Recoupling: Is Cancelling 30-year T-Bond Bullish?

October 31, 2001

Impressive thinking . . . on the part of Treasury (maybe with some Fed input too, we suspect), as the termination of 30-year T-Bond offerings is extraordinarily (ultimately) more significant than realized by superficial financial press comments focusing on the meaning to traders, the condition of futures markets, or mostly on where the liquidity might be channeled, if these markets for long-paper essentially evaporate over time.

To us the answer is obvious, but not the key aspect to their taking that key decision in a time of current economic weakness, and financial demands on Government to fight the war. It's very glaring as to how it should be interpreted, coming now rather than at more normal times when it was long rumored (due to surplus, surely not the reason in this environment). First of all there will not be a surplus for years; second of all, while a bit of a long-shot, we speculated that some of the week's earlier Dollar weakness might have been a slight currency-raid, possibly by Saudi's or others with large sums in Dollar-denominated assets, who might have wanted to convey a message that the growing vocal opposition to their (brazen?) attempts to influence our foreign policies, might (if we rebuffed them) result in lower investments in U.S. investments, such as Treasuries. Note the Dollarimmediately stabilized after the U.S. T-Bond decision.

Inverted Relationship = Eventual Stimulus

Not my main point on this subject, but if so, the U.S. just checkmated any such ideas, by announcing the end of the long-term offerings. Hence, anyone seeking long-term bond holdings, will have to look more closely at higher-yielding U.S. corporates (thus helping needs for funding many such companies have, and thereby aiding recoveries there) at the same time as those wanting the 'security' of U.S. paper, will migrate over to short and intermediate-term portions of the Yield spectrum to fulfill their needs. As debt-needs migrate down to the 10-year and 5-year paper, demand for those will rise significantly, and that brings rates down. Remember debt has an inverted relationship between price and yield. If 30 years aren't available (over time), then you'll get less of a steepening, and the existing inversion (which has heavies buying 30 year while still able and borrowing shorter), you get an interesting spread that stokes the banks from a macro standpoint, and draws any raiders of the other day, right back into the fray.

On the surface one might wonder what can be gleaned by not 'locking-in' low-rates in the 5 or sub-5% area for 30 years, on the part of the Treasury. The answer is plenty. How about recoupling for example. Traditionally (forget the 1990's, that was forecast to be -and was- an historical and hysterical aberration to a large part; great fun for a lot of players who understood that), stocks and bonds can move in lockstep, and that is bullish in the long-run. Now, we could care less about all the talk about the earlier efforts to stimulate not taking hold. Actually, they were helping hold housing and the auto sector (and a couple others) together; but then a war came along. Big changes.

What does matter is the potential implication of this. The inverted long-bond now is dropping closer to the mid-range; a catch-down that finally helps long rates to better reflect the deflationary conditions that exist. Some say that's bearish; even the stock market finale might support that idea. Not the case however; what it does is accept the reality of the current situation, which therefore helps sustain some areas (again; housing and refinancing in particular, which might find their optimum point within the next few weeks now), and presses short-to-intermediate rates lower for now, so there is still a Yield Curve inversion, but it's not so glaring, and much more realistic.

The most important aspect however, of this decision, is that it was taken in realization that there is no charade of a 'surplus', and doesn't simply suggest the Government is girding for an extended deflation, or super-duper recession, beyond the war. Rather, it suggests Government believes that domestic security will be established (we think we have to reserve this forward fundamental/economic discussion for subscribers in courtesy for their loyalty, though our conclusions are rather clear about implications).

As for the Global Recession, that is (as we've contended all along) exacerbated by a world-war (or nearly risking that, with ill-defined enemies, which nevertheless have or are threatening most civilized countries on Earth, or even some undeveloped ones.)

The .4 drop in GDP reported today is milder than it should be, and probably subject to a downward-revision later. It's a little suspicious actually, given the near-collapse in so many economic sectors. We agree that nations should reduce barriers, but even if they do in such a challenging environment, many companies have no taste for many new foreign ventures, which will hurt the very poorest who need activity the most. As to the U.S. Trade Deficit, it will be partially managed by a forced-retrenchment; not as a policy determination by Government, but one that has been pushed on the U.S.

