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The Thigh Bone is Connected to the Hip Bone


In the quest to cure my son's illness, my wife and I have spent an excruciating amount of time surveying the healthcare landscape over these last 9 months: reading medical journals, speaking with specialists, purchasing books, researching nutrition, tracking down studies, waiting for procedures, analyzing a lifetime's worth of tests, joining support groups, and otherwise gulping hard from the medical fountain. It is not a drink I recommend.

But here's what we've learned: the hip bone really is connected to the thigh bone.

No, I'm not trying to be blasé. Our travels - real and metaphoric - have taken us through an extraordinarily wide range of medical specialties, allowing us to see, well, how they all interconnect: how the medical field's hip bone is connected to the thigh bone. And let me tell you, few in the healthcare industry know that the hip bone is connected to the thigh bone. Surgeons know surgery. Specialists know their specialty. Researchers know research. Almost none know about the other. And fewer even can see the connected forest from the seemingly disparate trees.

But this is not a diatribe against the profession. No, it is merely an important observation: everything is connected, either directly or indirectly. In medicine (hip bone and thigh bone), in physics (string theory), in mathematics (chaos theory), in life (charity), and - you guessed it - in the capital markets.

Tomorrow Fed Governor Ben Bernanke is giving a speech at UC San Diego at 11 AM ET. He will speak about "An Unwelcome Fall in Inflation." Governor Bernanke first spoke about deflation way back in November 2002, with a speech entitled "Deflation: Making sure 'it' doesn't happen here". It was, as we now know, the (in)famous printing press speech, setting the financial table with the Greenspan Put (the Fed will buy your treasuries from you), a falling dollar (the DXY was at 105.80 - it is now 96.40), and some pretty serious liquidity-driven speculation in the stock market.

The treasury market has been selling off at a pretty rapid pace since the last 25 bps clip of the Fed funds rate on June 25, with the Ten year yield going from 3.2% to today's 4.2: 100 basis points in 27 days. That's the equivalent of four 25 bps tightening actions in the Fed funds rate. And the word on the Street is that the Fed is none too happy about the bond market's reaction the 25 bps clip on the Fed Funds rate. After all, they'd like rates to remain as low as possible so that mortgage refi-induced consumer spending gets the US economy through the Capex trough. Yes rates are still low and balance sheets have improved, but consumer liquidity needs to remain high to get us over that capex hump. 100 bps matters. It will certainly matter to the mortgage business. It will matter to retail sales. It will matter to car sales and other consumer durables.

From the beginning of 2000 to April of 2003, stocks and bond yields have had a positive correlation of 89%: as bond yields fell, so did stocks. From April to now, there has been no correlation between the two. The latest bond yield run-up has been in an environment of largely sideways stocks.

So here's what we have: a Fed that is frustrated by the increase in yields, a speech by one of the more vocal reflationists in the Federal Reserve, an overbought US dollar at its trendline resistance, oversold bonds, stocks that are signaling technical damage, expectations (in earnings, in bullishness) at positive extremes, and poor seasonality.

I have no idea what Bernanke is going to say tomorrow. Maybe he will jawbone to get a bid for treasuries. Maybe the dollar gets sold again if he talks about all the free money the Fed can print. Maybe the bond/stock correlation of 1/00 to 4/03 will return. But his November 21st speech was notable for timing purposes: stocks, bond yields, and the dollar all put in important tops four days later.

Keep in mind our lesson from above, that everything is connected. Bernanke's jaw bone make affect this stock market's thigh bone. Let's see if it does.
No positions in stocks mentioned.

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