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Don't let the cheerleaders drown out the credit market signals

| December 12, 2019
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Season's Greetings!  

I hope that you and your's had a wonderful Thanksgiving!  It's almost Christmas now (hard to believe how fast 2019 flew by, right?) !!!

Let's get some laughs in before we get to the nerdy, analytical stuff.

FOUR comedy DVDs?

One year for Christmas (at least ten years ago), I bought my wife and kids four comedy DVDs.  Now before that, I gotta say..I think we owned zero.  These are not comedy movies, these are stand-up comedy DVDs.  We had none.  Now, we have four.  A friend of mine and I took our sons to an Air Force museum to look at cool airplanes and when we met them in the parking lot, they opened their car doors and were laughing hysterically and I asked them what was so funny and they said they were listening to a comedy CD.  I thought vicariously, 'I'm gonna encourage myself and my family to laugh more in the coming year.'  That was over-doing it a little perhaps, but that family had just endured a pretty heavy year of cancer (this man's beautiful wife and these boys' mother eventually passed away at a young age to cancer), and I figured it couldn't hurt to laugh a little more.  What's the harm?

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Four cartoons?  (over-doing it again)...

Santa Powell (Federal Reserve Jerome Powell)

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Homer Simpson's got FOMO (Fear of Missing Out) over the stock market

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Unemployment Data

Glancing ONLY at the headline data and not examining it CAREFULLY

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This is the least funny of the cartoons, but possibly the most accurate

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Okay.  With that out of the way, let's get started and talk about Your Money..

Perspective is a funny thing

"The budget should be balanced, the treasury should be refilled, the public debt should be reduced and the arrogance of public officials should be controlled."  Ross Perot

Boy that seems like a notion from a by-gone era, doesn't it?  I mean, that's SO yesterday.  That's SO old-fashioned.  (While looking at what I'm gonna buy on my phone (eye-roll))...

Did you know?

...That it took Canada seven years to reach a trade deal with the E.U.  

...The Euro was a currency that was adopted in 1999.  Over 340 million Europeans use it daily as their currency.

..."In Europe, negative interest rates are inducing depositors to put currency in vaults and to save even more for retirement than spend".  (Gary Shilling)

...December 20'th 2019 was a U.S. debt ceiling deadline that you heard virtually nothing about.

...The U.S. will print a $1Trillion annual deficit in 2020.

...Wharton Business School just wrapped up a study that concluded that Elizabeth Warren's wealth tax plan would raise $1Trillion less than she estimated (is that a tad more than a rounding error (30% less than she said). (CNBC)

...That Donald Trump said that we should adopt negative interest rates in the U.S. like Europe has so that we can "compete".

...The Nikkei 225 (the U.S. S&P 500's Japanese cousin (oft-cited index)) was at 39,000 in 1989.  Today, it's at 24,000 (that's 30 years).

Just for some perspective...

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QE5?

"QE5 - let's not even, for a second, debate whether or not Bernanke and Co. [Yellen & Powell], will do QE3 or not.  Some form of it is maybe a done deal.  It may be soon and it may not be for a few years.  In Japan, the big chunks of intervention came several years apart - once in 1991 and again in 1998.  Why do you think I've been so evangelistic about bonds over the past five years?  It's not been because I've been trying to argue that bonds are better than stocks or that the timing of my call is surgical and perfect and that your entry and exit point will allow you to trade for huge profits and then get back into stocks.  If I'm right about the overall direction of interest rates and the implications for bond yields, you are running out of opportunities to purchase solid bonds at reasonable (based on historic U.S., fixed income measures), rates of return.  The math overwhelmingly affirms this thesis."  Jack Parsons - June 24, 2011

I hear this a decent bit...

"All of this is nonsense about low inflation being bad...why is it bad?

SO WHAT?  Low inflation is good, right?  It means low interest rates and I can borrow at great rates (the Fed's got my back and the values will never go down), and buy rental houses  (because the consumer is in 'AMAZING' shape), and be a landlord (because occupation rates don't matter anymore because 'cycles don't exist anymore'), and AAPL stock (it's price to sales ratio doesn't matter a'la Cisco Systems (Nasdaq symbol:  CSCO circa Jan 2000), and watch it get to a $1.2T market cap, and buy a $100k car (a guaranteed depreciating asset), at zero percent interest rates, and also, low interest rates are rocket fuel for stocks right???  The U.S. is not Japan, I mean come on...that's silly..."

The U.S. is so arrogant to believe that the same financial viruses that infect other countries can't infect us because we're the good ol' US of A.  I'm as patriotic as the next guy - believe me.  But it's arrogance and ignorance (I'm sorry to say).