Remember, the market's discounting mechanism. No guarantees, but that's going to be tested in the days and weeks ahead, and we suspect (given no 'second shoe' that drops on us, and a couple attempts were probably thwarted just today by the way) in such an eventuality, that the chances of a secondary test being successful were thus enhanced. The Dow Industrials(or at least old multinational blue-chips within them) are going to continue to be the least-benefited of the stocks, while domestic-centric issues we've emphasized since nailing the September lows, are primary beneficiaries of this move. Rubinesque to say the least (by the way); but likely mutually agreed on.

Technically . . . some of the real strength in technology andSemiconductors (SOX) through the close, while some blue-chips again 'caved' late in the day, reinforces our perspective of beneficiaries not only from these monetary policies, but also demand in the post-war world, as we see it (or at least the free-world while much of the rest of it is sidelined, through no fault of America's, though they'll never likely see it that way) and have speculated about it. The Administration is fighting hard not to divide people, and that is laudable; but heavy damage is done, causing many companies to remain loath to stick their necks out overseas (more than exists already), and Government is not going to easily change such trepidations (though they will try, and eventually will).

NASDAQ and the Nasdaq 100 (NDX) comments follow, but must be reserved for our readers, as they are forward-looking. Of course we don't expect high levels above the market to be immediately challenged; it has been our purpose in these past weeks to denote where we think the pressures in terms of risk would be reflected, and where risks are comparatively minimized. At this point there is little proof, other than that we have been right about price behavior both in the rebound from 9-11- panic, and the rally that completed itself in the manner projected over the preceding couple weeks.

In any event (lest I digress, far be it for me) the December S&P failed on it's rebound to the daily moving average, as projected and should have downside acceleration as it goes below 1060, enroute to (our goals), or maybe either side of that. Though the market has a superficial 'tone' to it that defies an importance of the Treasury decision, we believe that in fact will 'cushion' the downside, to the extent that the handwriting is already evident for the eventual comeback, with timing sensitive to events & progress on the war-front. This should accelerate reallocation from debt to equities; but trouble is that so many of the institutions keep buying the constantly-downgraded blue-chips.

And yes, as noted the other day, we continue to expect the Dow Industrials to move into the 8,000's; fairly soon. We thought there would be some effort to hesitate (call it defend 9000 if you prefer), and then take it out with a bit of a short-term vengeance in November, so there's no change in expectations; just (these) so-far right projections.

Daily action . . . probably should observe the continued homefront pressures, as not so well noticed (because fortunately nothing bad happened) there were several items that suggest the increased security is having some dividends. First of all; there were a couple detainments of suspect passengers (one with an artist's knife) on different flights today; one coming in from Tokyo to Seattle. In another case, two passengers were detained. Separately there's an unconfirmed report that one of the most-wanted terrorists was captured in the Queens-Midtown tunnel in NYC today, though nothing was said after an initial note about that. Also the backdrop allows the Attn'y. General to directly challenge those aliens who come here without embracing desire to be in the U.S. for normal reasons, and talks about deporting those who change their views while here. Again, these are not unreasonable wartime considerations, while certainly disruptive to anyone (or their families) who decides to turn against America; not just a political party, and reflects the realization of the grossly inadequate previous controls. Finally, there is a growing chorus that countries who deny their airlines an obligation to provide a full and complete passenger and crew list to U.S. authorities prior to their entering U.S. airspace, simply don't have to fly here; the U.S. can skip their business.

Meanwhile just two days after we posted (for the first time ever) anEarthquake chart in the Letter, California experienced an even stronger temblor than the Beverly Hills- Inglewood shake; this time near Palm Springs. We'll post a chart of the entire State in this report, not only because many of our readers are in California (they are), but as if these clusters precede anything more ominous, it's would be an awful financial time to address it (State or Nationally), and as Californians may want to track the patterns.

