Looking back at the start of this

year, the markets began the year with good cheer and likely a fair dollop of

complacency. Fast forward to the second quarter, and all of a sudden the PIIGS

group of countries, double dip recession, and stubbornly high unemployment began

to gain investor attention.

As has been commented upon in this

space before, the bond market tends to be a better prognosticator of the

economy's direction than the equity markets - most of the time. In general,

rising bond yields have correlated with rising equity markets and falling bond

yields (i.e. falling interest rates) come about as economic uncertainty gives

rise to fear and panic.

So much effort is often expended on

trying to predict market direction or how much the economy will grow (often

turning out to be a fruitless endeavor) that all too often the obvious is

missed. From our perspective, we have been keeping a keen eye on the 10 year

Treasury yield (i.e. the level of interest investors are "charging" to be

lenders to the US Treasury).

Even the 2 Year Treasury yield has

come down to record lows as the bond market begins to price in an economic

slowdown and the potential for deflation to set it in. At this point, perhaps it

is too much too soon. Markets (including bond yields) never go up or down in a

straight line. But since April, our line in the sand was drawn as we watched

investors run for the safety of the bond market. This line in the sand was drawn

at the 3.10% level. As we can see from the chart above, the line in the sand has

been breached.

At these levels, the bond market

has discounted little fear of inflation. The gold bugs have been pounding the

table for years about the coming inflationary crisis that will be fueled by the

printing of money by the world's central banks.

From the most recent data from the

US Federal Reserve and the European Central Bank (ECB) it would seem that all of

the monetary grease that they have put into the economy is not making its way

into the economy - and this will be the case so long as the banking system

globally is not running at optimal efficiency.

It is hard to argue inflation when

US GDP numbers are being revised lower (not higher) for the last two quarters,

Europe is undergoing spending cuts and tax increases, and even the Canadian

economy has seemingly hit a rough patch for the month of April - surprising many

an economist. Yet if they would bother to pay attention to the bond market

(above chart), an economic deceleration has been slowly getting priced in.

However, that slowdown scenario

does not presage yet another recession or double dip. A double dip recession is

an infrequent occurrence - happening only once since the Great Depression.

However, for many individuals looking to recover from the last recession or to

get back into the labor force, the words "double dip" or "economic slowdown" are

just semantics - the impact is real.

Pacifica Partners Capital

Management
Suite 213 5455 152nd St
Surrey, BC, Canada
V3S 5A5

Tel: 604.576.8908
Tol Free:

1.877.576.8908
Fax: 604.574.2096

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