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Nick Godt's Market Medics
Dec. 9, 2010, 5:27 p.m. EST
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Kodak shorts on the run
By Nick Godt, MarketWatch
NEW YORK (MarketWatch) "” Stock market and bond market investors are having it out just before closing the books on the year, if not about which asset is going to win in the coming year, at least about what narrative to which they should stick.
A sell-off in U.S. government debt this week came in the wake of the extension of the Bush-era tax cuts, which would add $4 trillion to the deficit over the next 10 years should they be extended beyond 2012, according to the independent Congressional Budget Office.
For stock bulls, the narrative runs this way: Keeping payroll tax cuts will boost consumption, while the tax cuts for the rich will encourage small business owners to hire. And both work to lift the economy out of its current morass.
David Reilly says that when it comes to bolstering growth prospects, or at least investors' belief in them, the Fed may deserve a better grade than it's been given credit for.
From a stock market point of view, this explains the sell-off in government bonds, which lose value as fixed-income assets when the outlook for growth and inflation improves.
Bond market investors, meanwhile, say the sell-off is due to the huge amount of extra government debt that will result from the tax cuts. Their narrative again raising the specter of the so-called bond-market vigilantes. After savaging the sovereign debt in Greece, Ireland, Spain and Portugal, they've now set their targets on U.S. debt, we're told.
Treasury yields, used to benchmark key borrowing costs such as mortgage rates, are about to soar. That will throw the U.S. in the same boat as Europe, unless deep cuts in government spending are made elsewhere, they say.
But both narratives have to be taken with, say, 10 grains of salt.
First, the "?sell-off" in the bond market has brought yields in benchmark 10-year notes /quotes/comstock/31*!ust10y (UST10Y 3.21, 0.00, -0.09%) back to their level from June. Thus far in 2010, yields are still down, reflecting both a much slower economy than most expected at the start of the year and the Federal Reserve's purchases of Treasurys to try and contain the damage.
Second, as CBO director Doug Elmendorf told Congress back in September, the economic boost from extending the tax cuts is expected to be rather small next year, as the psychological impact is reduced when cuts are not made permanent.
Third, the very weak November employment report and Fed chief Ben Bernanke's recent remarks all strongly suggest that the central bank won't back down from its commitment to support the economy and fight deflation by buying more Treasurys.
More than anything, it's that commitment that's keeping stocks afloat, guaranteeing investors can borrow cheaply and seek higher yields wherever they may be.
And by Thursday, the higher U.S. yields already seemed attractive enough to bring back interest in government debt. Meanwhile, bond vigilantes were likely out having a drink somewhere.
Nick Godt is MarketWatch's markets editor, based in New York.
A sudden pop in the share price of Eastman Kodak rattles those still betting against the company, Jim Jelter writes.
3:06 p.m. Dec. 9, 2010
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"RT @tpoletti: Salesforce.com making deals, slinging mud http://on.mktw.net/gxGMD1" 6:23 p.m. EST, Dec. 9, 2010 from MarketWatch
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