As for the hotline (900.933.GENE), multiple homerun theoretical gains were doable on Wednesday, primarily centered around the December S&Pshort-sale early in the day around 1073, and then the cover and buy around 1059, closed in the low 1070's, followed by yet-another short, intended to scalp some of the final hour's late fade. By the time all was said and done; and with the S&P closing a bit early at month-end, it should have been feasible for S&P guidelines to have netted at least 2000 or maybe as much as 3000 net points, since we caught virtually all these important oscillations. (Balance is too forward-looking, and must be reserved for ingerletter.com readers.)

Overall . . . last night's remarks provided both potential targets for the downside that we projected from a topping process about two weeks ago, and included remarks in fact predating those in the Journal about the 'Saudi connection', the role of Oil in this conflict, and what (besides that as well) surrounds the true basis behind the attacks on the West, aside from the scapegoating and lack of self-criticism among the foes, or potentially more surreptitious funding by some would-be friendlier 'state' entities.

The intercepts today, and reports (believed to have come from Canada) of terrorist efforts to penetrate our increased security, particularly around nuclear power plants, suggest that the FBI may have done a very impressive job of rounding-up suspects directly connected to supporting roles in the 9-11 atrocities (a plus), but is dealing with a new effort by enemies to either reinforce (or stoke) remaining 5th columns. It is a question not of political bias, but of self-defense. The sooner tranquility's restored in the U.S. and Western Europe, the sooner the newly-primed monetary backdrop will be able to have the desired effect, which is to get the U.S. out of this 'liquidity trap' of sorts; one that we felt the Fed contributed to creating back in-front of Y2k, but let's not engage in placing blame, because that was our argument over two years ago.

The Fed (then) contributed to rampant speculation, and ensured the maximization of a bust that was on the agenda anyway. Now, with so much worry about deficits and costs of a war, not to mention a deepening worldwide recession; to be sure there are no solid certainties. But the climate increasingly resembles 1990 or so; a time that preceded something other than the slowdown and misery preceding it, even if few realized at the time that the stage was being set for an eventual robust recovery. Is it possible that the pessimists in this forecast downward extension will be as wrong as the optimists were into the parabolic enthusiasm that prevailed in early 2000? Stay tuned, it promises to be an interesting few months coming up, besides the conflict.

In summary . . . the FBI's alert for assaults somewhere this week is increasingly clear with some of the disruptions seen today; though unsettling with little information that can be effectively used by citizens. Again, as for the GDP data, expected to be soft, it is historically the case that as a 'recession' is confirmed, a bottom has already taken place, though it may be tested, and of course that is conventional; not in wartime. To us this is all part and parcel of the expected topping process over the past weeks, as our forecast rebound from the September lows to the October highs came to an end.

Wednesday's McClellan Oscillator on the NYSE eased to +5, and NASDAQ, after reversing belatedly compared to the NYSE, rebounded to the +26 level. We have in fact argued for about six weeks that the comeback would be more interesting in much of the NASDAQ, particularly tech, than in the multinational blue-chips. It has been so.

As to the market this week, we expected to see some profit-taking early, then another thrust attempt, but foresaw those likely easily reversed, especially as we moved into the midweek portion that equates with failing rebounds and the funds fiscal yearend timing, not to mention threats of new attacks within the week. While institutions don't normally sell at the very end of the fiscal year, we think some of that, more so than a fear of incidents on Halloween, characterized the soft close, that the 900.933.GENE hotline caught, on Wednesday, which captured several of the intraday reversals that were outlined via guidelines. Here in the DB, we forecast a probable down-up-down-up session (and added a late fade); and still foresee a break below DJIA 9,000 from all this, but it was problematic whether that would be seen quite as yet; but either this week or next, and then we'll approach the next phase of expectation, as you all know. Preliminary forecast for Thursday: up-down-up-down-up; again with a likely late fade, and we'll finesse the moves on the hotline during the day, as markets may require.

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