Thursday, June 25, 2009

Consumer comfort bodes ill for risky assets but should depress government bond yields

While not that much news has come out this week and despite risky assets having shot higher again over the past two days, Bunds continue marching higher in a quiet fashion. The bear-trend which started in early March has by now been broken (see chart), confirming the brightening outlook for govies.
Furthermore, while USTs have lagged over the past days (also in the wake of yesterday's FOMC-statement), this week's UST auctions have calmed concerns about a buyer's strike, at least for the time being.
Interesting to note as well is that the ABC weekly consumer comfort index is almost back to its lows. The index bottomed in December/January and then recovered up to early May. However, since then it dropped by 10 points again and is just 1 point ahead of the former lows. The reasons for the renewed drop are likely to be found in the combination of ongoing weakness in the housing market, more job losses, tame wage growth and the rise in oil prices. The chart below compares the development of this ABC index with the S&P500. The consumer comfort index peaked in early 2007, well ahead of equities. It bottomed during December08/January09, two months ahead of the bottom in the S&P. From that perspective the drop over the past 5 weeks does not bode well for equities.
Source: Bloomberg
The chart below compares the ABC index with the development of 10y UST. Here, the co-movement appears even closer. Last year, there was one big divergence as bond yields rose starting late March, whereas consumer comfort declined further. Over the past weeks, the same divergence has re-appeared.
Source: Bloomberg
I think that the health of the consumer (and its demand for consumer goods) is vital to get us back on a sustainable growth path, not least because of the high size of consumption relative to GDP. From a historic and a fundamental perspective, the latest drop in consumer comfort bodes ill for consumption which might well drag equities and government bond yields lower again. Stick to a defensive asset allocation and stay long in UST and Bunds.

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