2011-Long the Dow

US 2 Yr yields today reached 0.75. Seems the market is inclined to follow the footsteps of the QE1 trade, stocks up, treasuries down? And what of the Dollar? Will the dollar be sold as the Dow is bought?

Quotes:


Dow 11562
FTSE 5973
GBP/USD 15364
EUR/USD 13106
Gold 1405
Silver 30.23
Crude 9125
US 10 YR 3.49
US 2 YR 0.75
USD/JPY 83.74
USD Index 80.4


Treasury auctions today attracted the weakest demand in 6 months, with a bid to cover ratio of 2.61. So are Treasury's a buy or a sell right now? Depends on your timeframe. From what I have read it seems likely that in March, with $700 Billion of debt willl require restructuring from the likes of Portugal, Spain, and Belgium, so the typical buy treasury's safe haven scenario as we have seen with Greece and Ireland is likely to play out again. I think it unlikely that the 2010 lows reached by the 10yr and 2 yr alike would be likely to be breached.
Further bad came from US home prices declining more than expected.

Ok so I have been trying to figure out whether it's inflation or deflation, whether the 20 yr bull market in bonds has come to an end? And having read extensively over the arguements on either side. Here are my findings;

The central tenet of the deflation arguement, in the US, is that there is 54 Trillion USD of outstanding debt, the ratio private sector debt to GDP is at record levels. The arguement is that the sheer weight of this debt, and the addition of private sector deleveraging, and the destruction it has on money supply (i.e. the lack of additional loan creation which increases the supply via fractional reserve banking) means deflation will be the driving force.

Now this is a strong arguement, one that has some similarities to the Japanese deflation era (however the savins rate in Japan is much higher, and also the population demographic is rather different), and despite years of money printing/quanttiative easing Japan has not managed to escape these "deflationary" forces.

The premise of the arguement for inflation, is essentially unprovable, in quantitative means. It's more of a proof by historical reference, whereby the majority of times money has been printed to such an extent, when the economy recovered, money veolcity picked up, the excess reserves flowed out, and inflation soared. As you can see with commodities reaching record highs, gold at $1400, Silver at $30, the market does not believe Ben Bernanke will be able to act accordingly to put inflation back into it's place. Given the oustanding debt and weak housing market, does he have the capacity to raise rates?

Neither of these arguement's really governs my outlook. Essentially my base case for 2011 is that the Dow will continue to rise. Corporate earnings will continue to outperform, and beat estimates. This is a bull market, and the consensus that inflation, or deflation, Bernanke will continue to print to accomodate the market, means, in my opinion, that the Dow is likely to continue to trend upwards and perhaps even make new highs in 2011.

Given this, and given the nature of the market dynamic in 2009, I think it is likely that traders will stick to a similar script of yields moving higher. Eurozone issues are likely to provide opportunities to buy into the Dow and to sell treasuries as risk comes back in after the moments of panic. Now, what of the Dollar?

Surely it is too early, even with earnings season coming up, and the likelihood of the Dow to conintue upwards to 12,000, surely it is too soon for the market to price in interest rate increases (by the Fed). I would be observant of how in the ocming weeks the dollar trades, with respect to the rising Dow, to decide at which point it is favourable to begin longing the dollar as part of a possible move up to 90 and beyond, on the dollar index. However, with Eurozone issues likely to take a backstage as earnings news comes in, we will have to see whether the dollar will be rallying with the dow, or selling off with it to observe what the correct trade will be.