"If I were trying to create a deflationary bust, I would do exactly what the world's central bankers have been doing the last six years." Stan Druckenmiller, May 3, 2018 - 2018 Alexander Hamilton Awards at the Manhattan Institute
I hope that life finds you very well - in good health and in good spirits. Before we get started, I have a personal wish that we witness a trend towards unity versus division in our country as we come off of our nation’s 4’th of July holiday. I was recently in Washington D.C., and I couldn’t help but carve out some time to go and walk around the Lincoln Memorial (so special). I know you know what an incredible privelege it is to be a citizen in this great country of our’s (and that time certainly served as a reminder for me). Now, I was not working during the Vietnam conflict years and so I cannot say firsthand how bad the division was then. But I cannot imagine that the harsh division we’re seeing today is any better than it was back then (seems worse today to me). My sincere hope is that we all come together more as Americans as opposed to being at each other’s throats.
Sneak Peak 2018
The popular parts of the stock market sort of peaked around January 26’th. On the 23’rd, Insights was titled, “Pick Some Things and Sell Them 3.0”. I didn’t say sell everything and head for the hills. I also didn’t try to call a top in the market. Being invested and staying invested through cycles is very important. But also recognizing late cycle warnings is critical to preserving capital, as I’ve mentioned many times. Though this market’s earnings has legs (see the runner below), at this point in the cycle, you’ve just got to be aware of the hurdles and headwinds it’s facing. Overall, as I’ve said for months now, you want to be a net seller of risky assets rather than a net buyer of risky assets.
Tailwinds AND Headwinds
Why be a net seller of risky assets?
“Facts do not cease to exist because they are ignored.” - Aldous Huxley
One of the best ways to avoid big mistakes in stocks is to avoid the ones that have high price-to-sales ratios.
"High Price-to-Sales Ratio Stocks are Toxic." Jim O'Shaughnessy from his book, What Works on Wall Street - research done from December 31, 1963 through December 31, 2009
Because historically, paying more than 1.5-2.0 on a Price-to-Sales basis for speculative stocks, even if you do have a ten year time horizon, is dangerous. from What Works on Wall Street by Jim O’Shaughnessy
Year to date, 100% of the gains in the S&P 500 are in 10 stocks.
(See 10 stocks that represent 100% of S&P 500’s YTD gain (Q1-Q2), BELOW))
And do you know what the average Price-to-Sales ratio is for those stocks du’jour?
It’s 10.61 X as of July 6, 2018.
Now, just because insiders are selling some of their company’s shares doesn’t mean that it’s a bad time for regular, non-insiders to buy the company’s shares. Sometimes, it makes a lot of sense for those insiders to systematically sell chunks of their concentrated holdings and to diversify so that all of their net-worth-eggs are not in one basket. It makes sense. However, when I looked at the insider trading activity over the last 90 days of those top ten stocks, I only saw ONE insider BUY. That was Microsoft.
Example: Facebook (NYSE: FB (below))
- Yields have moved dramatically on the front end of the curve but have gone nowhere on the longer end as I’ve been saying for some time. Two year T-notes are beginning to look attractive and will REALLY look that way when yielding around 3%.
That 2.536% yield on a U.S. Treasury is NOT for a 30 year bond, or a 10 year bond, it's for a 2 year bond (they call 'em notes).
Gary Shilling so wise
One of the main reasons I started Vickery Creek nearly 10 years ago, as most folks know, was because I was convinced we'd see an interest rate disinflationary period similar to what Japan and Sweden have seen. Some time back, Gary Shilling completed some research on the correlation between the Fed raising the Fed Funds rate and the increase in the yields on 10 year and 30 year yields. Now lest we forget that inflation is a component, too, I'm not suggesting here that we've seen a peak in yields for the cycle, but it's not completely out of the question that around a 3.25% on the 10 year could be peak'ish before we head considerably lower in the next recession. We don't have enough information yet.
By way of review...
Dec 2015 when Fed started raising Fed Funds rate:
10 year yield then: 2.35% Now (7-6-18): 2.827% (so....an increase of 50 bps or 0.5%)
30 year yield then: 2.689% Now (7-6-18): 2.936% (so...an increase of 25 bps or 0.25%)
This is history book stuff we're living through and another reason we maybe should discuss a personal, private pension income strategy if we haven't already. Because remember: yields always decline in recessions, so how many more quarters are we looking at before we may be facing a sub 2% 10 year yield...?...
