Possible Bottom in One to Two Months?

 In the next one to two months I expect panic in the markets to reach a new high due to three issues:

(1) U.S. "Paying the Piper"
(2) European Debt Crisis
(3) Slowing Asian Economic Growth

During this time I expect the yield on the 30-year treasury to dip well below 3% as investors seek out safe harbors and away from volatile equity markets. Yields on longer term treasuries may even go lower if the markets believe the Federal Reserve may pursue "Operation Twist." This initiative by the Fed would effectively involve buying longer-term bonds in an effort to push down the yield curve, a theoretical economic stimulus. I am not yet convinced of this potential action since I believe the Fed is increasingly pointing the finger at Congress to address structural problems in the economy. But, if speculation builds and yields fall, then I may sell my 30-year treasury position into the buying strength.

U.S. "Paying the Piper"
Everyone has an opinion about who is at fault for the mess, and even a few have opinions about the correct path forward. However, as I laid out in my July 12 article of Pro-inflation Democrats versus Pro-deflation Republicans, whatever path we follow likely involves pain. The future pain is called "paying the piper" for 30+ years of rising debt levels, perversion of the government by special interest money, and an over-active monetary policy that enabled bad behavior. Given the anticipated on-going partisan politics, I expect nothing short of complete crisis to force the two sides into constructive efforts forward. A telling sign of what's to come is the composition of the super committee put together to find $1.5 billion in deficit reductions. Both sides favored members who lean away from compromise. Given that both sides are gearing up for a Presidential election, the outlook for country first, party second is quite bleak.

So with the consumer confidence falling, zero job growth, a government actively suing for billions of dollars from the banks, and a government favoring austerity; it seems like an economic slowdown is in the cards going forward. Americans are already sick of politicians fighting and I expect to hear a lot more partisan bickering over the next couple months. This is likely bad for stocks and good for treasuries in the short-term.

European Debt Crisis
Europe appears caught in a death spiral of austerity initiatives to reduce deficits resulting in slowing economic growth and thus larger deficits. Greece and Spain are about a year into this spiral and now Italy looks set to follow in its foot steps. As yields on the country's ten-year bond approaches 7%, I expect increasing panic to set in since 7% is considered an unsustainable level for debt service. The CEO of Deutsche Bank warned that weaker banks in Europe are vulnerable to a revaluation of sovereign debt, suggesting that sticking the problem to the banks is not a viable solution. Thus the issue likely circles back to the governments who either vote for bailouts of weaker countries (unpopular in Germany) or a combination of further austerity measures and debt defaults. I expect these issues to come to a head over the next couple months as bond investors increasingly fear a default, thus driving up yields and forcing the hands of the politicians.

Slowing Asian Economic Growth
China's economy appears to be slowing, as shown by a service sector flirting with actual contraction, increasing signs of corruption impacting middle class decisions, and signs of the potential popping of a real estate bubble. China's economy is the second largest in the world and therefore a slowdown likely impacts global financial markets. For some time there has been speculation that the growing wealth within the middle class could propel internal growth, lessening the reliance on exports. However, it is hard to imagine how China could continue to prosper if both the U.S. and Europe went into a recession since well over a third of China's GDP comes from exports. Even more so since the government already made a massive fiscal stimulus into the economy in 2008. Therefore, I believe financial markets likely increasingly focus on slowing growth in Asia as a concern.