The Real Reason Stocks Look Shaky

Andy Snyder|September 29, 2021

What’s going on with the market?

Stocks have fallen. Rates have risen. And investors are getting nervous that more pain is on the way.

They shouldn’t be.

The same forces that have propelled stocks to one record after another are still in force. And they’re as strong as ever. This week, though, those key indicators were covered in a film of filthy smog spewed out by the folks in Washington.

We’ve long said the biggest threat to your money isn’t a faltering American economy or some fundamental issue with stocks. It’s the dopes in D.C.

Proof, as always, comes from the never-tell-a-lie Treasury market.

Digging Deeper

Turn on the TV or go to the most popular financial news sites, and you’ll see a quote for the 10-year Treasury. It’s the benchmark. We use it all the time.

But it’s only the cover of the book. It gives us a fair glimpse of what lies inside. But it fails to offer much detail.

There are a few reasons for this.

First, the 10-year represents the secondary market. It represents the yield on bonds that are already trading. It doesn’t give us much of a sense of the overall demand for all the new stuff being dumped into the market.

For that, we must turn to the primary market… or the auctions that issue new debt.

And while the 10-year represents a bit of a Goldilocks time frame, it doesn’t give us a view of the broad spectrum. For that, we need to look at short-term and long-term notes.

We got a good view of the former earlier this week.

The auction action for two- and five-year Treasurys tells us exactly what is going on with this market. It’s not a view you’ll get by merely scanning the headlines.

The Truth… Revealed

On Monday, Janet Yellen and her crew at the Treasury auctioned off some $60 billion in brand-new two-year debt.

It was a bad week for Washington to hock more debt.

Not only is Jay Powell making his rounds on Capitol Hill this week saying inflation will stick around longer than he thought, but the power-yielding folks who were actually elected to their positions (unlike Powell and his front-running cronies) are also pushing the nation’s government to the brink of not just a shutdown… but a showboating default.

The yield on the auctioned-off two-year notes came in at 0.31%. That’s the highest rate since the height of last year’s meltdown.

But the Treasury devil is in the details… or the decimals.

You see, government debt is first announced and then issued. And the boys on Wall Street are impatient and greedy. They start trading new Treasurys as soon as they’re announced. They don’t wait for the printer. It’s usually just a few days.

That’s why there’s something called the “when-issued yield.” It represents the initial price traders were willing to pay.

In this case, that price was nearly a full basis point higher than the auction yield. It tells us that bond prices fell significantly in the short time between the announcement and the issue.

That’s not a good sign.

Nor is the bid-to-cover ratio.

This key figure shows us how much money was in the pockets of folks bidding for Treasurys. It measures the total bids for an auction versus the amount up for sale.

The higher the number, the higher the demand for Uncle Sam’s debt.

In the case of this week’s two-year notes, the bid-to-cover plunged to 2.28 – the lowest level since, gulp, the Lehman Brothers bankruptcy in late 2008.

Again… that’s the two-year Treasury, the short-term end of the spectrum.

Longer Looks Better

Uncle Sam also sold a slew of five-year notes on Monday. These notes accounted for $61 billion worth of debt.

In the grand scheme of things, the difference between the two-year and the five-year is not all that large. But when we’re looking for short-term clues in the market, the gap gives us a good sense of the trend (a 20- or 30-year bond would be better, but the last auction of those was several weeks ago).

In Monday’s action, the five-year auction was much healthier. The auction yield was 0.4 basis points lower than the when-offered price… signaling that demand was on the rise with this one.

Better yet, the bid-to-cover ratio was higher than it was last month – coming in at 2.37.

What does this tell us?

It’s pretty simple.

If long-term inflation were the worry, the gap between the two-year and the five-year wouldn’t matter all that much. In fact, longer-dated bonds would likely look worse.

But that’s not the case – not at all.

It’s not inflation that the investors who are selling their stocks this week are worried about… it’s a shorter-term mess. It’s the debt ceiling fight and the small but lingering chance of a crushing default.

For investors willing to go against the crowd, it’s a tremendous trading opportunity.

Remember, we’ve been through this childish mess every year for the last decade or more. It’s a short-term blip fueled by politics.

Our advice… take advantage of it.