A View from the Trenches, June 22nd 2009: "Retrenchment"
The chart below, which shows last Friday’s intraday action in 30-yr
Treasuries vs. the S&P500 Index, says it all: Retrenchment. Indeed,
personally, I don’t think we have made any progress last week. This is
perhaps reflected in wider credit spreads (CDX IG12 20 bps wider, to
143bps), lower equity prices, and the action in mortgages last Thursday.
I have recently been thinking at the ultra-macro level. Bear with
me, please. I’ve come to realize that since the French Revolution,
humans have been growing up, have been raised, have been educated and
are educating their children under the paradigm that proposes that
value can be added by “creation”, by “innovation”. When we don’t
innovate, when we don’t create, we assume no value is created. But now
think of the children in Ancient Greece: They grew up listening to the
story of the sacking of Troy. Pillaging was honorable and Achilles was
legendary three thousand years ago. There was honor in conquering.
Value was added by taking, not creating. This notion must have lasted a
while, because even under Elizabeth I, people were fascinated with
characters like Francis Drake (and understandably so, given what Sir
Drake contributed to the kingdom’s coffers). However, in those days,
there was consistency between politics and economics. The political
apparatus, the legal system, encouraged monopolies, sacking, taking
from other nations, while our current “value creation” paradigm is not
consistent. We are told we add value innovating. But our legal systems
encourage oligopolies every time our central banks and governments
decide to bail out dinosaurs; mediocrity, when economic success is
taxed at increasing rates; and paralysis, when relative prices are
manipulated and we ignore the future value of today’s medium of
exchange. But value creation only works if people can accumulate
capital. To accumulate capital, people must save. To save, people must
know, ex ante, that what they save will be safe. Saving is boring and
hard. It means restricting consumption today, in favor of consumption
tomorrow. The British played this game right for a century, between say
1815 and 1914, thanks in many ways to David Ricardo. But then, then
people thought they could cheat a bit. We thought we could get away
without the hardships of saving, as long as we managed an “optimal”
speed of money supply. We experimented a lot with it, particularly
after World War II. Today, the latest expression of this illusion is
the famous Taylor’s rule (http://en.wikipedia.org/wiki/Taylor_rule ).
The illusion continues as we anxiously await now the FOMC meeting to
tell us, on June 24th, what the monetization speed will be, what assets
it will use (Treasuries, agency debt, mortgages). Uncertainty is
preventing investors from putting their savings to work. More so, when
we read of major regulatory reforms every week. The bottom line? I
think we can step to the sidelines in equities and Treasuries. Will
sellers of Treasuries continue to reallocate funds to credit? I don’t
know. The waters are divided here, with some analysts on either side,
both in investment grade and high yield. But under uncertainty and
inconsistency, liquidity gains relevance once more, favoring index
positions, vs. single names… What is left to trade this week? Event
risk? I don’t like it…
June 19th, 2009 Intraday: 30-yr Treasury vs. S&P500 Index (orange)
Source: Bloomberg Analysis: A View from the Trenches
(A View from the Trenches is not published on Fridays. Have
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