Friday, September 10, 2010

Higher yields on Treasuries is good news


The 34 bps rise in 10-yr Treasury yields this month is a good indication of how market sentiment—which by late August was obsessed by the belief that the U.S. economy was on the verge of a double-dip recession—is changing. As I've explained many times before, very low yields on Treasuries only make sense if one believes that the prospects for the economy are dim. Rising yields therefore reflect rising optimism (or perhaps it would be better to say receding pessimism). The economic data of late have been not nearly as bad as the market had expected, and of course commodity prices continue to rise.

Not surprisingly, yields and equity prices have moved higher in virtual lockstep this month. I'm guessing this is only the first chapter in what will be a long story of recovery: higher yields and higher prices for risky assets.

It would be a mistake to think that higher yields threaten the recovery. It's the other way around—the recovery threatens those who have purchased Treasuries.

18 comments:

In Transition said...

Greetings Scott,
I am curious if you saw President Obama's news conference this a.m. and if you did what is your opinion on his comments about his efforts to stimulate the economy?

Thanks for any thoughts.

John said...

Intrans,

Scott mentioned earlier that he has friends in town from his wife's native Argentina. He is doubtless engaged with that.

Don Luskin, a contemporary of Scott's, addresses the President's speech in a column just published. Mr. Luskin's opinions are respected by Scott, so you might want to check out his point of view.

You can find the link on the left side of Scott's homepage.

Bill said...

I listened to NPR's marketplace for the first time in a year this afternoon on the way home from work and was struck by the negativity on the economy. The guests (from liberal media) were all about doom and gloom. I guess that's what we are to expect from Obama and the Democrats for the next two years. Let's hope for "change" in November and then again in 2012.

John said...

Bill,

The similarities between now and 1991 are to me, striking. I know every cycle is different and many will scorn the analogy but I sense the same kind of pessimism and defeatism I remember so well from that year...and it began the decade of the ninties, the most lucrative decade of my life. I'm not saying there's another dotcom bubble coming but it will be something. Better economic times lie ahead. Stay alert and stay optimistic. Opportunities will present themselves.

Benjamin said...

my guess is that T-bills go don from here. What does Japan sell debt for?

Bill said...

I hope you are right John. I'm afraid, however, that Obama is more of a true believer in socialism than Clinton. He may well prefer to lose in 2012 than pivot to the right and support fiscal restraint and pro-business policies.

John said...

Bill,

My guess is that President Obama pivots quickly to the center after November. We'll see but if he stays where he is he will lose big in 2012. Just my cheap opinion.

Charles said...

Obama will not pivot to the center for two reasons: he is not skillful enough politically and he is a "principled" ideologue.

Bill said...

I would be interested in your reaction to the news that many companies are buying back their stock instead of using their cash to invest and rehire. Do you see this as a long term trend or temporary?

John said...

@Bill:

The libs on Marketplace and elsewhere are disappointed with Obama because he has not dealt with unemployment. Many of us want him to directly hire workers along the lines of another WPA or CCC. There are so many young guys out of work and now they have to compete with us boomers who can't afford to retire.

Germany dealt with unemployment by cutting hours, not bodies. American companies don't seem to like that approach. After all, is labor an asset or a cost?

Obama "pivoted to the center" a long time ago and that's too far to the right to suit me, and many others.

Expect watered down policies with continued deference to Republican policies, like tax cuts. And a very slow recovery.

John said...

Bill,

I will assume your stock buyback question is addressed to me.

Corporate stock buybacks are not new. Many publicly traded companies have such programs in place. In recent years they have been popular because of the double taxation of dividends (companies pay dividends from after tax earnings, and those dividends are again taxed if owned in taxable accounts). The idea was that capital could be returned to shareholders more efficiently through buybacks. The other reason given is that in times of panic buybacks can help stabilize share prices.

Those opposed to such policies argue that companies do a poor job of evaluating their stock's attractiveness (they tend to overpay). Also, they argue that stocks supported by high and rising dividends decline less during panics than those without them.

There are other points but I believe these are the main ones.

Today I think the pendulum is swinging back toward dividends. With deposit and bond rates low, shareowners are chafing at huge cash balances building on corporate balance sheets while dividend policies are seen as chincy. IMO the pressure is building in corporate boardrooms to shift their emphasis from buybacks to dividends.

Hope this helps.

Bill said...

As always, thanks John. I wonder how the markets will react to the possible agreement to extend tax cuts for the middle class (as opposed to those of us who are "rich" and comprise the "non-working families.")

John said...

Bill,

As general rule, higher taxes are bearish for equity prices and vice versa.

Scott Grannis said...

Another reason for an increase in buybacks today is that next year the tax on dividend income could be greater than the capital gains tax. Buybacks give investors a chance to receive capital gains instead of dividend income.

John said...

Several companies are currently very active in issuing bonds. For instance Home Depot has recently raised money to refund debt coming due in later years.

A rumor has been going around that Exxon will soon bring a massive bond offering and use the proceeds to buy in stock (I repeat this is a rank rumor). However to me it makes tremendous sense from a sentiment perspective. Sell what the market wants and buy what it does not.

Scott Grannis said...

Agree with John. When money is cheap and plentiful as it isnow you should borrow it. Stocks are also cheap (scorned) so you should buy them. Borrow and buy.

Daniel said...

yep I agree. Borrow at 8% for a 20-30% return! you would be dumb NOT to borrow. :)

John said...

Well, so it wasn't Exxon, it was Microsoft. MSFT is up big today on news they are issuing debt to fund stock buybacks and dividend hikes.

Sell what the market wants and buy what it does not. That is precisely what the big boys are doing. And MSFT's success in hiking their share price by doing so will NOT be missed by a single corporate CFO out there.

This is very bullish.