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Bond market selloff WAY overdone; buy bonds (even with duration), with both hands

May 09, 2022
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Good morning / afternoon.  I hope that your spring is going well and that you've been enjoying the song-birds, the blooms, the flowers and the vibrant colors.

"Spring work is going on with joyful enthusiasm." - John Muir

"You can cut all the flowers but you cannot keep Spring from coming." Pablo Neruda

"Spring is nature's way of saying, 'Let's Party!" - Robin Williams

"In the spring, I have counted 136 different kinds of weather inside of 24 hours." - Mark Twain

This (below), is a picture I took of some Rhododendron up in the North Georgia Mountains in April of this year.

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Bond Market Selloff Q1 2022 was the worst in modern history and is WAY, WAY overdone

Before we discuss the bond market, let's review what has happened YTD through mid-day May 9'th, 2022 from a sheer performance perspective to some select EQUITY investments:

Equities:

Home Depot:  -27.10%

Microsoft:  -20.26%

Netflix:  -70.55%

Amazon:  -35.10%

Tesla:  -32.74%

Rivian: -77.43%

Nasdaq: -25.95%

S&P 500: -16.25%

Russell 2000: -22.11%

South Korea KOSPI Index:  -12.65%

Japan Nikkei 225 Index:  -10.18%

Germany DAX Index:  -21.47%

Baron Focused Growth Fund Inst. Shares:  -22.93%

WOW...

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In 1792, Columbus Sailed the Ocean Blue

"Indeed, the most detested asset class on the planet.  The global bond market index has performed worse than in any full year back to 1792, except one when the economy was coming out of the depression in 1842.  Long-term US Treasuries have generated a -18% net loss in just over four months -- so bad that it takes out the year-long loss of -17% ending in March 1980."  - David Rosenberg - May 9, 2022

This is the worst 4 months for global bond markets that I can remember outside of the Great Financial Crisis.  Oh, I guess, thanks, Dave-since 1792 (see above).  It's overdone.  As you probably know if you think about it:  markets go too high and they go too low.  Most bond markets around the globe were too expensive heading into 2022 and many (not all), are now way too cheap.

You cannot have the Chinese shut down all but one of their provinces and lock down due to 'Covid-craziness' and expect to be able to properly operate the global economy.  In addition, you cannot expect to have a shooting war with World War III implications and expect to not see severe SUPPLY SHOCKS.

IF you normalize Chinese supply chains and take away the war, the 10 year UST is under 2% and the inflation rate is ~2.5% and the Federal Reserve is probably about where they are now with the Fed Funds Rate around 0.75%.  

The Fed has only blunt instruments.  The Fed is either going to: 

A) Destroy Demand by raising the Fed Funds Rate above 1.75% quickly and deepen the recession we're currently in (I've been saying we were going into a recession since November 2021);

B) Pivot before too long since financial conditions have already tightened quite a bit and pause and cite slowdowns and other reasons for NOT raising the FF rate as high as they've stated they intend to.

Simply put:  The Fed knows that they are going to have to lower rates in the next recession and if they don't have any room to go from 3.5% down to 0 (zero), they won't be able to spur the economy towards growth enough by simply going from 1.75% to 0 (zero).  Notably, we're only at 0.75% on the Fed Funds Rate at this time.  It is about as tough of a position as you could ever imagine being in as a policy maker (exception maybe sending young men off to war).

The surge in the inflation rate is supply shocks.  Period.  The cure for high interest rates is higher interest rates.  They will come back down.  Energy and Food in short supply... if those things don't get fixed due to better global leadership, poor people are going to go hungry and bad guys are going to get back in power and maybe stay there.  This is very serious stuff.  

During/after this next recession, interest rates are gonna drop like a rock.  This inflation backdrop you're living through is awful.  I am not trying to be insensitive about it...  IT IS NOT PERMANENT.  DEFLATION is next and it should appear by end of 2022.  Seriously.

You cannot have the 10 year UST go up from 0.54% to 3.18%, the 30 year US mortgage go from 2.5% to 5.5%, CPI inflation go from 3%-8.5%, the cost of energy doubling, ** (BIGGIE:  the cost of funds for corporations and municipalities in many cases doubled) - ALL in very short order, and incomes stay relatively flat and NOT be in a recession.  It does not work that way.  Sorry.

