Tuesday, December 8, 2009

Markets are still pessimistic

These two charts record the most dramatic rally in the corporate bond market in modern history, and it's far from being over. Earlier this year, when spreads were at their peak, the market was effectively forecasting that a deep depression and a global deflation would wipe out a huge percentage of the world's companies. Now, as spreads have come back down to the worst levels we saw during the 2001 recession and the subsequent corporate credit crisis (second chart), the market is effectively saying that what the future holds in store for us is a garden-variety, but still rather nasty recession.

My takeaway from this is that the rally we have seen in corporate bonds and equities this year has been more about the market becoming less fearful of the future than it has been about a market that has turned optimistic. Stocks and bonds are still priced to some fearsome assumptions, and this is hardly the stuff of an overbought or overextended market.


Rick said...

Scott, what is happening in the 90 day treasury given that its yield continues to be significantly lower than the 30 day? Thanks in advance.

Scott Grannis said...

T-bills are essentially trading at a zero yield. There are lots of possible explanations for this, but the ones that carry the most weight for me are these:

1) the market is very, very concerned about a variety of things: a double-dip recession, a collapse of the commercial real estate market, a second wave of home mortgage defaults, the impact of higher taxes, and a general deflation.

2) the market is absolutely convinced that the Fed is not going to hike rates for at least many months, so the opportunity cost of staying in cash versus taking some risk by venturing out along the curve is not significant.

3) the market is very concerned that when the Fed does raise rates we might find ourselves with an inflation problem and that would greatly complicate things. Bond managers who worry about rising bond yields have no choice but to park money in bills to avoid the losses that would occur if and when bond yields rise.

Bill said...


How likely do you think it is that the rating agencies will downgrade US debt or that China will pull its money out of the US?

Scott Grannis said...

Very unlikely.

alstry said...


What percentage of S&P revenues are simply based on government payments....entitlement and otherwise.

For example, what percentage of WalMart's sales comes from the 40,000,000 food stamp recipients, the 16,000,000 unemployment recipients, the drug sales to medicare and medicaid recipients plus other government based spend????

Do you think that the market may be beginning to factor that the days of massive deficits may be coming to an end and discounting those revenues to the S&P????

With Obama in office....it doesn't seem likely as Fed Ex supports improvement on the margin.....

Scott Grannis said...

alstry: if the days of massive deficits were coming to an end, and especially if that involved serious reductions in government transfer payments, that would be about the most bullish thing for the markets that I could hope for.

alstry said...

I agree....it would be great for the nation if we operated off of a balanced budget.

But if we stopped handing out 40,000,000 food stamps every month....wouldn't there be 40,000,000 million people standing in food lines that the private sector would have to feed.?

In your opinion, what would be the reduction in GDP from the government cutting $1.4 Trillion of deficit spending factoring the multiplier effect from the deficit spending in the stream of sales?

MadTax said...

Government spending as a percentage of GDP

Year Spend(Billions) %

2008 $14165.6 37.40
2009 $14240.2 45.34
2010 $14728.8 42.11

MadTax said...

Year GDP-US Welfare-total
1994 7072.2 234.25
1995 7397.7 247.23
1996 7816.9 247.44
1997 8304.3 249.35
1998 8679.66 244.16
1999 9201.14 253.88
2000 9749.1 267.66
2001 10058.2 290.16
2002 10398.4 320.34
2003 10886.2 390.56
2004 11607 380.28
2005 12339 404.04
2006 13090.8 411.39
2007 13715.7 414.86
2008 14165.6 477.25
2009 14240.2 562.67
2010 14728.8 590.41
2011 15499.8 584.44
2012 16470.4 566.05
2013 17497.8 560.14
2014 18386.4 561.35

Bob said...


That government deficit spending in the form of foodstamps/welfare finds its way to final sales is a foregone conclusion. If we were so lucky as to have someone in a position of power that would reduce those numbers would be ultimately beneficial. But it would have to been done incrementally so as to put no one in a beggers line. Hence the impact to GDP would be minimal. JMHO

Scott Grannis said...

nobody knows what the multiplier really is. My guess is that it is well below 1. So a reduction in government spending on non-productive things like transfer payments would actually boost GDP because the money would be used by the private sector more productively.

Bill said...

Also, many (or most) of the people currently receiving government transfer payments are fully capable of working and would do so if they did not receive said monies. So, cutting them off should boost economic activity as they would then be forced to go out and participate in the private sector.

Paul said...

Wait, transfer payments? I thought it all came from Obama's stash.

A friend of mine, an Obama voter 'natch, has been unemployed for about a year now. I asked him why he doesn't go get some basic job to keep from going crazy while he's looking for a job in his field. His reply was that income would cut into his unemployment benefits.

alstry said...


The private sector would not have access to the money because it is being generated form Obama insane monetization uncontrollable spending habits.....

With only a $4 trillion GDP, China doesn't have the capacity to fund our deficit anymore now that we are on track to reach $2 trillion.

The game seems to be essentially a Ponzi scheme.....unless you have a different perspective.

Scott Grannis said...

Paul: and your example is an excellent example of how steep our marginal tax rates are. They are a huge disincentive to work. It's a real crime.