Signs Point Away From Treasuries, but Not Because of Downgrade

Consider the evidence:

• Today, there is no liquidity crisis, as there was three years ago.
• Corporations are flush with cash.
• Corporate profits are at record levels, and more than 70% of earnings reports in Q2 2011 beat estimates.
• The broad economic data is still positive, admittedly slow, but positive nonetheless.
• We are adding about 150k jobs per month on average.

These are slow but positive numbers that against the backdrop of the recent equity markes moves seem to have a disconnect. Now, enter the Fed’s latest announcement meant to assure the market in the wake of the S&P U.S. debt downgrade. The Fed took the unprecedented step of signaling future action and putting a date on it. In the past, the Fed has said it will keep interest rates exceptionally low for an extended period of time. Last week, it said rates will be kept at these low, accommodative levels until at least mid-2013.

Reading the Fed’s tea leaves we arrive at two very interesting  conclusions. First, the Fed has in essence thumbed its nose at S&P and its debt downgrade. Normally a reduction in creditworthiness drives up rates because investors have to be enticed to buy debt that, supposedly, is more risky. Bernanke and Company, however, have  essentially told S&P: “You think rates are going up? Guess again. We’re keeping them low for two years.”

No silly downgrade is going to raise rates, not on Bernanke’s watch—unless, of course, economic fundamentals deem such a move appropriate. Further, the Fed is stating very clearly that investors will get nothing—nada, zero—in interest on short-term fixed income investments for two years, so look for something else.

As investors look for other opportunities, the obvious place will be stocks. The market appears to agree.