Stocks in 1974 or Japanese Bonds in 1996?

Roll, roll me away,
I'm gonna roll me away tonight
Gotta keep rollin, gotta keep ridin',
keep searchin' till I find what's right
And as the sunset faded
I spoke to the faintest first starlight
And I said next time
Next time
We'll get it right

-- Bob Seger, "Roll Me Away"

If I see one more chart from the bulls comparing this market to 1973-74, I'm going to react badly. The year 1975 witnessed the rise of both disco and the leisure suit, and I hereby submit to the jury that we should not permit any similar developments peaceably.

We are at the point in financial markets where as bad as stocks look, bonds may be just as risky. With 10-year notes yielding a scant 3.665% and 30-years at 4.714%, the future total return of fixed-income instruments is getting pretty skinny.

Even a 50-basis-point increase in Treasury yields will knock the price of the 8.125% bond due Aug. 15, 2021, the cheapest-to-deliver issue against the Treasury bond future, down to 134.68 from its present 142.31. A 100 basis-point backup, hardly inconceivable given the experiences of 1994 and 1999, sends the price down to 127.61.

No Cure For the Bubbletime Blues

Just because rates are low doesn't mean they cannot go lower. The postbubble markets of the U.S. in the 1930s and Japan in the 1990s, not the event-driven bear market of 1973-74, remain our best guideposts, but even these aren't very good ones.

The 1930s were a far worse period economically, and the Japanese experience has been characterized by runaway stupidity to the extent that the Bank of Japan is now trying to save member banks by buying their stock holdings.

Despite the depressions that have hit our technology, telecommunications and merchant energy sectors, and despite the massive losses in our stockholdings, our general macroeconomic picture is still better than those two episodes.

Most importantly, we can debate whether we are in any sort of deflation; those episodes clearly were deflationary.

Let's examine the Japanese interest rate experience of the 1990s and overlay our situation to see whether a reasonable analogy is developing in the interest rate market. Take a look at the yields on six-month eurodollar and euroyen markets. These interbank rates at the six-month horizon are most reflective of the market's expectations for short-term monetary policy.