Good morning / afternoon. I hope that your summer was mild, your fall was cool and full of vibrant, autumn colors, and that you have a good coat for winter!
"If we had no winter, the spring would not be so pleasant; if we did not sometimes taste of adversity, prosperity would not be so welcome." Anne Broadstreet
"In seed time learn, in harvest teach, in winter enjoy." William Blake
"Let us love winter, for it is the spring of genius." Pietro Aretino
This (below), is a picture I took a couple of weeks ago on a friend's farm along the banks of the Shenandoah River in Virginia while on a camping trip with my daughter.
Bond bull market 2023-2024
"No winter lasts forever; no spring skips its turn." Hal Borland
I received a text from my son this morning as he was about to go outside and start his car and head to work, and the text said that it was -5 degrees (Colorado). Brrr...
Analogously, with the exception of several bear market rallies in the stock market in 2022, and stocks in the traditional energy sector, it's been a quite frigid investment climate for stocks year to date. The same has held true until, call it yesterday, for the bond markets. This has been an absolutely brutal bond bear market year with borrowing costs / interest rates increasing 100% YoY (year over year), in many cases for borrowers.
Photo: Breckenridge, Colorado (stock photo (online))
"Carry on my wayward son...there'll be peace when you are done..." (Kansas lyrics)
For years, I've been saying that as we selectively acquire / invest in bonds, mostly in the secondary markets, we have to emphasize higher coupons so that when rates rise (even if temporarily), we have higher income 'carry' than what most other bond managers' / investors' bond portfolios are able to produce because they invest mostly in the primary markets (where there have been historically low coupons).
What does that mean? It means that during episodes of inflation and higher interest rates, the higher coupon rates on our bonds 'keep up' better with inflation than the lower (issuer-friendly as opposed to investor-friendly coupon rates).
In May, I was watching closely the 3.24% level on the 10 year UST and it blasted through that level, even hitting 4.24%, last month. Bond strategists at JP Morgan and Blackrock (not picking on them, it's just notable), started to get really cocky in their bearish bets and prognostications on just how far the Fed could get before they went too far. I think that sometime in that 2023-2024 timeframe, the 10 year yield will melt back down through the 3% level. I don't have enough acuity at this point in the cycle yet, but suffice it to say, if you're not careful, you can get too greedy and try to get 12% corporate bond yields instead of settling for 9%-10%. I think that's a mistake as I think there's a solid chance you'll miss out on an opportunity and you'll be back to looking at 6% yields within a short time period. Parenthetically here, many strategists are thinking that credit spreads on the aggregate high yield bond index will get into the 700 bps spread level above it's present 466 bps level. I understand the thinking and respect it since it's based on recession-research, and I'm not saying it won't happen, I'm just saying it's possible that the bond markets may not get that soft in credit before something else breaks in the US economy and the Fed has to pivot by mid 2023. Just because the aggregate bond spread data are not there ignores the fact that spreads on bonds of some companies that are tied to the consumer are north of 1000 bps. Many of these strategists are not dealing with the granular stuff that I deal with every day. The bond markets have been wrecked. Full stop. Capital markets are more influenced by the bond markets than they are the stock markets, by let's say, a country-boy factor of...say...10x. Seriously.
This current period of time is opportunistic for patient investors
Example of some bonds I like:
- Kohl's 6% to 2033: Yielding 10% per year BB+ rated
As I stated above, the consumer is hurting and major headwinds are in store for retailers and online, but the leaders will emerge even though right-sizing the businesses and closing some stores and embarking on cost-cutting, new leadership vision, and investing will need to take place.
- Also, Dana Corp, founded in 1904, has 9% yielding bonds that are awesome; they manufacture 4x4 transfer cases, axles, driveshafts, transmissions, etc for both conventional, hybrid and electric-powered vehicles.
- Parsippany, NJ township 5.1%, 12 month municipal bonds that have the highest short term Moody's credit rating of MIG1 yielding 5.1% for only 12 months!
I was early on my call to buy bonds 'with both hands', in May of this year, but just this week, Guggenheim Partners' Scott Minerd was telling a CNBC interviewer that his firm was buying duration (long-dated bonds), and buying credit (below investment-grade), my paraphrase (not his words): [ with both hands]< he called it a 'once in a generation opportunity to buy bonds'. Source: CNBC
As the reality of the recession takes hold and executives pay down debt, postpone issuing debt to buy back common shares, cut their common dividends, it's only going to be BULLISH for bond holders and preferred stock holders.
