Thursday, March 19, 2009

Treasury Rally and Equity Markets

WSJ reports:

The Fed said that over the next six months, it would buy as much as $300 billion of Treasury's in maturities from two to 10 years, starting as early as next week. (See related article on the Fed's moves.)
The yield on the 10-year Treasury, which is used as a benchmark for mortgage rates, fell close to half a percentage point, its largest one-day point decline since Oct. 20, 1987.

So what does this all mean for equity and risk markets? Using history as a guide (data since 1962), when the 10-year Treasury Bond rallied by similar amounts, the equity market (as defined by the S&P) has tended to outperform over the next three months.

My thoughts? This isn't like those past situations. Rather than a Treasury rally due to a flight to quality, (which historically likely coincided with an equity sell-off, thus the next three month outperformance being a reversion to the mean), this was likely a flight ahead of the Fed / a lot of short covering. In addition, it coincided with a continuation of what very likely will be written in the history books as just another equity dead cat bounce. To brag a bit (I am wrong enough that I need to brag when I appear to have been right), just two weeks ago I made this comment in response to feedback on my post regarding hedge fund performance in February:
I will be more clear in my prediction. The market will bounce 20% back within the next month up from whatever low is hit this month. After the 20% is covered, I am shorting the crap out of this pig.
Unless the Fed begins buying actual equity, I still expect this rally to lose steam regardless of what the Fed does to help the economy.


Irrational Doomsday Blog said...

Yeah, this move is different- way different. The other risk if prognosticating that equities go down at this point is that there is a nominal runup due to inflation or a runup due to devaluing dollars. On the other side there's a risk of capital flight out of US and dollar denominated assets or out of any risk. I have no idea what is going to happen, but I'm really worried with this one.

Literature Student said...

I just have one question: Last week the Dow Jones Industrial Average rose 9%. How will this change the future outlook of the housing market?

Jake said...

if the equity market truly is able to rebound it increases the wealth of those investors participating in the equity market. an increase in wealth helps with the down payments and with consumer sentiment, the latter which will help the economy as sentiment drives consumption. anything good for the economy in turn helps reduce unemployment, which in turn allows housing prices to bottom...

but 9%? so the market is now "only" down 45%? come on now...

Earnings Trader said...

Can u measure the % change from 3 month low of equity before the date of the treasury spike? That might be interesting.

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