Bias towards active versus passive for the next few years is gonna pay off for you
"The bottom line is that the wisdom of investing passively depends, ironically, on some people investing actively. When active investing is dismissed totally and all active efforts cease, passive investing will become imprudent and opportunities for superior returns from active investing will emerge." - Howard Marks of Oaktree June 2018 letter to clients
If you're a client, you know we use some ETF's. Whether you're a client or not, you should know (the obvious), that ETF's are not "SAFE". They're a basket of stocks. Now I know, the media and the ETF sponsor want investors to believe that they're this Failproof, A.I., brainchild, sexy, new sophisticated way to beat your neighbor or hedge fund manager that's never been seen before. But, there WILL be a mass exodus out of many of these investment products when the downturn occurs. It'll be epic. A rush for the exit is another way to put it. So, to that end, I'm uber-selective and I'm under no illusion here, so I don't want you to be, either. ETF's are comprised of stocks and stocks have risk. Period.
Last thing I'll say here on this
When you see articles on LinkedIn about how milennials are saying they're gonna retire at age 56 due to their masterful insight with ETF's, I hope that sounds the Contrarian Alarm in your head that makes you want to trim those risky ones.
Yields for reasonable High Yield hooking up
By way of an update, at present, value is in the inside-of-3 years on select, A rated corporates. And also in BB- to BBB- High Yield from 4-8 years, and select, both short and intermediate municipals. Now is a great time to exchange growth units (stocks), for income units (select bonds). CCC rated stuff is mostly toxic and honestly sort of scary right now as many of those companies face a wall of debt maturities and may not be able to find ways to refinance the debt.
A side note here: by way of update, as I've been saying for some time, both the corporate debt deals in the public markets and the leverage levels in the private equity space are really, really concerning. Unfortunately, some grandmas and grandpas own that debt and even the stock, not just hedge fund managers.
"Corporate debt has soared, but most of it has been used for financial engineering. Bankruptcies have been minimal in the most disruptive economy since the Industrial Revolution. Who knows how many corporate zombies are out there because free money is keeping them alive." Stan Druckenmiller - May 3, 2018
A Case where I like the Stock AND I like the Bond: BGS (B&G Foods)
Here's a consumer staples stock (B&G Foods), that's had a nice little run that we own in certain accounts, that pays over a 6% common stock dividend AND the six and half year Senior bonds pay 6.4% per year. Below is a list of some (not an exhaustive list), of their brands - we could probably find some of the items in your pantry.
Energy as a sector looks solid in here
Some bonds we recently purchased were investment grade rated Murphy Oil Corp., 5.69% Yield to Worst (yield per year), that mature in five years. That's good value right there.
Highlighting Biotech and Pharma
SHSSX - our investment in Blackrock Health Science Opportunities Institutional Shares mutual fund is up 14% over a twelve month period and up over 4% YTD. We just saw where Biogen's Alzheimer's drug showed very promising data results and the group as a whole is not nearly as expensive as it's been in the recent past, though some names are flirting with very expensive valuations when considering their debt profiles due to acquiring technology and science at expensive prices. Plus, an additional positive for some of the companies, (such as Gilead Sciences), in the group, are the ones that are positioned properly in the the CAR T-cell therapy field (which shows incredible cancer curing potential). And lastly, there's finally a dividend yield to receive when having investment dollars in some of these names. There's definitely risk here, but there's also a lot of potential reward.
China Value over Growth (example), through the use of American Depository Receipts:
Lenovo versus Alibaba
I’ll take Lenovo (I’ve watched their profit ratio go down 60+% since 2015 and their share price has moved similarly since), over Alibaba (popular stock du jour). Baba pays ZERO dividend while Lenovo pays a 6.25% dividend and also, in the China iShare (NYSE symbol: MCHI), Baba represents nearly 13% of the entire portfolio and is currently priced at a whopping 13.5 X sales. That’s astronomical. Conversely, Lenovo (they make the Thinkpad laptops and desktops, and they’re also Motorola Mobility), and their dividends are yankee dollar denominated, has a 0.21% weighting in the iShare, and is currently priced at 0.1 X sales. VALUE baby.
I'm ALWAYS asked, "What's the Fed gonna do?"