If you look through the windshield at leading economic indicators, you don't have to be an expert to see that inflation is melting for several reasons:
1) The supply chain logjams have been improving for months;
2) The interest rates charged to borrowers have been causing demand to weaken across many sectors of the global economy;
3) CEOs are implementing cost cutting measures such as hiring freezes, layoffs, debt reduction plans (these are all disinflationary; not inflationary);
4) The consumer is hurting and reading the consumer correctly is a big deal since he/she is 2/3 of the US economy<ask the company Wayfair (NYSE symbol: W): as their stock is down -84% over the last 12 months as online sales struggle;
5) Housing is hurting;
6) Commercial real estate is set for a serious pullback in early 2023;
7) The lagged effects of the Fed's actions haven't even been fully felt yet as it takes approx 6-12 months after the final interest rate increase to 'feel' the full cumulative impact of such an historic upswing in interest rates;
Questions I have been fielding of late:
"Has the stock market bottomed?" Short answer: No. The stock market can't bottom until the treasury bond market bottoms, and we're starting that process in full earnest as of yesterday, frankly, but no. The emphasis will move away from inflation and will instead move towards earnings weakness.
"When will corporate and municipal bond prices begin to improve and move higher?" Short answer: 2023-2024. The Fed SHOULD be finished with this incredibly rapid increase in the Fed Funds rate with one more 50 bps increase in December and no more in 2023. They are intimating more in early 2023, though, and that's simply a bad move if they go through with that.
The economy works with lags when there are significant changes to interest rates, regulations, big supply / demand curve shifts, war, extreme weather events, etc.
Please note that the rapid pace of the Fed's move: this time, assuming they increase the Fed Funds rate by 50 bps instead of 75 bps in December of this year, they will have moved approximately as much as they did before the Great Financial Crisis (more technically if you take into account the effect of Quantitative TIghtening on the Fed's balance sheet (effectively tightening liquidity by a bunch (I won't address this here))).
This time IS different
The difference is that they will have done this in 9 months instead of over 26 months. Don't think that the recession that's coming in 2023 won't be severe. I am not saying it will be, but it really could be. If you consider the move from 2.875% on the 30 year mortgage rate to over 7% in less than a year, floating borrowing costs going up 100% YoY (year over year), and corporate and municipal borrowing costs doubling and in some instances tripling YoY, JUST THOSE THINGS ALONE are ENOUGH to put us into a recession honestly.
Please be patient with bond prices. They went too high and stayed too high for too long and now they've gone too low and are staying too low too long. 2023-24 won't be straight up and prices may be more volatile and more jagged, but the value in bonds is presently astounding. It's gonna be the place to be over the next 1-2 years. No question.
Income Later math looks really attractive
If you are a client or are considering whether or not you might become one, please consider not just the 'Income Now' part of our value proposition, but also please consider the 'Income Later' part. Insurance companies that offer fixed indexed annuities (think private pensions), are increasing their interest rate assumptions and payout percentages and these two factors will mean much more income during the retirement income distribution phase of such investments. It means more income during retirement. This is a window that, in my mind won't be open in 2024, as those same companies will likely be lowering those rates and the income figures will be lower on new contracts. Let's discuss this as a potential complement to your retirement plan solve.
In closing, here's a quote from a former client, friend, mentor, and passionate outdoorsman. Jansport (now a VF Corp brand), founder, Skip Yowell, who inspired so many people to adventure outdoors and to be a quality human being: "The business just took off. In the beginning, my major worry was whether or not I was gonna have enough money to go skiing!" Here's to you, Skip!... as we start ski season, winter backpacking, alpine mountaineering, cross country skiing, hunting and/or just exercising outdoors during the upcoming winter. May God bless the folks that miss you the most: your family and friends and former colleagues.
Photo above: barn in Park City, Utah flying our flag
Have a wonderful Veterans Day weekend, Thanksgiving and Holidays!
I have a great job and people like you make it possible. THANK YOU.
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), “A Tangled Web: Impact of Supply Chain and Inflation on the US Economy” – Moody’s Analytics – Dec 7,
2021,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.