Thursday, April 7, 2016

The Bond Market Is GDP Bearish

In today's linkfest, I linked to a post from the Capital Spectator that argues (I believe convincingly) the treasury market is predicting a weaker equity market.

I wanted to briefly expand on the author's point.  

Treasuries rally when traders see weaker economic growth and, in correlation, lower inflation.  The reason is simple: slower economic growth leads to lower revenue growth, leading to weaker earnings. And weak earnings are a drag on equity indexes.  In addition, in a weaker growth environment, traders like to increase the treasury component of their portfolios for their stable and predictable return.  Finally, weak growth usually leads to lower inflationary pressures.  

The converse is also true: when traders see stronger fundamental growth, they sell treasuries, opting for the potentially higher returns of the equity market.  In addition, stronger growth usually leads to increasing inflation.

That being said, here is the weekly chart for the IEFs -- the 7-10 year treasury market ETF:

The market has been in an uptrend since the end of 2013.  Let's now turn to the TLTs:


There are three primary patterns.

1.) A rally from the end of 2013 to the beginning of 2015
2.) A brief sell-off followed by a triangle consolidation in 2015
3.) A rally through upside resistance of the consolidation triangle at the beginning of 2016.

Notice there is no sell-off in sight.

Consider the above developments in conjunction with the latest release from the Atlanta GDP Now model:

The GDPNow model forecast for real GDP growth (seasonally adjusted annual rate) in the first quarter of 2016 is 0.4 percent on April 5, down from 0.7 percent on April 1. After yesterday morning's light vehicle sales release from the U.S. Bureau of Economic Analysis and the manufacturing report from the U.S. Bureau of the Census, the forecast for real GDP growth declined from 0.7 percent to 0.4 percent due to declines in the forecasts for real consumer spending growth and real equipment investment growth. The forecast for real GDP growth remained at 0.4 percent after this morning's international trade report from the U.S. Census Bureau, as a slight decline in the forecast for real net exports was offset by a slight increase in the forecast of real equipment investment growth.

The model has been decreasing since the beginning of February.

Overall, 1QGDP does not look good right now.