Trendline Deception

Every investor looks at charts.  Even those who are not technical analysts check out the captivating image.  A chart conveys plenty of information at a single glance.

Then there is the problem of interpretation.  At "A Dash" we have tried to do some de-bunking of deceptive charts.  A type that is particularly deceptive is the phony trendline.

Interest Rates and the Trend

With the ten-year note approaching a 5% yield, investors are taking note.  As a round number, it attracts attention.  Some also see some technical significance.  The chart below, cited today by Doug Kass in his influential column on StreetInsight (subscription required and worth it for serious investors) shows one interpretation of a long-term trend.

Doug's interpretation, represented by the white trendline, is that a thirty-year trend to lower rates has been broken.

The implication is not clearly stated, but it seems that we are to fear an  upside breakout in rates.

Interpreting Trendlines

A trendline based upon a moving average covering a relevant time period can be quite helpful.  What about a "trend" that takes two data points, thirty years apart, and suggests some inference?

Our conclusion:  Totally bogus!

There are several problems.

• Who cares about the slope from the peak of  the high-inflation era in the late 70's to the peak of a year ago?  If rates had been a little higher back then, the slope would be steeper.  If rates had been a little lower at the peak, it would be more gradual.  Use some common sense!  What difference does the exact peak thirty years ago have for today's bond prices?  None.
• Such charts are extremely subjective. The red line on the chart shows a different trend connecting several peaks.  What did that tell us?  If you started the chart in the 90's you would have yet another picture -- totally different.
• The conclusion makes no sense. The "trend" suggests that interest rates are going to zero at some point, mostly because of the 70's extreme.  That rates would level off at some point is not at all surprising, and did not signal an out-of-control breakout.
• One could pick various other peaks and draw different lines.  So what?  The result is in the eye of the beholder, and the person drawing the trendline.

Factors Influencing Interest Rates

Barry Ritholtz at the Big Picture had a nice summary of fundamental factors influencing interest rates.  The elements include an increase in global rates, strong foreign economies, reduced chances for an imminent Fed rate cut, and a possible move by foreign governments away from U.S. debt instruments.  While Barry does not like to acknowledge this, we would add recognition by investors of greater strength in the U.S. economy, shown by all of the second quarter data.

The fundamental factors are important, and interest rates may well move a bit higher.  It is an important thing for all investors to watch.  We certainly are.

Conclusion

The "stock yield" from forward earnings projections remains much higher than the bond yield, even with bonds hitting 5%.  That is part of our thesis for stocks moving much higher in 2007.

Meanwhile, we continue to wait for those who based recession forecasts on the inverted yield curve to draw the intellectual honest and consistent conclusion that recession chances have declined.  Readers may wish to watch for this conclusion or whether the recession  predictors use some tortured logic to explain why this time is different.

Our conclusion is that the economy is healthy and current interest rates are still supportive of higher stock prices. 

Comments

[Bill aka NO DooDahs!]

http://theroxylandr.wordpress.com/2007/03/06/goldilocks-have-bad-productivity/
"Just relax and prepare yourself for the recession." - from 3 months ago.

http://theroxylandr.wordpress.com/2007/01/24/the-recession-call/
"Here I would like to join those very few who predict that a recession will happen sometimes this year." - from 5 months ago. LOL on the "very few" line, bears like to pretend they're all alone.

http://theroxylandr.wordpress.com/2006/12/07/about-first-day-of-recession/
Said we had 3 months before the recession, worst case, and that was 6 months ago. Later updated to say we wouldn't have a recession before April.

http://theroxylandr.wordpress.com/2006/08/01/bushnomics-heading-to-recession/
The title says it all, from 10 months ago.

Cheers!

[Steve]

theroxylandr,

Be honest. How long have you been saying that?

[theroxylandr]

I totally agree that yield curve will invert back before we get into recession. It could take another 2-3 months before that happens, it's not so fast.

So, if anyone think that we'll have a recession in just a few weeks - no, we will not.

[oldprof]

Barry --

The White House forecast for the year is now 2.3%. Since the first quarter is already in the books at .6%, that means the average for the rest of the year has to be almost 2.9% (the original forecast).

Let's put the question this way: If GDP growth rebounds during the rest of the year, making Q107 the low point of the cycle, most will say that growth is recovering. Would you still call it "decelerating"?

Any period that includes Q1 is going to look weak.....

[Barry Ritholtz]

It looks like the White House is joining those who see the economy decellerating: They just lowered their forecast for economic growth this year even as it slightly upgraded its outlook for unemployment.

Under the administration's new forecast, gross domestic product, or GDP, will grow by 2.3 percent as measured from the fourth quarter of last year to the fourth quarter of this year. That's down from a previous projection of 2.9 percent.

[oldprof]

Barry,

Thanks once again for stopping by to make sure that I reflected your viewpoint accurately.

I was really just trying to add a factor to your excellent list of fundamentals. Many investors see solid strength in the low jobless claims, unemployment rate, ISM manufacturing and services reports, and consumer confidence. The 1st quarter GDP and last quarter's railroad revenues are old news for bond traders.

So -- even if you are correct in your long-standing opinion about economic growth, the market is bigger than any single pundit.
Those who do not share your viewpoint about weak economic prospects for the US economy are undoubtedly among those selling bonds.

Thanks again,

Jeff

[oldprof]

Steve -

The mortgage and PCE chart was widely publicized by Doug Kass, but I get the feeling that he did not actually create it.

The chart used here also happens to come from Kass, but it is an example of something that many people do.

Thanks,
Jeff

[RB]

The inverted yield curve based on the Wright model using 90-day average of bond yields did not predict a recession.

[Barry Ritholtz]

This is a perfect example of why I do not think the economy is so robust:

Sector Snap: Rails Down on Freight News
http://www.chron.com/disp/story.mpl/ap/fn/4866624.html

Shares of the nation's largest freight railroad operators traded lower on Wednesday, after an executive at eastern carrier Norfolk Southern Corp. reported that its freight volumes so far this year are down nearly 4 percent.

Shares of Norfolk Southern fell $1.13 to $56.84 in midday trading, while shares of eastern rival CSX Corp. retreated 99 cents, or 2.2 percent, to $44.94. Shares of Union Pacific Corp., the nation's largest railroad, gave up $1.58 to $119.40 and shares of its rival in the west, Burlington Northern Santa Fe Corp., fell $1.72 to $91.18.

The activity came after Norfolk Southern Executive Vice President Don Seale told analysts earlier in the morning that economic headwinds continue to affect its freight volumes.

Seale said in a Webcast he agreed with popular sentiment that says the U.S. economy currently lies "somewhere between resumed growth and recession." He said freight volumes at Norfolk Southern so far this year are down nearly 4 percent.

[Barry Ritholtz]

Its not that I don't "like to acknowledge it," its that I simply do not find much strength in the US economy -- most especially when compared with Europe and Asia.

The 2nd Q looks better than Q1, but thats onluy by dint of the pathetic 0.15% growth for the Q (0.6% annualized).

We should see some inventory rebuild, and exporting manufacturers are doing well thanks to global demand and the weak dollar.

But Housing remains a drag, and as we have seen from the Retailers, consumers are starting to tire.

[Steve]

Was it Kass who made that mortgage tightening vs. PCE chart?