now be overly optimistic as earnings growth naturally slows in the fifth year of a recovery.
However, it’s important to note that even if negative estimate revisions persist, S&P 500 earnings are likely to finish the year around a 6% increase. While this is lower than the current consensus estimate of 11.4%, it aligns with the post-WWII average of 6.2%.
Thirty years is a lengthy commitment, but is it too long for today’s investors? The Treasury seems not to think so, as evidenced by the imminent reintroduction of the 30-year bond.
Last issued in August 2001, the climate was markedly different. At that time, the tragic events of 9/11 were still a looming threat that few investors truly understood. Inflation was relatively mild at a 2.7% annual rate.
Fast forward to February 2006, and investor sentiment has shifted. There’s a growing awareness of the risks that can emerge unexpectedly, affecting bond values significantly. Current inflation, at an annualized rate of 3.4%, is notably higher than during the last issuance of this bond.
Today’s January employment report counters the pessimism fueled by last week’s unexpectedly weak fourth quarter economic data. This week’s generally favorable economic news presents a stark contrast to the disappointing GDP report from Friday. However, it comes at a time when inflation expectations are rising, as evidenced by a bullish trend in gold prices.
Regarding employment, there’s reason to be optimistic. The Labor Department has announced that the unemployment rate dropped to 4.7%, the lowest since July 2001. In January, the economy generated 193,000 new jobs, an increase from December’s 140,000. While the remarkable 354,000 jobs created in November feels distant now, it is evident that the American economy is still creating jobs robustly in 2006. This month marks the 29th consecutive month of job growth, drawing close to the previous record of 33 months ending in May 2000 (which could have been 52 months without a minor hiccup in August 1997).
Notably, the job growth in January was widespread, even the manufacturing sector, often criticized for its sluggishness, added 7,000 jobs. Although retail trade and government experienced slight losses, overall, the outlook remains positive.
While it’s premature to determine the defining trend of the Bernanke era in central banking, the ongoing bull market in gold may find its place in the history books. This precious metal has seen a substantial rise, reflecting a lack of unwavering confidence in the stewardship of paper currencies.
As of yesterday’s close, gold prices have increased by 10% in 2006. The rise is attributed to geopolitical and economic catalysts, with geopolitical tensions (such as Iran’s nuclear program and Hamas’ election in Palestine) and economic worries related to America’s budget deficit and rising oil prices at the forefront.
As we embark on the Bernanke era of central banking, a pressing question lingers: is the economy truly slowing, and if so, to what extent?
This question gained momentum last week following the disheartening first estimate of the nation’s gross domestic product, which was significantly lower than anticipated. Optimists quickly pointed out that the data may contain inaccuracies and future revisions could reflect a more robust economic pace.
Recent consumer spending data supports this optimism. As reported by the government on Monday, personal consumption surged by 0.9% in December, consistent with a similar increase in November. This reinforces the notion that consumers remain eager to spend; personal consumption accounts for about 70% of GDP. If consumer enthusiasm wanes, the economy may be vulnerable.
If a significant slowdown is on the horizon, consumers seem oblivious to the potential threat. This raises the question: can a slowdown occur when consumer confidence is this strong?
Alan Greenspan concludes his remarkable 18-and-a-half-year tenure today, leaving the financial landscape of the United States in a stronger position than when he began. His legacy is marked by several key accomplishments: reduced inflation, milder recessions, and enhanced transparency in monetary policy.
While his record boasts significant achievements, Greenspan has not been immune to criticism—concerns about the escalating trade deficit, surging government debt, and rampant consumer spending have been prevalent. Nevertheless, the Federal Reserve operates within a constrained mandate and has limited tools at its disposal. Thus, assessing a Fed chair’s performance is complex.
Despite the successes of Greenspan’s era, uncertainties lie ahead. The reliance on the American consumer remains high, raising concerns about sustainability given the increasing levels of personal debt. Moreover, Greenspan is passing the reins to Ben Bernanke without a clear guide for managing a central bank. The maestro’s legacy will be one of adaptability rather than a fixed economic approach, leaving Bernanke to grapple with an array of challenges.
The federal government operates like a massive organization, churning out economic reports as frequently as political announcements. Today, releases present a buffet of statistics, allowing consumers to select data that fits their outlook.
For those feeling pessimistic about Friday’s disappointing GDP report, Treasury Secretary John Snow offers a contrasting perspective. He suggested the advanced estimate for fourth-quarter GDP misrepresents the U.S. economy’s true strength, urging analysts to look elsewhere for insights. “I would not place too much emphasis on today’s numbers,” he advised, pointing to their anomalous character.
### Conclusion
The economic landscape is shifting, with significant changes evident in the bond market and employment figures as we enter a new era following Alan Greenspan’s departure. Investors and analysts are navigating a complex environment marked by fluctuating yields, inflation concerns, and varied economic indicators. Following the trends and adapting to these changes will be essential for understanding the future of both the market and the broader economy.
