What's triggering this bizarre bond market behavior where interest rates are plummeting at the same time the U.S. economy seems to be humming along?
What's causing the 10-year Treasury to yield less than the 2-year -- a highly unusual set-up that we haven't seen since 2007, the eve of the Great Recession?
How the heck is that possible?
Why can the 30-year treasury go to record lows, when unemployment is the lowest in 50 years?
This stuff shouldn't be happening.
What the heck is going here, and why is it in total control of stocks, meaning as rates go lower stocks go lower with it?
Finally, how can something so bullish as lower interest rates, something that's basically a giveaway to anyone who needs a mortgage or wants to refinance, lead to a slow-motion crash in stock prices?
This kind of wacky -- some would say, irrational -- activity has to be explored and taken seriously, because any time we have seen Treasuries behave like this, a recession surely follows. Those are powerful odds, odds that make anyone feel awful about buying stocks and feel great about selling them.
So Wednesday, even though I don't think we are going to have a recession any time soon, I am going to put on my doom and gloom investigation hat, and offer some theories about why this erratic action may be occurring.
Keep in mind that these are just conjectures, I don't know anymore than anyone else, but I do have my ear to the ground, so let me tell you what I am hearing. Keep in mind lots of people were talking Wednesday about an elephant in the room and then they would mention a different element, so I would say there's a veritable herd of elephants in the joint.
First, and most obvious, there's a belief that our trade war with China is causing the amount of world trade to plummet. The history buffs among investors, of which there are many, believe that we are going to have something that we haven't had since the Great Depression, when we put up giant trade barriers. Tariffs have, at times, had a disastrous effect on commerce.
When that happens, you buy treasuries and man are they ever buying Treasuries. If this theory is true and the Chinese and the United States were to have some sort of meeting of the minds, then many of the stocks that have been pummeled into bear market territory, like the banks, would zoom higher and you will wish that you took our a mortgage at this very moment.
Second, our interest rates, especially our short term rates are way too high because the Fed raised rates repeatedly in this country, without much thought of the impact they could have. This is the president's theory. He is anxious to not have the tariffs presented at the rout of the rout in stocks, even as lower interest rates usually bring about a stronger economy. The Fed could instantly cut rates big, and that might make it so we don't have short rates above long rates, but it won't impact the 30-year treasury, as that's too long dated.
Of course, the president could announce a gigantic 30 year infrastructure bond, say $500 billion and even a 50 year bond for $500 billion and fix all of our airports and roads, bridges and tunnels. Why not take advantage of what I think are absurdly low levels? To not do so is a total failure of imagination. We may never see these rates again.
Third, a huge percentage of government bonds worldwide are selling at negative interest rates. That's typically because countries around the world have very little economic growth. If you manage money in those countries, you should be using the fluidity of currencies to buy dollars and then buy U.S. bonds, which are yielding, even at these low levels, far more than many other places. Given the strength of the dollar and the credit-worthy nature of our country, this is a perfectly natural occurrence. It will continue, as long as our rates are higher than those of others, which may mean many more sessions like this one, until our bonds yield as little as everyone else's.
Fourth, our bonds are signaling a recession is right around the corner, which is justified given what we are seeing from some corners of the economy. We could argue that aerospace, which had been the strongest portion of the economy, is grinding to a halt, because of the problems with the Boeing 737 Supermax. Most companies could never move the needle in terms of growth of the gross domestic product. Boeing (BA) is not most companies.
The consumer could be flashing red, because this morning Macy's (M) reported a horrific quarter and, even though Macy's may not represent the way people shop anymore, that quarter was worrisome. More on that later.
Fifth, maybe a hard Brexit is a disaster. Maybe it is going to cause a freeze in commerce in Europe at the same time that there's a dramatic decline in Chinese consumption. In my travel to Europe, I do hear the specter of depression from Brexit and it would be difficult to stop on the continent. This is the Armageddon scenario that would lead to the failure of major European banks and a total shutdown of credit.
Sixth, the trading floors were alive with talk that this stock decline is a precursor to a victory by U.S. Sens. Elizabeth Warren or Bernie Sanders. These two represent an anathema to capital, this theory goes, and we better get used to the fear these two instill among the wealthy who own stocks. The decline in stocks that have good yields even though the bond market is upside-down and offers little competition might be another signal that taxes on capital gains and dividend income could be about to soar. Such a change would require a wholesale sweep by the Dems next year. That would definitely shock people and maybe investors are just trying to get ahead of that.
Seventh and final explanation: Several large institutions are short or are betting against these bonds and they are caught and could be about to go bust. I typically wouldn't believe this could occur, but it did happen in 1998 with the failure of Long Term Capital, a hedge fund run by people who thought they were so smart and yet turned out to be taking unfathomable and stupid risks.
No matter what happens, we cannot ignore this bond market behavior. Of course, we also have to recognize that many of these could be reversible and almost all are man-made and therefor can change.
Right now, though, our stock market is handcuffed to the bond market and if that is the case the momentum is with the bears not the bulls -- even if they are wrong.
Right now this market is ruled entirely by fear. I don't like to be scared into anything when it comes to money. I actually think that the Cassandras will most likely be wrong, because of how strong the economy is.
But in the interim, I accept that being calm and patient is not in vogue.
I want to be opportunistic and say that the bonds are just plain wrong and there's plenty left to buy. But I have been selling for my charitable trust, which you can follow along at Actionalertsplus.com, raising a cash position to 10% in reaction to this bizarre behavior.
If you joined me, I don't mind. But a panic, wholesale dumping of stock? Not with this strong an economy here, especially because governments could raise money and rebuild infrastructure, putting people to work and strengthening, not weakening countries worldwide.