How many times has the CPI EVER been up in the clouds like this?  Try NEVER in modern history.  Don't buy into the lie that this temporary bout of inflation is permanent.  Please have a sense of perspective and trust that IT WILL go back down with the recession.  (see chart below)

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Inflation is peaking, I strongly think; and yes!  I'm in 'Team Transitory'.  The Fed did a terrible job communicating what that term might mean.  People are so short-term minded, BUT, that term can mean 2-3 years it doesn't HAVE to mean 2 months. I understand what is happening in the credit markets at present and I know that folks that sell their really good bonds with really good interest rates to buy beaten down stocks will be SO sorry they did that.  The expensive stocks have another -30% to go from here before they're more reasonably priced.

So...the big thing I'm looking at is does the 10 year UST go above and STAY above 3.24% for very long?  I am quite concerned about that.  I'm not trying to time anything, I just have a good sense of the capital markets and risk because I work in them every day and have since 1997.

The Fed can do NOTHING about the type of inflation we are seeing unless they DESTROY demand by deepening the recession.

To repeat, they have blunt tools; and as you know their main one is the Fed Funds Rate

Two questions:

1) How does the Fed Funds Rate influence Chinese policy around opening or locking down provinces because they're scared about Covid-spread?

2) How does the Fed Funds Rate cause Putin to give up, call a truce and 'allow' Ukraine it's independence and peace and give up on his dream of reassembling the former Soviet Union?

Either Jay Powell pivots and pauses and then within 12 months starts lowering rates again or he goes through with what he says and risky financial asset values like stocks and real estate go down -50% or somewhere in between those two goal posts.  I don't mean to seem binary, but you see, their are absolute financial and economic laws that work in financial markets and you can't just close your eyes and wish those away.  It doesn't work like that.

This is gonna be a super short Insights blog this time and it's gonna be REALLY light on charts except I want you to see how rare it is to register a CPI reading like the one that is in the rearview mirror now at this point in a cycle.  IT NEVER happens, SO...as things slow down, that rate is gonna drop like a rock.  UNLESS we're in a World War or another pandemic (or both), or something nutty like that.  I LOVE how clients are positioned.  We have a focus on income and a focus on risk management and we're looking through the windshield rather than in the rearview mirror "INFLATION, INFLATION!!!!!"....AHH...  Trust me, it's gonna roll over.

Take heart.  We're in a chronically, disinflationary world and income wins over gambling; and income is CHEAP, CHEAP, CHEAP right now!

You can garner 6% easily now from the corporate bond market; you can garner 3% easily from the municipal bond market.

This is not an anti-stock posture, it's just a risk management point to be strongly considered at this point in history as risky investments destroy wealth.

Friday, we added to our B&G Foods equity position (the common stock yields 8% per year), most of our pre-Covid, legacy, cost-basis-positions in the stock are approximately 32% lower than the current price level.  Mostly, we trimmed equity risk late last year and into this year, but we are very selectively adding to select equity positions just as we are adding to bond positions.

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How about income?  How about this?  7.65% per year for 20 years?

Murphy Oil Senior Corporate Bonds maturing in 2042 (20 years of clipping NICE coupons), the price has been wrecked and currently yields 7.65% per year for 20 years.  Who needs to own their stock when you can make that level of income by owning a bond and having a contractual obligation with the company that they HAVE to pay you or they are considered to be in default/bankrupt?  The company has been around since the 1950's and has never missed an interest payment and is one and half notches below investment grade and despite the recession, traditional energy still screens very well from a fundamental analysis point of view.

I hope that I'm not being insensitive here, but we've had YEARS of free money and Robinhood, Crypto, and all sorts of nonsense, so with a shooting war, China supply shocks and citizens in our country not being able to sit down together and even have a meal together (because of political differences)...should anyone be surprised?

We will get through this.  Seriously.  Try to enjoy your Spring and Summer.  Turn off the financial media stuff and let me/us do our job and help you not: 'get rich' but 'keep from going poor'.  That approach wins.

I'll take certain accounts down 7.5% YTD versus -30% for a lot of folks out there...and we've still got seven months left to earn income at a roughly 5-6% clip (considering the historical context and comparisons).  Parenthetically here, Nuveen Georgia Quality Municipal Bond Fund (ticker:  NKG), is down -20% YTD; Doubleline Total Return Bond Fund Inst Class ($35 Billion in size; and my understanding of their portfolio is that they have very little duration (so they have anemic bond coupon income flowing in for investors)), is down over -9% YTD (through Friday, May 6, 2022)).

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In closing, here's a quote from UVA Men's Lacrosse Head Coach, Lars Tiffany:  "Nobody wants to get kicked in the pants.  It's an opportunity to grow and learn from it.  But at the moment, it's painful."   

I know it's scary right now.  But we have a game plan.  Let's talk soon.

Have a wonderful day.  

I have a great job and people like you make it possible.  THANK YOU.

Yours,

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, 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