The persistence with which the market has pushed higher the last few weeks has caught plenty of people by surprise. Macro Man pieces together data from several markets, offering a good perspective on the kind of rally that’s being seen. It’s significant in the equity markets, which are up 20% off the November lows, and many sectors that have been taken out to the woodshed previously are up even more.

Across several quality classes, the credit markets have also seen bounces off their lows and rallied hard in December.

Corporate bonds have participated. First is the investment grades…

…and next is the high-vol credits.

Even AAA-rated subprime has caught a bid.

And much-maligned leveraged loan spreads have come down substantially.

Where does that put us? Well, the rally in stocks comes off what I’m calling the “Citigroup (C) Bottom” – attribute it to what you will (sheer bear exhaustion?), but the major event at that time was the government’s secondary capital injection into Citi. The reversal in sentiment toward equities since has been stunning.

As I noted before, Laszlo Birinyi is adamant that the S&P has bottomed. But I’m not ready to agree, because the current bottom coincided with a very artificial inducement – the government assuming hundreds of billions of risk off Citi’s balance sheet. The roots of this crisis started with an artificial market bottom because of policies that allowed a critical mass of debt to build up; right now that debt is not being worked off through repayment or write-offs; instead it is being transferred to the federal government.

Being the world’s reserve currency has its benefits, and the US has a relative advantage over, say, the EU, because of that. But longer-term, dollar holders will only accept monetizing deficits – which seems to be exactly what will happen – to a point. And if that point is reached, then it’s doubtful we will be worrying about lows on the S&P, because inflation will have already done a number on purchasing power. But bubbles normally persist much longer than anticipated, and that’s why I don’t expect the great Treasury unwind to be a 2009 story.
A final note: despite the rally in the equity and credit markets through December, short Treasury yields are basically unchanged, although yields on the long end have edged up a bit. This is one indicator that the appetite for return-free risk is still strong.

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