Good morning / afternoon. I hope that your summer went well and that you're enjoying the cooler weather and the beautiful, leaf color this fall.
"Fall has always been my favorite season. The time when everything bursts with its last beauty, as if nature had been saving up all year for the grand finale." - Lauren Destefano
"Winter is an etching, spring a watercolor, summer an oil painting and autumn a mosaic of them all." - Stanley Horowitz
This (below), is a picture I took while on a mountain bike last week just across the North Carolina border from the North Georgia mountains.
Picture (above) is from a mountain bike ride on a trail in North Carolina just across the border from the North Georgia line
Balance Sheet Recession
A type of recession that occurs when high levels of private sector debt cause individuals or companies to collectively focus on saving by paying down debt rather than spending or investing causing economic growth to slow or decline.
WHAT is going on...?...?!?
One question I've been fielding a lot lately: "What the heck is going on with the markets?"
I'll try to answer that question in the simplest ways I know how, broken down into distinct parts:
The Covid 19 economic shock should largely be considered a supply shock rather than a demand shock. This is a very important distinction. Because this is a supply shock, the price inflation in nearly all products and services we're seeing inflation in, will be temporary BECAUSE supply will eventually meet demand. Importantly, we had a fundamentally disinflationary economy on our hands pre-Covid. So if you're in the 'inflation-hyperventilation' camp, you might want to consider the following:
The Fed and the other central banks around the world threw EVERYTHING they could to try to generate inflation, and they didn't get it, UNTIL we had a pandemic and until leadership said in unison, 'Shut the economy down. Everybody go home. Stop working (albeit temporarily)'. We had a recession and so they took interest rates negative (adjusted for inflation). So maybe ask yourself, "So a pandemic is all we needed? That's all? Oh okay..." (BIG eyeroll (emphasis mine))...
Example: In June of this year (last June 21 VC Insights), I wrote that the price of lumber and many other commodities would tumble as more supply hit the market...
Do you see how faulty that premise is (that all we needed to generate long-lasting inflation and get us out of a chronically, disinflationary environment was a pandemic)? We had a fundamentally disinflationary economy, and we got a pandemic recession. Remember, plants were closed, and people were sent home. And/or people got sick and stayed home instead of work going to work. In many cases, the government gave away billions of dollars in forgivable 'stimulus' money. That's all in the rear-view now.
As some of the retired guys I shoot sporting clays with say: 'folks are 'ridin Biden'; aka: they're 'on the dole' instead of working.
Those are supply shocks. Whether it's a supply of labor or a supply of parts for a thermostat, or semiconductors used to assemble F-150s, those are supply shocks.
It may take longer than some people think, but supply will eventually catch up. In addition, higher prices will erode (eliminate), some of the existing demand. Additionally, exogenous shocks (ex: recession), will also cause demand to weaken as well. The idea that we've entered some 'new era', is absurd.
CAVEAT: Now, if, due to unbridled, non-common-sense, over-regulation and governmental edicts that limit supply (we've seen this with energy projects being halted/made unlawful/cancelled), that will definitely cause price inflation problems that stick around longer than expected and are much harder to remedy. I don't think the new administration understands this. Jen Psaki, Biden's spokesperson recently said, "Companies are actually raising their prices to consumers and this is just wrong." Pardon me? What? I suppose those companies could just lay people off...(unbelievable).
Find a commodity that hasn't been monkeyed around with by some government restriction, and whose pricing functions are more natural (controlled by supply and demand with little regulation that restricts supply), and I'll show you a commodity that is not subject to much price inflation.
Recently, David Rosenberg asked me if he could use some of my research instead of the other way around. It was very flattering. He started his missive by using three pictures I took at my local WalMart bicycle aisle at three different points in time to illustrate my point that the 'bottleneck-supply-chain story' will only be temporary. So later that same week, an institutional research person cited my research in an email to his clients and heavily criticized my work. That generally means you are onto something when people get that offended. So, before you jump to the conclusion that in 2023 you won't find a semiconductor for your pickup truck or some other Covid-related supply chain item, go back and look at the WalMart bike aisle photos over 10 months. Supply will meet demand...eventually. (Click link below for Rosie's research (PLEASE READ))
The Capital Markets
Oh man...why do I get these assignments? Why me? Why do I get the 'fun' job of telling folks at the Holidays that 'govvie' bond yields are likely going lower? You know, I certainly have no idea when the next recession is coming but I feel strongly that we're closer to it than we are far from it and remember the rule: 'yields (govt yields) always go lower during recessions'.
