Good morning / evening. I hope that spring went well and that this summer season is going well for you and your loved ones.
"I can calculate the motions of the heavenly bodies but not the madness of the people." Sir Isaac Newton; the year was 1720 (during the British speculative investing era referred to as 'the South Sea Bubble').
Fear Of Missing Out (definition): anxiety that an exciting or interesting event may currently be happening elsewhere, often aroused by posts seen on social media.
Inflation (definition): a general increase in prices due to actual or perceived changes in supply and demand.
Extrapolation (definition): 1) the action of estimating or concluding something by assuming that existing trends will continue or a current method will remain applicable.
2) the extension of a graph, curve, or range of values by inferring unknown values from trends in the known data.
Hysteria (definition): exaggerated or uncontrollable emotion or excitement, especially among a group of people.
EVERYONE is an inflation expert now
The number one Google search for several weeks this year has been 'what is inflation?'
In my nearly 25 years in this business, I've never seen so many economists, pundits, strategists and investors trying to "call" inflation. WOW. The cover of Barron's last month showed the "I" word. Smart people like Bootle, Gundlach and Boockvar are saying inflation is not going to be transitory; that it's here to stay. "Look out! The invisible virus is gonna get you and the visible inflation is gonna get you!"...I'm not sure what they're trying to prove here by trying to call it before we get even 12 good, natural, (non-wonky) data-months to trend and analyze, but it's absolutely ridiculous. They're acting like ambulance-chasing, crazy people, reporting data points without analysis, immediately after the entire global economy was 'shut down' and thrown gobs of free money. Let's examine this file again in June 2022 and see where we are after we've been 'opened up' for a full year. This environment can remain longer than usual, but NOT for long.
I'm not denying we're seeing price inflation, (the numbers are the numbers), I'm just agreeing with the Fed (on this topic and right now (not always)), that the current price inflation will prove to be transitory
This is a chart of the cumulative inflation surprise index courtesy of Haver Analytics (I've doctored it a bit for an analogous comparison). The last time we saw this type of an upswing in the index we saw ten years of disinflation afterwards. I'm not saying this time will be the same, but prove to me that it won't be at least similar...
So do you see why I call this edition Inflation-Extrapolation Hysteria?
Another hysterical example:
"I gotta get me some lumber !!!!!!!!!"
This is a 25 year chart of the price of lumber (below). Some lumber mills were shut down as long as three months during the height of Covid. For example, in March 2020, Interfor, the world's fifth largest lumber producer cut their production by 60% for two weeks in British Columbia (Source: Woodworking Network).
Do you think that shutting down the mills affected supply much while simultaneously so many folks increased demand for that product? Do you think supply will ever catch up? Answer to both questions: YES (with emphasis). Will the price adjust (and normalize lower)? Answer: YES (again, with emphasis).
Should a buyer of lumber extrapolate the current prices of lumber to be this high for very long into the future? I'm not forecasting the price of lumber here, I'm simply showing a long-view chart of a commodity to make a point:
- Maybe don't extrapolate a once in a 100 year parabolic price-swing very far into the future
Not trying to be a 'know-it-all' here
Look, I'm not trying to be difficult here, and I'm not arguing that oil prices have not increased substantially and that used car prices are crazy high and that basically all financial asset prices are inflating and many are 'stupid-high' and in bubble territory. I am a strong believer in supply and demand. You are paying more for college in 2022 than you did in 1991. That is inflation.
My whole thing has been and will always be what is the direction of interest rates of the investments I'm invested/investing in?
It's one thing if you work for the Bureau of Labor and Statistics or for the New York Federal Reserve as an inflation expert. I have a good friend who does that in D.C. But guess what?...
The direction of U.S. Treasury interest rates is lower. Don't buy the hype. If we're lucky, the Fed can get the terminus as high as 2% on the Fed Funds Rate before the economy begins to implode. I don't think they'll be able to get it that high, though, the next rate raising cycle.
Risk interest rates are very, very stupidly and unsustainably low. They do not account for a realistic default rate scenario. But hopefully by 2022 that'll start to change and we can get back to being bond investors in full earnest again.
You don't always have to invest in the stock part of the capital structure and conversely, you don't always have to invest in the bond part of the capital structure. Especially at this point in the cycle, it's all about proper asset allocation. How, where and why are you invested? It matters when the tide goes out.
The reason I'm being like this is because there will turn out to be two years of data to throw out from this Covid recession. Year one will be the 'shut down' year where the data is very wonky and almost useless. Year two will be the 'open up' year when the data is compared to wonky data and that's not terribly helpful.
Importantly, Rosenberg's research team just concluded that consumer durable goods spending for the last fifteen months has been equivalent to six full years of spending. Six full years of pulled forward spending. WOW. Extrapolating this level of temporary, supply-chain-caused and speculative inflation is hysteria of the highest and least analytical order.