Well, if you're 60 years old and about ready to retire with the nest egg you've saved your whole working career and with 2020's starting point with stock market valuations as sky-high as they are, and you'd like to invest in safe investments yielding reasonable yields and interest rates are where they are, it's difficult to have a safe investment profile and actually be invested in the public markets, yes.  At the current time, private equity and private debt is SO over-valued and over-hyped and when sovereign pension funds have 1/4 of their assets there, from my lens, that's a 'yikes' response.   And there's very little transparency and liquidity by comparison.  And at some point, maybe soon, there may be even less liquidity there as opposed to open exchanges in public markets with hours of trading between 9:30am-4pm nearly every day of the work week.  If you're over 60, say between 70 and 80, and you have a lot of money invested and you don't want to see your nest egg go down a ton like it did in 2000 and in 2007, then you are probably more than a little concerned about all of the unconventional stuff going on in the world.  

What will you do if you're retired and the Fed lowers rates to zero again and CDs yield virtually nothing?  That's the bigger risk than 5% yielding money market rates. 

"So far this year, we have tracked over 1,500 basis points of rate cuts by nearly 20 central banks across the globe - with the Fed having contributed [75 (2019)] basis points."  David Rosenberg - Chief Economist - Gluskin Sheff - October 11, 2019

I know it seems weird and counter-intuitive considering that gargantuan amount of stimulus from monetary policy groups all over the globe (see above quote), but rates are most likely headed lower.  It's true.  I've done a LOT of research on the subject (and people WAY smarter than me have as well).  I've also invested in individual bonds nearly every day I've worked for over 22 years and don't forget (I am seriously humble about it but have to remind people), I'm one of the only advisors in the U.S. to have accurately predicted low interest rates this far out in the future.  I have studied and researched credit bubbles and monetary policy cases for many years now (and continue to do so).  In other words, "I was country, when country wasn't cool" (country song lyrics)  So I should have a tad of credibility on the subject.  (How to run your business?  I would have no clue)... 

  • I said there would be a credit market issue in August (called it "Tight 2.0"), and there was a BIG one in September.

Credit markets are going to continue to call the Fed's hand (until such a time that the Fed OWNS the entire market of a security):

  1. "We're raising rates" (Powell - Dec 2018)...< Credit markets' response...(credit spreads blow out (widen) and emphatically tell the Fed, "No you're not";  THEN:  Fed starts to lower rates;
  2. "There are no repo lending problems"...(Federal Reserve - Aug 2019) < Credit markets' response..."Yeah...there are"; Fed embarks on Q.E. 4 (they won't call it that, but it doesn't matter; that's what it is);
  3. 2020:  The Chinese Year of the Rat> "We're not gonna raise rates in 2020 [into 2021 (emphasis mine)]." < Credit markets' response..."Yeah...no kidding...you're gonna lower rates...and not just once."
    1. ** Please note that the quotes above in points 1-3 are not actual quotes I'm citing from Powell and the Fed, just what the suppositions were at the time by market participants.

The credit markets are a BIG DEAL.  A BIG, BIG, BIG DEAL.  

Without cheap, liquid credit, this whole thing we call a Global Economy comes to a halt.  

PROOF?

The new, closely watched and closely controlled SOFR rate which is intended to replace the LIBOR rate in / around 2021, on Friday, September 13'th, this SOFR rate traded at 2.20%.  By Tuesday, September, 17'th, that SOFR rate traded at 5.25%!  Similarly, the overnight Federal Reserve repo rate was over 9%!  Why? 

The credit markets said so.  You see, (rough example): I will loan you money really, really cheap because I know you'll pay me back...until I start to think you might not because of all the money that you owe other people and then I decide NOT to...and THEN...well, the Fed's gotta step in with big guns.  

A repurchase agreement (repo), transaction is a short-term (usually overnight), collateralized loan, in which the borrower (of cash), sells a security (typically government bonds as collateral), to the lender, with a commitment to buy it back later at the same price plus interest.  It is a crucial form of short-term borrowing for dealers in government securities.  At the current pace of recent [Fed liquidity] injections [Q.E. 4 (my emphasis here)], the Fed would own 20% of the T-bill market within six months compared with 1% today.

