Systematic Relative Strength

…but Congress is quietly discussing ways to allow states to file bankruptcy and discharge or restructure some of their obligations, the New York Times reports.

Daily Finance reports that Social Security is now running in the red:

…federal spending and income data from the Treasury department reveal that the Social Security program is already deep in the red, with outlays exceeding payroll tax revenues by $76 billion in 2010 alone.

This wasn’t projected to happen until 2018, but it happened last fiscal year. The author points out that the Treasury has had to borrow money to pay Social Security benefits for 15 of the last 25 months.

Think about the law of supply and demand for a moment. Lots of borrowing means lots of supply. (Back in the olden days, like 1980, credit market analysts used to worry about Federal borrowing crowding out other issuers.) To compensate for the increased supply, the bond market is going to require increased demand, if higher interest rates are to be avoided.

What will increase demand for bonds? It’s tough nowadays even to find the risk-averse buyers of last year, especially given the lousy performance of government bonds recently. Foreign buyers are going to care also about the performance of the dollar. A weaker dollar would likely dampen overseas demand. A stock market correction might temporarily increase the demand for a safe haven, but that would come along with other costs to the economy and the nascent wealth effect. In short, increasing demand is going to be tough.

The better alternative is for the Treasury to reduce their borrowing and hence the potential supply. Let’s hope the economy, and thus tax revenues, expands quickly enough to stem some of the need for borrowing. Stay tuned, as this is likely to be a headline issue for a while.

The chart below shows performance of US sectors and capitalizations over the trailing 12, 6, and 1 month(s). Relative strength strategies buy securities that have strong intermediate-term relative strength and hold them as long as they remain strong. Performance updated through 1/21/2011.