Thursday, May 20, 2010
As panics go, the current one is a doozy, eclipsed in modern times only by the Lehman collapse and the Crash of '87. Is Europe teetering on the brink of collapse? I suppose anything can happen, but surely it can't be very likely.
I think the explanation for the current panic is that investors are simply very skittish and the market is not nearly as liquid as one would like to think. Hair-trigger stop losses can overwhelm the market when the going gets tough. The panic feeds on itself. Pundits predict another calamity in the making. European policymakers do stupid things like prohibiting naked short selling.
With panic selling of equities comes panic buying of Treasuries. German 2-yr Bund yields are down to less than 0.5% (US 2-yr yields are 0.7%). 10-yr Treasury yields are down 75 bps from their April highs. As this chart suggests (my interpretation), yields at this level only make sense if we are on the verge of another recession. Yet there are simply no signs of a recession that I can find. Central banks are still very easy, yield curves are still quite steep, corporate profits are strong, commodity prices are still quite high, swap spreads haven't widened significantly, and many areas of the global economy are experiencing V-shaped recoveries.
Sovereign yields are very low, implied volatility is very high, gold is very strong and the dollar is up sharply against other major currencies, but the classic precursors of a recession are nowhere to be found—all this makes sense only in the context of a panic. When the panic subsides, prices are very likely to rise again, as this last chart suggests:
Posted by Scott Grannis at 9:21 AM