Interest rates and capital markets update
"If we ended up with a slightly higher interest rate environment it would actually be a plus for society's point of view and the Fed's point of view." Janet Yellen - U.S. Treasury Secretary - June 5, 2021
Put on your thinking hat for one quick second and think about what that infers:
Low interest rates are a negative for society. Right? Low interest rates have wrecked capital markets in Japan and Europe. And they're wrecking capital markets in the U.S. (as you know I've been saying for years). It doesn't look like it, though, right? It's the ultimate, speculative elixir. (Just give me my sub 3% mortgage and 2% margin rate; those are all I care about (with sarcasm)). Oh and also my Reddit-feed with my meme stock buy list.
Check out this updated chart on margin debt:
The Reddit markets
Just an observation here: AMC had a market cap of $27B yesterday. Their single C rated, (senior secured) corporate bonds shouldn't be bought by anyone (my opinion), much less their common stock. The stock is trading at 6X pre-Covid sales. But what do I know, right?
I'm not trying to be undemocratic here or cavalier, everyone's entitled to their opinion-I am just deeply concerned about how many young people may get burned by the hype being thrown about in chat rooms on the internet about stock trading in stocks that are fundamentally worthless because the underlying companies are not profitable and the debt is close to worthless and yet the prices are being driven higher using 'the greater fool theory'.
How does that end? At the end of the day, I don't have a blind faith that any single investment will 'just go higher'; each one is based on lots and lots of research and each one has financial merit, not just hype in some fantastical turnaround story.
If you've been a client for more than 10 years, you may remember our Scholastic Corp., bonds. Parenthetically here, 'those were great bonds!' 8% per year before they were called.
We lost a great leader in Richard Robinson, age 84, former CEO of Scholastic Corp., the children's book company. What a track record and what a positive influence the company has had (as a direct results of his teamwork and leadership), over the years encouraging children to read and form critical thinking skills. So with that, I wanted to segue into "Interplanet-Janet" (of Schoolhouse Rock fame). Most of you know Schoolhouse Rock that taught American kids ways to remember the process of how a bill becomes a law with songs like, "I'm just a Bill".
The character, "Interplanet-Janet ", was the character who'd traveled all over the solar system and that was very wise. As the song rolls, "Oh, there's never been a planet Janet hasn't seen."
Janet Yellen, as Biden's Treasury Secretary (no one questions how smart and experienced she is (I don't at least)), is becoming the road show cheerleader for some seriously, audacious spending plans. As Rosenberg said recently, "The only thing the Biden spending plans insure is the boom-bust cycle." Agreed.
(The AMC debt (but not the Scholastic debt), mentioned earlier in this edition would fall into this category of debt (chart below))
The Fed and the US Treasury are zombifying the very riskiest part of the junk bond market. It's not good. The Bank of Japan received a ton of criticism by Bernanke back in 2002 over the BOJ's zombifying of the banks in Japan. What this Fed and UST have done with the Main Street Lending and PPP programs is much worse. They're zombifying a broad group of sectors, not just the banks.
Consumer Goods Price Inflation and STILL lower interest rates on the horizon for the U.S.?
Even Japan has seen positive consumer goods inflation (from 2017- to start of Covid), in the neighborhood of ~+0.2% - ~+2.3% (data thanks to Haver Analytics), despite all of the disinflation news and yet their 10 year bond yields have still traded ~range of -0.28% - +0.15% (next slide)...
"Is that ALL you get for your money?" - lyrics from Movin' Out song by Billy Joel
That's a low yield...(Japan's 10 year JGB yield during a period of Consumer Price Inflation)
Finally, some good news for fans of naturally-functioning credit markets (as opposed to markets so heavily influenced by the strong arm of government).
Last Thursday, The NY Fed announced the start of the SMCCF (Secondary Market Corporate Credit Facility), wind-down. The Fed will be selling (with Blackrock's help), corporate bond ETFs and individual corporate bonds beginning June 7, 2021 and will conclude by the end of the calendar year. That's good news for investors who like to buy low (or at least at a reasonable price), and hold or sell high. I cannot say that the Fed won't be back in the credit markets pulling similar shenanigans again during the next recession, but all I can say, is that it's a positive development.
