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Wednesday, April 16, 2014

Financial market conditions

Knowing how to interpret economics signals is sometimes more art than science. First, there is no magic or commonly known formula that takes so many variables in to account that it can determine the direction of markets or economies with 100 percent or even 95 percent accuracy. If there was, the Great Recession would have been far less likely to have occurred. Secondly, the relationship between economic and market variables is so complex and elaborate that it would not only require a perfect formula, but also access to a large amount of timely data and a lot of computing power. These are not things every or even the majority of investors has available to them.

Having recognized the shortcoming of financial analysis reports, market information releases and economic forecasting formulas, they are not without their uses as they do have some evaluative accuracy and predictive capacity. Efforts are constantly made to understand, report about and forecast the future direction of prices. The following Accuvest slide show is one such attempt and includes 64 slides covering recent market, industrial and economic data. It is divided in to several sections including financial conditions, fixed income and credit, global equity, the economy and currencies and commodities.
Chart Book and Financial Market Update (4/14/14) from advisorshares

To illustrate how economic signals conflict, consider slide numbers 19 through 30. They detail information about fixed income and credit. Of these the break even inflation rate on slide 24, investment grade bond prices on slide 25 and the investment grade vs 10 yr-Treasury spread on slide 26 seem to stand out. This is because the economy is supposed to be improving per the Federal Reserve Bank. Moreover, if economic growth is accelerating, why is inflation declining? Monetary policy is one explanation as it affords low-cost debt at the moment. This can be interpreted as meaning the Federal Reserve Bank is still trying to accelerate economic growth.

The reason why the investment grade bond prices on slide 25 are interesting is because their prices are rising. Rising bond prices typically means higher demand and lower yield. Moreover, bond demand rises along with economic or market uncertainty. This seems to suggest that equity holders  and/or bond purchasers are sensing market risk therefore demanding more bonds, thus driving the price up and the yield down. High yield bond prices have also risen per slide 27. 

Treasury yields also indicate a rising demand as prices have been rising for them. Yet, the source of demand is more likely to be at least partially attributable to monetary policy.  Furthermore, according to Zero Hedge, the Federal Reserve Bank was the largest holder of U.S. Treasuries toward the end of 2013 and held $2.16 trillion worth of them, up $517 billion from a year earlier. In addition, many countries excluding China have been investing a greater amount of U.S. Treasuries per the U.S. Treasury Department.

Just based on the information discussed in this post, and not the entirety of the information within the slides, it is difficult to say where the economy is actually heading. This is because the Federal Reserve Bank is supporting and/or stating growth is on the rise, yet investment bond prices indicate otherwise. Equity markets, especially Japan, have also slipped recently and gold prices have been rising. So, there is conflicting evidence, which can mean more due diligence and research would be needed to develop a more accurate evaluation or that economic recovery is not too steady as the Federal Reserve Board Chairwoman has already stated.