"There was not enough liquidity provided into the marketplace by lenders and borrowers in the overnight market.  The banking system was sufficiently drained of liquidity and there weren't enough overnight lenders to keep rates within the Fed's target range." Steve Skancke (formerly of the U.S. Treasury's economic and policy team

"The freezing-up of repo markets was one of the most damaging aspects of the Great Financial Crisis (GFC)."  Fernando Avalos - Senior Economist, Monetary & Economic Dept., Financial Markets - Bank of International Settlements - December 8, 2019

"This is now far bigger than anyone thought this was going to be.  I think they're hoping that the market will magically fix itself.  I don't see why it would."  Jim Bianco - Bianco Research - December 2, 2019

This is a chart of the Secured Overnight Financing Rate (SOFR): (From NY Fed website)

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The Fed and the BLS measure and report inflation differently  

The Fed's preferred measure of inflation is their PCE deflator index.  The CPI is the index that the BLS (Bureau of Labor & Statistics), uses to measure CPI inflation.

Does it ever seem like there's a disconnect?  Yep.  There is.  This is for a number of reasons having to do with their separate methodology and weightings of components within each index.  Importantly, your own personal inflation experience varies greatly depending on how you live your life and what's going on in your life during any given month.  That's why the term financial repression that was coined years ago is appropriately named:  during deflationary periods like the one we're living in, interest rates on safe investments tend to be lower than the historical average while the costs for many of the goods and services that regular people purchase increase over time (think healthcare services and college tuition and toothpaste).

But as a mentor pointed out today, "The weight of shelter costs in the CPI basket (33%) is about double what it is in the Fed's preferred PCE deflator."  David Rosenberg - Chief Economist - Gluskin Sheff - December 12, 2019

How much more will housing prices and personal incomes need to move higher (and stay for a while in a higher range), in order for the Fed (using their PCE deflator methodology which excludes food and energy costs), to actually RAISE interest rates.  Jerome Powell said two days ago (my paraphrase here):  quite a bit.  So far be it for me to say the stock market's gonna crash DESPITE us going thru a four quarter earnings recession in 2019 and the stock market indexes climbing as much as they did (liquidity and momentum driven (not fundamental improvement in the underlying economy (think year 2000)).

Powell and The Fed are scared to death of the end of this cycle.  They don't want to be on the payroll when it happens.  You may want to be light risky investments around that time as well.

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Rate cuts are not bullish

Ten years in and some folks are thinking that the Fed has engineered some sort of economic nirvana where we don't have cycles any more.  I don't subscribe to that theory.  I also don't think that this is a 'mid-cycle adjustment' and that the Fed pauses and then raises rates again without causing serious damage.  I think the credit markets will force their hand to cut rates before they raise rates (with any sort of pattern).  The Fed Funds rate has most likely peaked for the cycle.  And that's not positive that our economy is so fragile and so addicted to cheap debt that it has to be on this level of life support and recession-level monetary accommodation.  Imagine where things go when we do actually have a significant slowdown...or do those not occur anymore?

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"Okay, Jack...I get a little bit of your world-view on the capital markets...but what are you buying?"

A list of some of the securities we've invested in since August Insights:

(Muni Bond) Racine, Wisconsin AA- rated Municipal bonds with a 2% taxable yield to worst (owned 4 months);

(Stock) New Jersey-based B&G Foods (NYSE symbol:  BGS (owner of Green Giant vegetables and many items you'll find in your cupboard), sporting an 11% common dividend (which I expect to be cut in half within the next 18 months (I am hopeful but company has made no mention of this)), to improve the credit ratings on the company's debt and trades at 0.7 Price to Sales;

(ETF) Physical Silver Trust iShares (SLV) ((hedge; no income));

(CD) BMO Harris AAA rated CD (Certificate of Deposit);

(Corp bond) Transcanada BBB- rated 5.5% long term bond;

(Corp bond and stock both) Olin Corp (4%+ (bonds are BB+ rated)); 

(Corp bond) Aircastle BBB- rated Corp bonds;

(Muni bond) Napa Valley, California A1 rated tax-free, General Obligation municipal bonds;

(Volatility ETF) Volatility Index (VXX) ((hedge; no income));

(Pref stock) AT&T BBB- rated preferred stock yielding 5% per year;

(Corp bond) Bank of America A2 rated short term bonds;

(Pref stock) Allstate BBB rated Preferred stock;

(Corp bond) Liberty Media 8.25% B+ rated bonds (owner of the Atlanta Braves and Sirius radio among other assets);

(Corp bond) Murphy Oil Ba2 rated bonds;

(Corp bond) Lexington Realty BBB- rated Corp bonds;

(Stock) Kinder Morgan KMI stock (5% dividend);

(Corp bond) Monsanto BBB rated bonds;

(Corp bond) CNF (XPO Logistics is parent), B+ rated transportation (trucking), bonds;

(Corp bond) Ford Motor BBB- rated (but bond rating likely cut to BB+ by end of 2021), Company bonds;

(Institutional stock Fund) Fidelity Japan Institutional fund;

(Corp bond) Western Digital BB+ rated bonds;

(Corp bond) Goodyear Tire BB- rated bonds;

(ETF) U.S. energy iShare ETF (IYE) [4% yield];

(Corp bond) Teva Pharmaceuticals duration 7% yielding bonds;

(Pref stock) Virginia-based utility, Dominion Resources BBB rated preferred stock.

