What do surging bond prices and tumbling bank stocks tell us about the economy?
Nothing good, posits Gluskin Sheff economist David Rosenberg. He notes that over the past two months, with the stock market pushing toward its highs, the KBW bank stocks index has tumbled 12%, while 10-year Treasury yields have dropped 40 basis points to a recent 3.17%.
He says the last time these three things happened at the same time was in late 2007, as the financial markets started to unwind after years of speculative excess, paving the way for the financial crisis of 2008. That was not exactly a banner year for stocks or much else, you may recall.
“I’ve been in the business 25 years and I have to say that when bank stocks and bond yields are going down in tandem it has not been a development that foreshadowed anything much good down the road,” Rosenberg writes in a note to clients Thursday.
It is easy to see that the trade that dominated the past nine months — buy stocks and commodities and sell the dollar – is not working lately. Silver sold off again Thursday, putting it nearly 30% below its late April high, and gold fell below $1,500 the ounce. Crude oil dropped below $96 in New York.
The commodity selloff is hardly a shocker, given how far many of these markets had come and the determination of regulators and exchange operators to prevent futures trading from being totally hijacked by speculators. The reduced liquidity that will result when the Fed ends its bond-buying next month isn’t doing much for commodity prices either.
But the question now is how much the momentum in the so-called risk-off trade will carry into stocks, which are up 28% since Ben Bernanke promised last August to do anything in his power to prop up domestic demand.
So far, Bernanke’s widely mocked embrace of the wealth effect is intact. The S&P 500, despite some recent selling, is just 2% below its 52-week high.
But bank stocks are down more sharply, with the KBW index dropping below 50 Thursday for the first time since Dec. 17. Goldman Sachs (GS) fell 3.5% and Citigroup (C) 2.5%, leaving both around 20% below their highs of the past year.
The selloff comes after first-quarter results showed the banks struggling to tamp down rising costs and to prop up tumbling revenue. Big commercial lenders haven’t been lending much, and with loan balances shrinking they been improving profits in part by releasing loan loss reserves into earnings – something that doesn’t contribute to economic growth and can’t continue forever.
Meanwhile, recent economic data has suggested the 4% growth many economists were hoping for this year will not come to pass and that 2011 will be at best another muddle-through year.
That’s why Rosenberg, who has spent most of the past two years calling U.S. stocks a bubble and tut-tutting those who questioned low Treasury yields, warns that the flight from risky assets will inevitably spread to stocks. Retail investors, he notes, withdrew $2.8 billion from stock funds over the past two weeks, while pouring $9 billion into bonds.
“The ‘buy-the-dips’ mentality may now be morphing into a ‘withdrew the net, can’t handle the volatility’ psyche,” Rosenberg writes. The way this month is playing out, anyone who can’t handle the volatility is in for an unpleasant ride.
