The treasury market has been wobbly, but the stock market has rallied—along with commodities, junk bonds and a wide range of other relatively risky asset classes in the US and abroad.
“In many ways, what we’re seeing is a mirror image of 2008,” said Mary J. Miller, the director of the fixed-income division at T. Rowe Price Group Inc. Treasuries soared in value last year when investors went on a wild “flight to quality”, driving down the prices of nearly everything else. That “fear trade” has abated as the financial system has stabilized, she said, and riskier assets have been rebounding. “It feels very different from last year,” she said.
Many investors who moved to the sidelines in the debacle of 2008 have begun to return to the stock market. “Investors don’t like to be left behind in any rally,” said Henry Kaufman, the veteran Wall Street economist. “The juices are beginning to work, and that’s a good thing.”
Even in a week when General Motors Corp. went into bankruptcy, the stock market took the bad news in stride. Still, recent reversals in the treasury market appear to underscore the continuing fragility of the stock market and of the global economy. Rising government bond rates could choke off an incipient recovery, particularly in the housing market, where mortgage rates are linked to treasury yields.
With the government forced to sell enormous quantities of bonds to finance its fiscal stimulus and financial rescue operations, treasury yields have risen sharply since the beginning of the year, and prices, which move in the opposite direction, have plummeted.
On Friday, the labour department’s monthly unemployment report, which showed that the nation’s job losses in May were much lower than anticipated, exacerbated this trend. Yields on 10-year treasurys, which started the year at 2.21%, closed on Friday at 3.83%, their highest level in many months.
The Barclays Capital US 20 (PLUS) Year Treasury Bond Index dropped 22.94% this year through Thursday, compared with a gain of 33.72% in 2008. By contrast, the Barclays Capital High-Yield Corporate Bond Index, which dropped 26.16% in 2008, climbed 29.5% this year. Meanwhile, the Standard & Poor’s 500-stock index, which lost 38.5%, is up 4.1% through Friday, and the Nasdaq composite, which fell 40.5%, is up 17.3%.
Amid gains like this, the turmoil in the treasury market is glaring. Individual investors who bought treasury securities and government bond funds last year to buffer their portfolios have seen the price of their holdings decline sharply (though the government guarantees the full value of treasury bonds that are held to maturity).
Those losses shouldn’t have been entirely surprising, though. After gaining so much in value, treasurys were bound to fall, many analysts warned, and fall they did.
The decline was caused by several factors, Kaufman said. These include anticipation of an economic recovery, the increasing supply of government debt, the mounting fiscal deficit and scepticism about the US Federal Reserve’s huge intervention. “The market is testing the Fed’s intentions and desires,” he said.
After the wild swings of last year and early 2009, many markets have been returning to more typical ranges in a process of “mean reversion”, said Timothy W. Hayes, chief investment strategist at Ned Davis Research Inc. in Venice, Florida. His firm last week shifted its asset-allocation recommendation to the most aggressive rating for equities, a judgement the stock market rally is very likely to continue.
But Kaufman foresees trouble ahead for stocks. It is “difficult to project a significant corporate profit recovery”, he said, and it is likely to become clear later in the year that another bout of fiscal stimulus is needed. The government bond market might rally, he said, “if the administration recognizes that the economic recovery is not as strong as projected”.
Meanwhile, he said, the stock market “does not want to deal with a subnormal economic expansion” and would weaken. Asked how he would advise investors, he said those in the stock market should limit themselves to companies with extremely strong balance sheets and market share. Unless a corporate bond investor is “in a position to do extraordinarily deep analysis”, he said, he would suggest avoiding anything that isn’t “very high quality”.
©2009/THE NEW YORK TIMES