When Government Bonds Go On Life Support

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Five years ago, if someone told you that a small but successful government bond auction was a sign of relief in the market, you would have concluded the market was in tatters. Government bond auctions are not supposed to be newsworthy. A sovereign government, until recently, was the lowest credit risk on the planet. Selling a few billion in three-year government bonds used to be so inconsequential that you might not even see it reported.

My, oh my, how things have changed! Today, the quality of sovereign credits is so lousy that a successful auction isn’t just news. It’s wildly bullish news! It’s so bullish that stocks in America rallied over one per cent overnight. Aussie stocks have followed that lead.

Could this stock market get any more dysfunctional? For the record, the Spanish government auctioned €3.2 billion worth of one-year and 18-month notes. This is chump change for the current times. And these are short-term borrowings. In other words, this should not be news. So why is it news?

It’s news because Europe’s banking system has been in intensive care for nearly two years now. It’s like a critically injured car crash victim hooked up to life support. Investors are like nervous family members who wake up and celebrate that the catheter is still in place and the respirator is still working.

Of course there is a big difference between a loved one in recovery and a monetary system on life support. But our point is you should look past the inconsequential news to the critical fact: Europe’s financial system is on central bank life support.

The plug will be pulled by either the public or the market. Officials are doing all they can to keep the patient alive. They are parasites. If the host organism dies, they die. You can understand their desire for self-preservation.

What is harder to understand, and what we’re urging you to resist, is the belief that any of this matters to the underlying earnings prospects of stocks. As our mate Kris Sayce says in his new presentation, “None of it matters!”

Our other mate Murray Dawes charged through the door with furrowed brow this morning. He says he hasn’t seen the Aussie market get stuck in a trading range like this for many years. It’s a combination of automatic flows into stocks from the superannuation industry, algorithm-dominated trading bots, and huge uncertainty about government intervention.

“Does that mean your theory of price action can’t operate correctly if there are external forces?” we asked.

“It means that in a normal market, the negative things that have stacked up – slower China growth, huge uncertainty, more volatility – would mean a big break in stocks. This isn’t a normal market.”

Murray is right about that. The stock market is now dependent on regular intervention in government bond markets to keep confidence up. In a perverse way, the support of government bonds by central bankers could drive everyone back into stocks. But that would be a reactionary move. We’d venture that most investors aren’t rushing into stocks because they have real value. They’re rushing into stocks because stocks aren’t government bonds.

Regards,

Dan Denning
for The Daily Reckoning Australia

From the Archives…

What the News on Bond Yields Say About the “Resolved” Eurozone Crisis
2012-04-13 – Eric Fry

The Art of Selling Stocks
2012-04-12 – Chris Mayer

Misguided Faith in an Economic Recovery
2012-04-11 – Joel Bowman

Beware the Big Government Debt Switcheroo
2012-04-10 – Dan Denning

The Discount Rate: Borrowers, Lenders and Bonds
2012-04-09 – Nick Hubble

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.
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2 Comments on "When Government Bonds Go On Life Support"

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Su-Lin
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Excellent write

Ross
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Courtesy of Karen Maley, the big 4 reserve banks now have 7 trillion on their balance sheets. With JPM’s whale positions and EU liquidity carry traders joining the reserve bankers useful idiot circus, the liquidity has to find a home at a time Obama looks like he might keep his powder dry in the Gulf and get out quicker from Afghanistan. A regular old melt up pre the US election – til the black swan next lands next week, anyway….

wpDiscuz
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