This is a chart of the 30 year US Treasury bond. It shows that we are roughly -25% lower on the yield of the UST30 than during the worst part of the balance sheet recession of 2008. And since govvie yields always go lower during recessions, how low do you think we'll go?
Approximately 72% of all net new corporate bond issuance is being used for refinancing existing debt; not for M&A, not to grow the business organically or to build plants or invest in equipment or even computing stuff. So that means that reported earnings could hold up for a few quarters longer as their interest expense on their debt continues to go lower, but it probably means that we're close to the deleveraging phase of the credit cycle. Which balance sheet you might ask? Corporations, Households, Margin debt...?... I don't know but it could be any / all.
Below is a chart of the total outstanding nonfinancial corporate business debt and loans. See how much higher it is Q3 21 vs Q3 08? See the hook-up during Covid to 'sustain the business' during Covid? These are big numbers on the liability-side of the balance sheet for corporations (post debt-binge).
Update on risk spreads
UST and advanced economies' bonds' linkages
It's important to analyze and understand the relationship between the following bond markets: US, Germany, UK, Japan, and Euro members (aka: advanced economies esp. 'the big guys')
There's of course no guarantee that the UST bond is gonna drift down and trade near the German bund; the German bund could hook up and trade near the UST bond. At this point in the cycle, you can't ignore charts like this though.
UST and developing economies' bonds' linkages
This is a chart of the Aussie 10 year Govt Bond against the 10 year US Govt Bond. Look at what happened the last time they spiked like that in 1994. They declined for years...
Also, please understand that iron ore exports represent 45% of Australia's exports. And also please know that 60% of those exports go to China. China's property development business is in the toilet and they're very linked. So Australia could easily roll back into recession. (Source: Rabobank Australia)
The results from the Virginia governor's race are most likely indicative of Democrats losing seats in 2022 and Republicans picking up those seats essentially reducing Democrats' power in 2022. This will equate to a ~stalemate (gridlock), in 2022-2023 leading up to the 2024 election.
Melt-up may actually continue
Higher highs may be on the way for the major indices
Monetary Policy Changes Coming in 2022
"Overreliance on monetary policy will not help the economy and will in fact exacerbate financial imbalances by triggering undesirable cycles of bubbles and balance sheet recessions. The lack of results convinces central bankers that they have not done enough and prompts them to do even more [QE], thereby increasing the funds that fund managers must invest in existing assets and contributing to the growth of bubbles." Richard Koo - Nomura Research Institute-2021
The economy is slowing. There is no question about that. The Fed is tightening financial conditions by supporting the mortgage and US Treasury markets less than they were and they say they'll be done with those extra-ordinary support-purchases by June 2022. Many people are taking that to mean that the Fed will start to raise rates in the July meeting and raise by 25 bps 2-3 times before the end of 2022. What I'm gonna tell you is that there are many things that can happen between now and then. We SHOULD be higher on the Fed Funds rate with inflation running what it is, and what rates are doing; however, I believe that's temporary (inflation), and I believe that they've gotten the patient SO ADDICTED to low rates (negative rates frankly for years), that it won't take much of a jolt to seriously upset the apple cart. Remember in early 2021 when mortgage rates went up 15 bps and deals dried up? Yikes. President Biden will be appointing three very powerful monetary policy decision-makers (Chair, Vice-Chair and Head Banking Regulator for Fed), at the Federal Reserve. So to that end, things COULD get VERY 'stimulative' indeed. I'll leave it at that until we can get better acuity into how the economy is responding to a tad less stimulus, changes in leadership, risk spreads, the winter months w Covid, etc. I will probably wait until April to update Insights. There are a lot of moving pieces between now and then.
Commercial Real Estate bubble
Balance Sheet Recession is on the way
Which balance sheet (sort of like the effect of a debt bubble bursting), will lead us into recession? I have no idea. Pick one. Will it be the unmanageable debt-load for corporations? Will it be another household balance sheet recession that leads the way? Which bubble will pop and start it? Will it be crypto? Will it be the bubble in ESG stocks? The property bubble bursting in China should remind international investors that bubbles don't go on forever.