Note:  we invested more heavily in U.S. based energy (oil and gas), than usual for folks that didn't already have a decent weighting because the entire energy complex (based on market capitalization), combined, totals less than the market cap for Apple stock.  That doesn't happen often and offers select opportunities.  Several names within oil and gas are problems, but it created opportunities for us.

Notable portfolio updates:  BB&T shareholders now see symbol:  TFC (Truist) in their statements post-merger between BB&T and SunTrust.

Technology stocks certainly performed better than we expected as well as consumer staples and even some cyclical names like International Paper had a good year.  In 2019, there were very few detractors despite the earnings recession (that no one mentions), we've endured.  That the indices enjoyed such a march-up despite the weaker YoY fundamentals (what's called a multiple expansion), doesn't bode well for 2020 performance expectations despite what the cheerleaders would have you believe.  That statement is based on history not some prognostication.

We enter 2020 being conservatively positioned.  We are positioned for a variety of outcomes.  I believe our portfolios are very well-positioned for a recession in 2020; I'm expecting much more volatility around interest rates in the private sector next year.  I'm expecting an increase of bankruptcies, less gargantuan share buybacks by big S&P names, fewer huge M&A deals, maybe a rate cut or two out of the Fed (not enough acuity on that yet).  I wouldn't rule out a further melt-up in the equity markets, but I'm telling people to be on the lookout for a 30% correction in the S&P 500. 

Just a comment here:  at 10 years into the cycle, it should concern investors that the Fed can't raise rates; that the economy is SO fragile, and inflation as measured by personal income and productivity is so anemic and yet financial asset price inflation is rampant.  That condition always portends deflationary busts.  

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In closing, like a lot of folks that work in the financial services industry, it's been a good year.  Not to throw water on a nice, comfortable, warm, campfire, but let's not extrapolate into the future what has worked in the past.  I don't think it's gonna be 'Easy Street' next year.  Dr. David Kelly, JP Morgan Chief Global Strategist, said today, "It's very much time for tweaks to conventional retirement portfolios."  Gary Shilling ended an article he penned in November like this:

"My advice to individual and institutional investors:  reduce your leverage and risk and adapt to an era of chronic flat real interest rates."  Gary Shilling - Bloomberg View - November, 2019

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Thank you so much for your business / interest in our company and how we can serve you and your family, trustees and/or beneficiaries, neighbors, advisors and colleagues. 

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

Have a VERY, Merry Christmas and a Happy New Year 2020 !

Yours,

Jack Parsons CTFA, AEP

President & Chief Investment Officer

Vickery Creek Capital Management, LLC

Sources:  Bloomberg, CNBC, Marketwatch, Thomson-Reuters, Fidelity Institutional Wealth Services, Blackrock, Gluskin Sheff, Goldman Sachs, Morgan Stanley, JP Morgan, Doubleline Funds, Haver Analytics, Financial Times, The Economist, NY Federal Reserve, St. Louis Federal Reserve, Atlanta Federal Reserve, San Francisco Federal Reserve, Bank of International Settlements, Bureau of Labor & Statistics, AgWeb (Powered by Farm Journal), CME Group, "Central Banks at a Crossroads - What can we learn from history?" - Bordo, Eitrheim, Flandreau & Qvigstad - Cambridge University Press 2016, LIBOR & SOFR rates (datasets & research & analyses), NY Fed Research & Statistics Group, Mike Kee - Intoon, Hedgeye cartoons, The Simpsons (Fox), Duke CFO survey, Gary Shilling, Barron's, Jeffrey Gundlach, "Inside the Yield Book - The Classic that created the science of Bond Analysis" - Martin Leibowitz & Sidney Homer - Wiley & Sons (Bloomberg Series) 2013, 'Funding Crunch In Short-Term Lending Raises Alarm' - Danielle Park, CFA - Seeking Alpha - Dec 6,'19, S&P Global Market Intelligence, Moody's, Vickery Creek Capital Mgmt., LLC Proprietary Research,  iR Research

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