blob

Everybody start talking bullish

It is well known to US bond investors that premiums being paid for the highest quality fixed income securities have had their future linked to the lack of confidence evidenced by all macro markets in recent months. These interrelationships have undergone a revolution since the credit crisis began last year. Just like last Spring when so few were worried about credit and equity, right now my sense is that too many may be worried about counterparty risk and near term earnings. While the roadmap seems to point to lower bond prices concurrently with higher equity prices, the catalysts are not clear yet. Tomorrows TSLF auction at 230p could be one catalyst, especially if the auction clearing level for premium paid to receive govt collateral winds up being less than 75bp. [expectations are mostly in the 75-150bp range].

• The conventional wisdom is that Q1 earnings are going to be poor. But the Fed has changed the game. My sense now is that some important investors are now looking not to where we will be in 1st half of 2008 but rather the end of the year in terms of earnings and gdp prospects.
  
• The conventional wisdom is also that counterparty risk is the big problem. But I think that insight was truly valuable in Q4 '07 and Q1 '08. The "hoarding" of cash into numerous flight to quality / liquidity vehicles has been indicative of that. The issues of counterparty failure are behind us in my view now that the Fed has been forced to look "under the hood" of Bear Stearns, especially once it became intertwined with JPM. And the Fed now has a much better idea of where the problems lie. We should be giving the Fed credit for having a steep learning curve. There are no analogs in history that I know of (yet) where the Fed has taken such a historic and aggressive stance.
  
• Money management pros and opinion makers that advise the big hedge funds are starting to say you have to get in to stocks. This will have an impact on fixed income and the structure of the curve. 
  
• The PBGC has recently said that it will change their own internal asset allocation to own more stocks and less fixed income. This is a reversal by the Elaine Chao/Bradley Belt driven policies of 2004/2005 which reduced the equity holdings and added to fixed income holdings.
  

At the end of Q4 2007, SPX finished at 1468 while  30s where at 4.45%. This is a move of 8.5% lower in SPX and about two points higher on the long bond over the course of the quarter. This tends to cause a sizeable amount of rebalancing by balanced funds [buying of stocks, selling of bonds] although not necessarily prior to the end of the quarter as most have some discretion on timing. These rebalancings have sometimes occurred at the start of the following quarter and it is also possible that some has occurred already.