They're gonna keep raising the Fed Funds rate as much as they can (but gradually), but they may encounter a hiccup in their balance sheet reduction plans. But bottom line, they're gonna continue on this path of tightening financial conditions. IF you consider both the increase in the Fed Funds rate AND the balance sheet reductions, by the end of 2019, and assuming they stay on their path they stated in June of this year, it'll represent around 5.25% in effective tightening. And I think that'll do it. And so, folks may be looking for an elongated interest rate cycle into 2021 with a continued increase in the Fed Funds rate into 2021, but I don't think it'll happen. Jay Powell said just yesterday that (paraphrase here), IF they keep rates too low for too long, it'll mean a very painful downturn. It seems that we are seeing late cycle signs weekly both in credit cycle terms and in business cycle terms: Inflation, retail establishment closings figures, record M&A, silly-high valuations, homes selling in 20 minutes for thousands more than asking price like in year 2000, drum-tight unemployment rates, etc.
What about Trump vs. China and all allies in "Trade War"?
There's no doubt that the trade gap and trade unfairness with China and other trading partner countries should be addressed. I don't think that we'll see things play out the way the media's leading folks to believe. I also don't think that this cyclical form of protectionism all over the globe is gonna win over the hearts and minds of the public as easily as the leaders of their countries believe. People engaged in trade as their career know that if you want more growth, you need more trade. This is about creating fewer barriers to trade, not more. It's a game of chicken. The Chinese need the U.S. as a market, and I think they'll reform. Edge to Trump on this one. If I'm wrong and this escalates and lasts 18 months plus, well, then there you go. My guess is three-six months tops and we'll be discussing other headlines. This trade "war" COULD get really, really ugly and if it persists, simply the downstream implications (even if the total tariff amounts are not that large in sum), could push us into a global recession on that alone. When Trump's response to business leaders is "be patient" - this tells me his administration wants to punch hard and rapidly for a TKO (sort of a Navy SEAL move - overwhelm with power and quickly with the illusion of a massive force even though it's just a few), on trade and then back off. Trump's team knows that less barriers for trade is better and so that's why this is a game of chicken to me. But if I'm incorrect, and this sort of thing is more permanent, then yikes. There will be all kinds of cost-push inflation with which to contend and lots of economic drama and certainly way more volatility. I think it's temporary and transitory as we transition into a newer, less onerous, global trading environment. With all of this said, we should remember, though, that EVEN IF things get better and fairer on trade after all of this chest-beating and sabre-rattling, this is a risky endeavor AND IF the existing systems that regulate trade are systematically dismantled rather than just having deals re-written and parameters modified, we'll be looking at some serious disruption and chaos. Systems and order are in place for a reason.
A few personal finance questions to consider at this juncture....
How did your portfolios perform in the last recession?
How important is it for you to avoid a repeat of that performance?
If you doubled your projected, monthly retirement income, would that change your lifestyle?
As you travel and vacation this Summer and Fall, please don't forget, it's really not wise to advertise your vacation plans on social media.
1) Find a purpose;
2) Think about your health;
3) Plan for income;
4) Stay positive;
5) Find your community;
6) Keep learning;
7) Keep moving;
8) Plan & Prepare;
9) Check off your Bucket list
I've been thinking about how I should communicate to prospective clients who have had a lot of investing success over the last several years, and not just to client referrals who may have a leadership vacuum and ask for my leadership.
Why be thinking about capital preservation now? Why change what has worked over the last several years? Because you may need a surgeon to get you thru this next leg of the cycle. Not simply a salesperson. I was reminded by an economist/money manager recently that over 13 million people have entered the investment business since the end of the last recession and so therefore none of those folks have managed money for other people through a cycle in their careers. If you are an investor and you're being led that way, I personally think you ought to be very, very sober and careful and consider scheduling a call/visit.
At this late stage of the cycle, I really want to try to help folks avoid big mistakes as much as I can.
Thank you so very much, as always, for your interest in how we can help serve you and your family. I have a great job and people like you make it possible.
All the best!
Jack Parsons CTFA, AEP
President & Chief Investment Officer
Vickery Creek Capital Mgmt., LLC
Sources: Bloomberg, CNBC, The Economist (KAL cartoon), Brookings Institute, Reuters, Blackrock, Goldman Sachs, Charles Schwab, Gluskin Sheff, Haver Analytics, Wall Street Journal, Morgan Stanley, Google Finance, Federal Reserve Banks of: New York, Richmond, Atlanta, San Francisco, Kansas City, Fidelity Institutional Wealth Services, Five Star Professional, Atlanta Magazine, American Equity Investment Life Holding, Trading Economics, Jeff Gundlach & DoubleLine Capital LP, Advisor Perspectives, UBS, Moody’s, The Other Half of Macro Economics and the fate of Globalization by Richard Koo (Nomura Research), S&P Global, Nixon Presidential Library, A History of Interest Rates by Homer & Sylla, What Works on Wall Street by Jim O’Shaugnessy, Vickery Creek Proprietary Research