Market Commentary for the week of April 12, 2010

Who’s right?

An intimidating debate is currently taking place between and amongst investment advisors, strategists, and media pundits.  It has to do with the role of debt, interest rates, and equity markets forecasting.  On the one hand, there are a number of factors which keep downward pressure on interest rates, such as a benign inflation picture and high consumer indebtedness.  On the other, there are forces which limit borrowing costs and the cost of money, like a wavering global economy, scarce natural resources, and a rising stock market.

Can you have both, or a little of each?  Certainly.  And today might be the confluence of both influences.

Netting the data out, however, draws some incontrovertible facts about rising inflation, rising rates, and a cessation in immediate upside gratification from stocks.

Interest rate debate.

As the benchmark 10 year yield hit 4% last week many investors became fearful that a continuation in the bond market’s bear phase was confirmed.  My bond market data has been turning negative since 2002, well before the credit collapse occurred in 2008.  A persistent bull phase in bonds had grown “long in the tooth,” and had already seen a cessation in momentum.  The credit scare was an exaggeration brought about, in part, by the excess influence of low rates and cheap money.  It was prudent for bonds to retreat and it is proper that a secular wave of reflation/reversal is beginning.  I continue to underweight the long end of the yield curve.

Around the globe there has been a congruence in the portfolio performance of sovereign bonds.  For most countries their bonds have seen the last, best sell opportunity of a generation.  The next leg in fixed income is likely to be a slight adjustment upwards in money costs around the globe.

This also presents the likelihood of a currency redistribution.  As all countries presently seem to be mired in a sea of debt, the dollar is likely to advance against most currencies.  Although some take the easy path of attacking the dollar (because of root economic factors in the U.S.), when all is discounted, the relative strength of the U.S. economy might bode well for the dollar’s position.  Conversely, one might conclude that the yen, yuan, and euro are vulnerable.  Deflation, trade imbalances, and debt put additional pressure on those non-dollar denominated nations.  This is an opportunity for the U.S. to expand its economic influence, if handled adroitly.

Rising.

Going forward, nothing is certain of course.  But the falling fortunes of the Euro markets, and significant Asian weakness, could yield significant upside pressure on U.S., and all, interest rates.  Most importantly, the likelihood of anticipated expectations will certainly change the global secular pattern of low rates and expansive borrowing.

I alluded also to the potential for higher inflation because of depleting natural resources.  The market’s recent anxiety has reflated gold and energy prices.  An increase in exports and inventories might raise the price of a basket of other commodities as well, forcing interest rates to rise.  A self-fulfilling evolution is likely.

All in all, one can argue that inertia, anxiety, valuation, secular and demographic trends and fundamentals are conspiring to create a tug of war which might truly lead to a “new paradigm economy” like the kind we may have envisioned a decade ago.