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Transitions

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All transitions in life involve some amount of risk. And some transitions are in fact perilous: perilous either in reality or merely in perception (and determining which peril that is is life's real challenge). The risk part comes from voluntarily changing your circumstances: your home life, your work life, your health, your friends, your geography, etc. You are upsetting the apple cart: there could be a cost to that.

The peril part stems mostly from the forced, involuntary nature of certain changes: you simply don't have much control over transitions like childhood to adulthood, from being a parent to being a grandparent, from being healthy to being sick. Still other transitions involve both risk and peril: risk because of the voluntary changes you make and peril because of the forced changes that can occur as a result.

Such is life. Such is the stock market. And such is the economy.

I have written in the past about how the consumer is the keystone to the economy, about how the Fed, understanding this, is injecting liquidity into the economy in order to stir the animal spirits of capitalism. Tthose animal spirits are certainly working in the stock market: time will tell if they will work in the real economy. And I have written about how unusual the economy is acting - recession-like employment and capacity utilization figures - this late in the "expansion".

Which brings us to the economic transition that the Fed is engineering. By again lowering rates, injecting liquidity into the economy, and signaling that they are ready to keep rates low for quite some time, the Fed's aim is transition. They aim to transition the economy from consumer-led growth (low rates = housing refis = disposable income = consumer spending) to corporate-led growth (cheap capital = capex spending = employment gains = consumer spending).

We know that transitions involve risk. By injecting more liquidity into the system the Fed is making cheap capital available for industries to expand in which overcapacity is still a major problem, the Fed is taking a risk.

We also know that transitions involve peril because of the involuntary effects of change. And here's the peril part. Since the Fed's easing of 25 bps on 6/25, the ten year treasury yield is higher by 43 basis points: 3.27% to 3.7% as I write. Despite the Fed easing, the cost of money has gone up. And it has gone up swiftly. Now this increase won't affect capex spending plans by CIOs too much: theirs is a multi-faceted decision depending on many factors. But, should the upturn in rates stick (an outcome not yet determined), the effect on the consumer - thru refis and the mortgage/homebuilding sector - could be more meaningful.

To this end, I pulled up a graph on my Bloomberg comparing the S&P 500 homebuilding index (S15HOME on your Bloomy) to the yield on the 10 year treasury. Then I checked their correlation since 1996: a negative 80.4% correlation (weekly scale, 392 observations). Makes sense, of course: higher rates mean fewer home purchases, mean lower earnings for the homebuilders, which mean lower stock prices for them.

There are lots of good reasons to be keeping an eye on the 10 year treasury. The fact that it may be throwing a wrench into the Fed-engineered economic transition from consumer to corporate growth is another one. There is risk, no doubt. The real question is whether the peril is real or imagined. Stay tuned.

No positions in stocks mentioned.

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