In the U.S., financial conditions are near perfect. But are the fundamentals perfect? The former head of the NY Fed implies no on a recent Brookings zoom call I was on:
"I can't imagine two years from now the financial conditions look ANYTHING [his emphasis] like they look now." former NY Fed Governor, Bill Dudley.
I've been reading Bill's work since he was chief economist at Goldman Sachs in 1997. I think he is implying (my words not his), that we will be in recession before too long; that these calm, financial conditions are the 'calm before the storm'. [Again, my read on his words, not his words explicitly]. I shared with a trusted mentor and he agreed on my read of what Bill said on the call.
This is an updated chart from the NY Fed on Household Credit. This chart compares Q3 2021 to Q3 2008. Does it look pragmatically good? Nope. The optimists say, "the interest expense coverage is SO much less this time around". You know what? That is true. There's no question. But when you're in recession and you lose your job and you have 2x the debt-load you had versus last time, you still owe 2x the amount (2x simply an example).
Okay, okay. But what are you BUYING? I can hear my friend Nick asking me this as I write this. I never provide a comprehensive list for everybody in the world to see but I'll highlight a few:
Ashland INC (symbol: ASH; (below is their stock chart along with their total long-term debt charted at the bottom of the chart))
This is Ashland INC 6.875% coupon bond:
Congratulations to the Atlanta Braves for winning the World Series 2021!
Liberty Media owns the Atlanta Braves, Qurate, QVC, Zulily, Sirius XM radio, a broadband business as well as other assets. This particular bond started out as a $1B issue in 2000 with an 8.25% coupon, the company has paid the issue down to $504mm.
Triton Corp Preferred Stock yielding 7.22% (current price 11-12-21)
Industry and company-specific fundamentals:
Municipal Bonds: Nuveen NXJ (New Jersey) Closed-end municipal bond fund paying north of 4%. As you know, I'm an individual bond guy, but there are VERY, VERY FEW individual bonds I'm buying either in the secondary (esp not the primary markets), currently. They're way too expensive.
Alternative to municipals with yields so anemic:
* For new money that would normally be earmarked for municipals, I'm utilizing tax-deferred, fixed indexed annuities. They offer guaranteed yields and relatively high, guaranteed distribution tables. I'm illustrating below a low cost, simplified, fixed-indexed annuity strategy (investment product chassis), that has built-in numbers that are sometimes more appropriate for clients than municipal bonds at present (due to how expensive munis currently are).
What's 25 basis points (0.25%)?! Who cares...
Just an example of more pain for folks who are retiring and need strong income generation from their investment assets:
When safe yields go down in the next recession, it will negatively impact the numbers insurance companies will be able to pay annuity / pension income recipients. if the insurance company payout only goes down only 25 bps, that would be equal to $71,664 in less total income over the income distribution period for a sample client (below).
Details for sample client example: Beginning balance: $620k; Starting Age: 52; deferring until age 67; income distribution begins at 67; using a 25bps reduction in the payout % and the income number is reduced by $2,986 per year which, if client lives to be age 91, that's a total reduction of $71,664 less income due the investor; hypothetical scenario is the table being reduced from 4.66% payout percentage at age 67, to 4.41%.
Equities: (B&G Foods; symbol: BGS): 125 year old packaged food company that pays a 5.8% dividend and has rather easily been able to pass increases in ingredients to consumers with no deleterious effects. It's a great little business. They've got Ortega, Green Giant frozen vegetables, Cream of Wheat, Mrs. Dash, Spice Islands, Polaner jellies, Crisco; to name a few. Some clients own their stock and some own their bonds and some own both!
REITs: (Cousins Properties; symbol: CUZ)
3.1% dividend and look at their portfolio! "Location, location, location." That's Cousins Properties (named after Tom Cousins (founder))
Their rents per square foot as well as their occupancies and leases all held up very, very strongly during Covid. They're quite the premier business in that space and their balance sheet is strong.
Funds and ETFs all holding up very well and passing due diligence reviews. We are trimming BFGIX (Baron Focused Growth Institutional Fund), as they hold a large position of TSLA and it's so obnoxiously over-valued.
We are adding selectively to Silver positions as a hedge and we'll likely be adding to volatility hedging positions in early 2022.
