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Kessler Market Comment 05-29-13

Kessler Market Comment 05-29-13

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Kessler Market Comment 05-29-13
Kessler Market Comment 05-29-13

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Published by: zerohedge on May 30, 2013
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Prepared by Kessler Investment Advisors, Inc. and Kessler & Company Investments, Inc. | 5/30/2013Page 1 of 6
Market Comment
— May 29th, 2013
 
What has happened to long-term U.S. Treasury yields andwhy they won’t stay up here for long
KESSLER INVESTMENT ADVISORS, INC.
 
KESSLER & COMPANY INVESTMENTS, INC.
 
What happened
US Treasury yields have risen sharply in the lastfour weeks with 10yr yields higher by about 50basis points (fig.1). We are the first to admit thatwe didn’t see this coming, but other than thesecular and political interest rate bears, no oneelse did either.Direct causation is hard to find. While theeconomic data has improved in places, theprices have moved much more than the facts
1
!For just about every good piece of data, therewas an equal piece of bad news. For instance,where the jobs report showed an unemploymentrate improving to 7.5% from 7.6%, the broader
under 
employment rate (U6) that includes thosethat would like to work but haven’t looked for ajob in the last 4 weeks, worsened to 13.9% from13.8%. Durable goods orders came in betterthan expected, yet Industrial production came inworse than expected. New home sales were
 
1.6%1.7%1.8%1.9%2.0%2.1%2.2%
fig.1 UST Yields so far in 2013
 
more than expected yet Building permits wereless than expected.For the whole picture, it helps to considerindicators that combine individual data for themonth into a single number. All of these show aslowing, not improving economy. The ChicagoFed National Activity Index showed a decreasein aggregate activity, the coincident indicatorsindex (correlates well with real GDP growth) grewat just an annualized rate of 1.2%, andour ‘Kessler Interest Rate Economic Indicator’modeled after the Chicago Fed National Activityindex is showing a decrease as well.Then of course, there is Ben Bernanke who madethe slightest hint to the possibility that a taperingof purchases could begin “in the next fewmeetings” if the economics warranted. It wasn’tso much what he said on its face, but just thatthe markets hadn’t imagined this possibility waseven entertained by him until that moment. Buttrying to position a trade based on the impact ofthe Fed quickly becomes a reflexive exercisegoing no place because the Treasury marketfinds a way to reflect macroeconomics despitethem. The history of the Fed shows thateconomics always trumps their effects. This isn’tto say that at any given moment, the Fed mayhave interest rates at a different level than theyotherwise would be, but it isn’t useful to use thisas a reason to buy or sell because a change intheir buying could just as easily mean that theeconomy will be weaker and thus rates would fallas that they would cause rates to rise.Regardless, yields have risen dramatically andwe are not trying to dismiss it. The price is theprice, however; it is important for us to expressour thoughts for where we think yields are
Data Source: Bloomberg
Jan Feb Mar Apr May
1
This phrase is borrowed from David Ader and Ian Lyngen at CRT Capital
+0.54%
10yr UST Yields
 
01/01/2013 — 05/29/2013
 
 
Prepared by Kessler Investment Advisors, Inc. and Kessler & Company Investments, Inc. | 5/30/2013Page 2 of 6
ultimately going, especially when there is virtuallyno one out there to make this case. We alsorealize that the market never trades based onwhat the economy looks like
now 
, but ratherwhere it thinks it
will be 
.And so, what this recent yield back-up boilsdown to is that the market is expecting that thereis self-sustaining, above trend, GDP growthcoming. It isn’t often that prices become thisdivorced from fundamentals. Expecting self-sustaining above trend growth is hoping, not theresult of a careful analysis.We continue to think that no matter how forcefulthis back-up has been, or where it ultimatelypeaks, we will see new low yields in the Treasurymarket before this cycle is over. Here is why.
Why we think they won’t stay up here forlong
In the short-run:
1. The macro ingredients aren’t nearly there forthe Fed to tighten policy and create a majorsell-off in bonds like 1994 or 1999. It is usefulto look at the state of the economy beforemajor previous Fed tightening episodes(fig.2).2. Higher consumer confidence was cited as amajor reason for the large bond sell-off thisTuesday (05/28/2013). This indicator is not aleading indicator. The market hopes thathigher consumer confidence will translate intohigher consumer spending but that is far fromguaranteed (fig.3).3. Inflation continues to fall. The core PCEdeflator is running at 1.1% (yoy%) and isexpected to drop to 1.0% this Friday,05/31/2013 (fig.4).
 
