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THE TODD MARKET TIMER
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(August 18, 1997) FINANCIAL INSTRUMENTS: BONDS BLOODIED BUT STILL FIGHTING–The title of this section in our last letter was “Bonds Bullish But Near Resistance.” Bonds broke above that resistance set back in December of 1996 very briefly, but quickly sold off causing trouble for the stock market in the process.
So what was the cause? Most gurus would have you believe that the currency problems in Asia caused selling of bonds to meet other financial obligations. But we don't think so. One could just as easily argue that disruptions in foreign countries would cause a flight to the U.S. bond market.
We cover the currency connection more fully in our discussion of stocks, but let me offer the same explanation that I did with the stock market. We have had a nice rally since April and markets have a tendency to correct for reasons as mundane as profit taking. The bond market has been doing yeoman work for several months and it needed a rest. This is not the stuff, however, that headlines are made of.
Fundamentally, nothing has changed. We are in a moderate growth economy with a producer price index that has just registered its seventh straight negative reading. The only thing holding bonds back is probably the rational fear of a misguided Fed that still adheres to a discredited Philip's curve mentality. You know the Phillips curve don't you? That's the theory that higher rates of employment lead to higher rates of inflation. In other words, prosperity is bad. Never mind that more workers mean more taxpayers and less government borrowing...Oh, don't get me started.
Stephen Todd
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