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.