1994 set-up1999 set-up
Data Date: 12/31/1993 12/31/1998 4/30/2013
Output Gap/Surplus
-1.7% 2.5%
-5.6%
Non-farm payrolls
(prior 12 month avg)
321k 251k
173k*
Unemployment Rate
6.5% 4.4%
7.5%
Real Retail Sales YoY
5.6% 5.2%
2.6%
Core Inflation (PCE)
2.1% 1.5%
1.1%
Economics that led the Fed to tighten
Now
*note: population has grown by 20% since 1994, and 14% since 1999
020406080100120140160
        1        9        9        9        2        0        0        0        2        0        0        1        2        0        0        2        2        0        0        3        2        0        0        4        2        0        0        5        2        0        0        6        2        0        0        7        2        0        0        8        2        0        0        9        2        0        1        0        2        0        1        1        2        0        1        2        2        0        1        3        2        0        1        4
fig.3 Consumer confidence is not a goodpredictor of the future
 
Data Source: Bloomberg
 
Confidence peaks whenstocks do, not a goodpredictor of futureconsumer behavior.
Data Source: Conference Board
Conference Board Consumer Confidence
 
01/1999 — 05/2013
 
Quite a bit different nowthan then.
fig.2 Economics now compared to prior tightening environments
 
1.0%1.2%1.4%1.6%1.8%2.0%2.2%2.4%2.6%2005200620072008200920102011201220132014
fig.4 Inflation is lower now than its post-crisis trough
 
Data Source: Bureau of Economic Analysis
PCE Core Inflation (yoy%)
 
01/2005 — 04/2013
 
Post crisis low: 1.2%Core inflation: 1.1%
 
Prepared by Kessler Investment Advisors, Inc. and Kessler & Company Investments, Inc. | 5/30/2013Page 3 of 6
4. Commodities are not confirming the risk-onsentiment, and for one important case, issuggesting the opposite (fig.5).5. Positive sentiment exploded with the housingnews released in May, but it is important tolook at these charts nominally. Because theyhave fallen so much, high growth ratesrepresent small nominal gains (fig.6).6. Europe is in recession. So far, the U.S. hasbeen able to ignore it because it hasn’t shownup in a measurable way. But, it would be astretch to expect that this won't have somedrag on U.S. growth when Europe representsnearly a quarter of global GDP (23%). Thenew Treasury Secretary, Jacob Lew, has beenharping on this and just yesterday, the OECDcut their 2013 global growth forecast (fig.7).
fig.6 Large percentages in housingnumbers are misleading
 
Data Source: U.S. Census Bureau
0k400k800k1,200k1,600k1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015
U.S. New Home Sales
(annual rate, thousands)
01/1960 — 04/2013
 
New Home Sales aretoiling at levels from the1960’sThis indicator has improved by 68.2%!from the trough, but the percentage isnearly meaningless when the valuehas fallen so much.
$220$260$300$340$380$4206/1/20129/1/201212/1/20123/1/20136/1/2013
fig.5 Commodities have been decreasingwhich is not consistent with a ‘risk-on’bull market
 
1502002503003504004505002005 2006 2007 2008 2009 2010 2011 2012 2013 201
-11.4%
CRB commodity index
 
01/2005 — 05/29/2013
 
...and a main ingredient for homes has beenfalling dramatically
 
Lumber Futures Contract (
price per 1k board feet)6/1/2012 — 05/29/2013
 
—31.6%
Data Sources: Thompson/Reuters, JefferiesData Source: Chicago Mercantile Exchange
Note: Lumber futures are not a heavily traded contract and thereasons for this price drop may eventually relate to reasonsendemic to the industry in addition to macroeconomic reasoning.

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