See the red, line segment in the above graph with two opposite directional arrows? That approximate ~7% is my country-boy guesstimate of what the Fed's Trillions of 'Stimulus' & SMCCF did to pricing. I do not mean to infer that some of those bonds will re-price to ~14%, I just mean that even though the winding down of the facility from its apex is only seeing ~$14B worth of securities sold (the facility was granted $750B leeway), the messaging of such a move was indeed without precedence and was a HUGE influence on capital markets pricing of risk. So that means that theoretically, between today and January 2022 this will help return the credit markets to a somewhat, more normal pricing-function (hopefully-fingers crossed). This timeframe should also be a few months into the post-heavy-handout era: September 2021 and earlier in some states, marks the ending of the extended unemployment benefits, and most likely coincides with the ending of eviction moratoriums and mortgage forbearance as well. This is not meant to sound mean and insensitive, it's simply to say that capitalism works best when the natural rules aren't jimmied with too much. We've got to get back to healthy price discovery and risk pricing within capital markets. It's a must. The Fed must agree or they wouldn't be concluding programs intended to "support credit to large employers by providing liquidity to outstanding corporate bonds of Eligible Issuers in the secondary market." (Source: NY Fed SMCCF website).
Uninterrupted Income examples:
Honda Motor Corp (NYSE ADR: HMC)
Up 17.5% YTD now trades at 0.5x Price to Sales (still paying a 3% dividend) and the dividend hasn't been cut through the pandemic like Ford Motor Corp common stock (we own their bonds (Ford), to 2046 and have around a 10% annual yield locked in based off of our purchase price).
So that's a reminder that sometimes it makes sense to own the common stock part of the capital structure and sometimes it makes sense to own the bonds.
Given those two examples, our income from the Auto sector has remained unchanged throughout the pandemic as Honda has paid the common dividends and Ford Motor has paid the interest on their bonds (even though Ford cut their common dividend during Covid and is not currently paying one).
Semiconductor chip investments:
We own Seagate and Western Digital bonds ~6% per year and that income has continued uninterrupted despite WDC common dividend being cut (doesn't affect us). Additionally, Intel has paid their common dividend and is a stock that is somewhat reasonably valued, has a good dividend, is actually building a plant and growing their business, has improving margins, and also is seeing some of the only insider BUYING around.
Uninterrupted income is, ahem, a very good thing indeed (duh!) ((inferred smiley face here))
Peter & Paul
Let's hope that Peter doesn't get robbed any more and that Paul doesn't expect a hand out.
Never before has the public purse been robbed so eggregiously, without shame, audit, sufficient reason, and accountability.
I am hoping that in 2021-2022, fraud in cryptocurrency will come to the forefront. Maybe then, the fraud in PPP loans and unemployment monies will surface by 2022-2023.
We are positioned with heartier portions of cash and liquidity than normal to take advantage of dislocations in the market some time in the near future.
It's foolish to not trim your speculative stock holdings at a time when the Insider Trading Sells to Buys Ratio is 143X. I've never seen it anywhere close to that in my career (it doesn't mean it hasn't been that high, I've just never seen it that one-sided).
Update from January Walmart bicycle supply shortage (just my local store, not deep, exhaustive, analytic, inventory research (see January edition of Insights for that picture of totally empty shelves))
Picture taken today, June 10, 2021
In closing, let's finish up with another humility quote:
"I can't wait for this 10-hour bus ride home. I never want it to end." - Coach Lars Tiffany (UVA Men's Lacrosse Coach after winning his second national championship).
I have a great job and you and people like you make it possible. Thank you.
Have a wonderful summer! Here's to your health!
Jack Parsons CTFA, AEP
President & Chief Investment Officer
Vickery Creek Capital Management, LLC
Sources: St. Louis Federal Reserve, NY Fed Research & Statistics Group, NY Fed Secondary Market Corporate Credit Facility (policy & implementation group), San Francisco Federal Reserve, Bureau of Labor & Statistics, Blackrock, Fidelity Institutional Wealth Services, S&P Global Market Intelligence, Rosenberg Research, Haver Analytics, Smarsh, "Money for Nothing: Real Wealth, Financial Fantasies and the Economy of the Future" - by Roger Bootle (Nicholas Brealey Publishing), "A History of Interest Rates" - by Homer & Sylla (Wiley), "Manias, Panics & Crashes - A History of Financial Crises" - by Charles Kindleberger (Wiley), Dr. Lacy Hunt - Van Hoisington, Yardeni Research, Arbor Data Science, Advisor Perspectives, Trading Economics, Statistics Canada, Woodworking Network, Capitol Economics, Intel - investor relations website, Charles Schwab, The Conference Board, Annual SIC Conference-Mauldin Economics, Ned Davis Research, Factset, Marketwatch, Google, CNBC: 'Scott Gottlieb: Vaccines not the only factor driving Covid cases (May 21, 2021), McKinsey & Co, Reddit, NY Fed staff report paper #971: "Interest, Reserves and Prices" - by Gianluca Benigno & Pierpaolo Benigno - June 2021, Ctr. for Macro Data-Household Debt & Credit-NY Fed (released May 2021), "The Case Against An Inflation Surge" - by Andrew Cates - Haver Analytics - May 20, 2021, iR Research, Vickery Creek Capital Mgmt, LLC