Underwater balance sheets
Many balance sheets are underwater and for those that aren't now, if priority for debt repayment is not higher than profit maximization in coming quarters, then the balance sheets that aren't underwater yet, will be. That's how bubbles work.
The Federal Reserve is largely responsible for the next recession because of their myopic focus on the labor market and ignoring asset bubbles. They've had several opportunities to calibrate the Fed Funds rate by being responsible adults (a'la Alan Greenspan and his predecessors), and wrong-footing the futures' markets and just making changes; instead, they've treated market participants like children and coddled them. In the process, they've created financial asset bubbles. Unfortunately, some people always get hurt in recessions, but in the next recession, it's could be really, really ugly. Financial crises all have one thing in common (and always will): excessive debts. Debt bubbles. I didn't make the rules, that's just how it is.
Main closing point: Valuations and fundamental analysis are terrible timing devices but they're great indicators of future returns though.
In closing, here's a humility quote from one of my favorite Bible teachers, the late Dr. Howards Hendricks: "Experience is not the best teacher. Evaluated experience is."
Here's to a great season of Thanksgiving and gratitude. Join me in praying for our great nation this Holiday season.
I have a great job and people like you make it possible. Thank you.
I hope that you have a wonderful Thanksgiving and Christmas / Hanukkah Holiday with your family, loved ones, and friends.
Here's to a great start to 2022!
Jack Parsons CTFA, AEP
President & Chief Investment Officer
Vickery Creek Capital Management, LLC
Sources: Bloomberg, WSJ, Marketwatch, CNBC, NY Fed Research & Statistics Group, St. Louis Fed, Atlanta Fed, San Francisco Fed, Rosenberg Research, Richard Koo (Nomura Securities), Fidelity Institutional Wealth Services, "Is the COVID-19 Pandemic a Supply or a Demand Shock?"-St. Louis Fed (Brinca Duarte, Faria-e-Castro)-2020-#31-"Economic Synopses' (Series), Chicago Fed National Activity Index for August 2021, "Grande" Difficulties in Chinese Property Market-Rabobank-Oct 2021-Australia Economic Update, "The Sahm Rule and Predicting the Great Recession Across OECD Countries"-working paper NBER-Sept 2021-Prof. David Blanchflower (Dartmouth), NY Fed Secondary Market Corp Credit Facility (policy & implementation group), 'Blackrock Sees Shallowest Interest Rate Hike Path in Decades'-Blackrock Investment Institute-Bloomberg Surveillance-Sept 27, 2021, Wal Mart Corp, "The Imbalances of the Bretton Woods System 1965-1973: U.S. Inflation, the Elephant in the Room"-working paper-NBER-Dec 2018-Prof. Michael Bordo (Rutgers), "Australia Economy Could Slide Back Into Recession, Citi, AMP says"-Bloomberg-Aug 30, 2021, "Changing role of neoliberalism across the stages of economic development"-Richard Koo-Nomura Research Institute, Japan-2021, "The Aftermath of Debt Surges"-working paper NBER-Sept 2021-Kose, Ohnsorge, Reinhart, Rogoff, "Corporate Buyout Loans Near Highs of 2007"-WSJ-Matt Wirtz-Sep 26, 2021, Dr. Howard Hendricks: 1968 talk to an assembly of folks in The Navigators, [Columbus Bible Study podcast], Liberty Street Economics: 'The New York Fed DSGE Model Forecast-Sept 2021', 'Low Interest Rates'-Speech Remarks-Stanley Fischer-Vice Chairman-Federal Reserve-40'th Annual Central Banking Seminar-NY Fed-Oct 5, 2016, "The International Experience of Central Bank Asset Purchases & Inflation"-NY Fed-Liberty Street Economics-(Benigno, Pesenti)-Oct 20, 2021, Thompson-Reuters, Securities & Exchange Commission, FINRA, iR Research, Vickery Creek Capital Mgmt., LLC
Disclaimer: The research contained in Insights blog posts are intended to inform and educate Vickery Creek clients as well as prospective clients. The thoughts, views and opinions are those of Jack Parsons and are not intended for sale and are not implicit guarantees of any security or company. Past results are not indicative of future returns. Numbers are estimates and are sometimes imprecise due to changing market conditions.