...and it is starting to get painful! It seems likely that it will only get worse. But first, let me catch up with my misses from my last post (an entire year ago!). The Fed did not raise rates to 5.5%, but held steady at 5.25%. OK, I was wrong! Now I feel better.
Anyway the chart above shows what has happened in the bond market in the last twelve months. I didn't exactly get that one right, although I didn't exactly get it wrong either, but rather the bond market went nowhere in the last twelve months. But the path it took to nowhere is interesting. First, was the selloff pushing yields higher above 5 1/4%. This must have been worrying the Fed and then the sharp rally which has brought us to new lows in yield. Do I smell a whiff of deflation? It seems that the bond market does. Combined with a weak stock market, strong dollar and strong commodities, especially gold, the Fed's job has become substantially more difficult. Of course, they only have themselves to blame. In short, with Fed Funds at 4.5% and the 10 year Treasury Note at 4.3%, the market is saying that they have not done enough.
But with the dollar at 1.46 Euro and Dollar Index at 75, their back is against the wall. Throw in gold at 834 and things must be a little stressful in Ben Bernanke's office today. The media coverage of the dollar and gold suggest that in the short term things may be over done and the rubber band will snap back a little. That would agree with a stronger bond market, weaker stocks and slower economy. This would give the Fed the room to lower again in December. But by then where will long term bond yields be? My guess is lower. So that leaves the Fed still behind the curve and would suggest deflation, Ben's bugaboo. Personally, I would welcome a little deflation as I have no debt, but I am not the typical American, who is loaded with the stuff. So we need to watch the 4.5% level on the ten year Note and the 12800 level on the Dow. Or 1385 on SPX or 1800 for NDX. These are the levels which would indicate that inflation is going to continue or that deflation is going to start to be felt. Personally, I am betting that 4.5% will hold and the others will be broken. I say this because I consider the bond market to be a leading indicator relative to stocks. Also, the Dow Transports have already broken their August lows (although this is one of the few major indexes to break down). But this has not been confirmed by any of the other major averages, as Richard Russell has pointed out. But the number of distribution days in the last few weeks does not bode well for the future and we have seen false breakouts on all of the averages which have broken out to new highs and failed and have fallen below the previous highs. So the signals suggesting that the rally is over are in and we are waiting for the signals saying that a bear market has begun. This could only take one or two volatile days. My guess is that we are not going to see this right away, as we could be due for a bounce after this last week, but that the next 5 weeks could be treacherous. Another negative point is that the market leaders have broken. GOOG, AAPL, VMW have all sold off sharply with the latest weakness suggesting that the last, strongest pillars of this bull are shaking and at risk of toppling over. I, for one, am waiting with bated breath.
