Friday, May 16, 2014

A Hint From Heloise

She always asked the rhetorical question of, when you drop a piece of toast, why does it land with jelly-side down, making the floor more difficult to clean up?  Why cannot toast land jelly-side up?

The same is true with market data.  Yesterday, the benchmark interest rate on 10-year Treasuries dropped below 2.5%, the lowest in over six months.  Most Americans would find it comforting that our government can borrow so cheaply.  If rates were higher, our budget deficit would be higher, and the need to increase taxes would be greater.

Traders read that information differently.  It used to be that geopolitical troubles would cause the price of gold to increase.  Now, gold prices are considered too volatile to park money during geopolitical troubles.  So, people buy ultra-safe U.S. Treasuries.

During economic troubles or bear markets, it used to be that investors would sell stocks and remain in cash.  Now, having recently experienced banking troubles, money market accounts are not considered safe enough, above the FDIC insurance.  Why not buy Treasuries which has the same government guarantee as FDIC?

Yesterday, with interest rates dropping,which means that people are buying Treasuries, bidding up the price.  This takes on special importance among those who believe the bond market is much "smarter" than the stock market.  The bond market was saying traders should sell stocks and buy safe Treasuries.

What actually happened was a tsunami of cash from Europe, bidding up the price of Treasuries, which drives down interest rates.  As low as interest rates are in the U.S., they are lower in Europe.  Why hold your money in Europe when you can get a higher return in the U.S.?  One reason is that the dollar may change value against the euro.

You'll recall that ECB Head Draghi announced additional monetary measures to strengthen the European economy and drive down the price of the euro.  So, you can sell your euros before they lose any more value, buy dollars (which are getting stronger against the euro) and use those dollars to buy U.S. Treasuries, earning more than your European holdings and with a stronger guarantee.  When you later sell the Treasuries, the dollars will buy even more euros when you repatriate the cash.  It was a smart move by European investors, which also helped the U.S.

So, the toast was really landing jelly-side up, but the traders insisted it was jelly-side down.  They were wrong!  Why do some people always insist that any news is bad news?  Why do they assume the toast landed jelly-side down before even looking?  Oh, because Heloise told them!