Not everyone’s worrying that rising crude oil prices will impair economic growth, but you can count the bond market in as one more pessimist.
We say that based on the observation that the yield on the 10-year Treasury Note has come down off its late-winter/early spring spike. After jumping to roughly 4.65% in late March (the highest since June 2004), the tide has since turned. The rate on the 10-year closed at roughly 4.4% in today’s session, and the way traders are feeling lately it wouldn’t take much to imagine that a test of the 4.0% level is coming.
In the standard scramble among journalists to “explain” why rates are falling and the bond ghouls are becoming giddy once again, Reuters ventured a guess by reporting that a profit warning from Ford last week spooked the market. One bond trader observed: “There’s a huge camp out there that believes the economy is slowing down, and the Ford thing urges them on.”
Perhaps. If so, Tuesday’s retail sales report from the U.S. Census Bureau provides an opportunity to support or reject the renewed confidence of the bond bulls by parsing the March tally. For the moment, it’s anyone’s guess as to the outcome, says one economist on the eve before the release. “Retail sales is a real big uncertainty–we will find out how higher gasoline prices have impacted consumer spending,” Richard Yamarone, director of economic research at Argus Research, says via ObviousNews.com. “There are a number of questions that are lingering, and as always the number-one question for bond holders is ‘what is the inflation outlook?'”
But the strategists at BCA Research aren’t waiting. On Friday last, the respected advisory shop in Montreal, Canada dramatically reduced its global equity weighting for April to 66% from 91% in March. “This month’s reduction is across the board: weights were reduced in both Europe and Japan,” BCA writes. “The model maintains a zero weight in U.S. equities.” Where’s the money going? “Capital has been re-allocated to bonds, the bulk of which is in the U.S. market, following the backup in yields in the past two months.” (Yields, of course, may be turning down again, but let’s not quibble just yet.)
To the extent money managers need or want equity exposure, what’s a prudent investor to do? For one thing, start thinking like a bond investor and then translate that into equity management. BCA offers some tips, starting with a review of who’s vulnerable to high oil prices and who’s less vulnerable. “The impact of rising oil prices on equity markets is a function of the oil intensity of economic activity and the composition of stock market capitalization,” BCA counsels.
By that reckoning, the Japanese market is the “biggest direct loser” of a gusher in oil prices by virtue of the county’s 1.3% total market cap in oil producers vs. 38.5% in oil consumers. A bearish ratio, to say the least. On the opposite extreme is Canada, whose equity market cap is comprised of 21.6% percent vs. 10.5% in oil consumers. (For U.S. perspective, the scales tip in favor of oil consumers: 14.3% over oil producers’ 8.2%.)
The outlook that oil prices will stay relatively high, if not continue to ascend, favors oil-heavy stock markets such as Canada’s, the BCA report suggests. In other words, if you want to stay bullish as an equity investor, start thinking like a bond trader.
On the other hand, higher-than-expected inflation may trip up paper assets of any and all varieties. For the moment, hope springs eternal that only good news will prevail, in part nurtured by the Fed’s long-running comments using such buzzwords as “contained” on matters of future overall price trends. But then why is Philadelphia Fed President Anthony Santomero, who’s also a voting member of the Federal Open Market Committee, making noises to the contrary? Then again, is he making noises to the contrary?
“We have to be vigilant about inflation…” Santomero told Reuters yesterday. “We are looking at an economy that, to the extent that it continues to move in the direction at the speed we think and most forecasters believe is the case, we can continue to move as we have.” Translated: the 25-basis-point rate hikes that have prevailed since last June will continue. “But we are prepared to do what is necessary either way to respond to incoming data.”