Broker Check

From interest rate risks to credit risks

March 24, 2023

Greetings and Happy Spring!  I hope that your winter was reasonable, the start to your spring is good; your health is good, your relationships are strong and you're as content as you can be under the circumstances.  Circumstances?  What circumstances...?...  Well... the know; where chaos seems to be the norm...

Photo:  On a hike with my daughter near Yankee Boy Basin, near Ouray, Colorado - July 2022


"Civilization begins with order, grows with liberty, and dies with chaos." - Will Durant

"There cannot be a crisis next week.  My schedule is already full." - Henry Kissinger

I'm taking a break from the seasonal quotes and going straight to the heart of the chaos in the markets for this post.  I hope that's okay...


Strong Banks, Strong Economy; Weak Banks, Weak Economy

Chaos and weakness cause a severe RE-EVALUATION of asset values (a good thing, but is painful during the process).

Remember me saying in November 2022 that the magnitude and duration of this increase in the Fed Funds rate was historic and that they did in 9 months what last time took them 26 months? we are.  The metaphorical apple cart has been knocked over and the Feds are in the process of picking them all back up and putting them back into newly created carts that will, on a forward-looking basis have more scrutiny, tighter lending standards, and restrictions and this and many other things occurring at this point in the credit cycle are DISINFLATIONARY.

What are we doin'?

Please remember that we are primarily invested in the leading parts (most are part of the S&P 500 or the Russell 2000), of the industrial, manufacturing and distribution complex in the United States of America and the mostly-free democratic regions of the world (through mostly American & Canadian based companies), though we do have light European and Asian based exposure.  We are heavily invested in the Senior debt of those corporations.  We are also heavily invested in the municipal bonds issued by some of the strongest municipal bond issuers in the world with some of the best balance sheets and coverage ratios available and some of those have insurance, and US Treasuries and US Agencies.  These bonds have above-market coupon rates carefully selected mostly in the secondary markets.  For some clients, we do own some equities (i.e. stocks), but very little, and the ones we do own are priced reasonably based on price to sales metrics, and those stocks are notably getting cheaper and cheaper and likely to get even cheaper still due to the 'lags effect' of monetary policy tightening and tighter overall financial conditions (this increases to costs of borrowing).  Margin debt loans under $1mm are now around 10.7%.  That's very significant.



Kinder Morgan Bonds and stock (NYSE:  KMI), for that matter (I think the equity shares are very attractive as well for certain risk tolerances and time horizons)


KMI 8.05% fixed coupon, non-callable, 5.6% yielding (if purchased today, but most clients have a better buy price and are closer to 7-8% yields per year), maturing in 2030


Question I'm getting a lot of late:  "With new money, how do I avoid big mistakes in the stock market?"

Jim O'Shaughnessy wrote a 650 page book (that's more pages than what Warren Buffett calls his 'investing bible' (Security Analysis by Graham & Dodd) has)), called 'What Works on Wall Street', and really it can be summed up in just a few words [my emphasis here]:  Don't buy high price to sales stocks in a recession.

The Japanification of the Price to Sales metrics in the United States

I've written and spoken extensively about the 'Japan-ification' of the Federal Balance Sheets and interest rates in the USA.  We're about to live through the Japanification of the price to sales metric within equity markets.  I'm not going to camp out here, I'm just introducing a concept:

Honda Motor Corp (NYSE ADR:  HMC), stock trades at 0.4 price to sales.  I can remember when it traded for years in the 2.0-2.4 range.

Home Depot (NYSE:  HD), stock trades at 2.0 price to sales.  They've amassed $43 Billion USD in debt.  Almost twice the level they had 5 years ago.  Costco trades at 0.9 P/S, CVS trades at 0.3 P/S, Kroger trades at 0.2 price to sales.  HD won't be able to sustain a P/S ratio that high in coming years I don't believe.

Look for the cap-weighted (the regular old S&P 500), to go down 20-30% (base-case), in the coming quarters, and the Nasdaq?  Well, let's just say that AAPL on a reasonable, recession-projected looking sales comparison (NOT trailing sales), is trading around a 9-10 x P/S basis.  And many of the components in the Nasdaq 100 are, in my estimation, trading at 2-3X reasonable price to sales ratios.  So I'll let you guess where I think those names are headed.

That's not meant to be pessimistic or bearish or anything negative, it is meant to be a clinical and historic observation.


Top concerns 

The absolute lack of true engagement with all leaders, regardless of ideology, on the global stage by US leadership, is my #1 concern.  We send money we don't have; we bailout things our government can't legally bailout... again, with money we don't have...There are huge, important meetings happening, and the USA and other free, capitalist countries don't have a member present at that meeting.  It's just bad guys.  No good guys.  Es no bueno.

My top capital market concerns right now are commercial real estate and regional banks. 

I want to buy back Cousins Properties REIT, but until we get better acuity into CRE and this credit crunch we're living in with the banks, I cannot.  I also want to buy back the position in our institutional Real Estate Portfolio fund but I cannot do that either.

This is a chart of the small bank share of CRE lending: 

Here's Fidelity Capital Markets' take on the Sillicon Valley Bank collapse in case you're interested:  Fidelity's take on SVB collapse-Mar 2023

SVB was the 16'th largest bank in the USA until 2 Fridays ago today, and to my understanding, they couldn't find a buyer and still can't and have declared bankruptcy.

Yellen and Powell are downplaying how serious this situation is.  It'll get fixed and banks will have to be able to attract capital for investment, period.  Yellen intimating that bondholders and preferred stock holders won't be 'protected', just depositors, is surely a popular, politically populist message, but it's illegal to say that when there are legal contracts involved between bondholders and banks.  But, I took it seriously and sold all of the regional bank preferred shares I thought could be subject to 'drama'.


Better value in some parts of the yield curve with some bonds than 12 months ago

A sample (but a real), portfolio with money put to work approx 12 months ago.  This portfolio yields 6% per year for approx 5.85 years.  If I were to put this together today and deploy the same strategy, you'd pick up about 100 bps more in yield per year (based on today's pricing-figures (always subject to change of course))



Inflation is SO yesterday.  

Please also look through the windshield (future business activity), instead of only into the rear-view mirror (past inflation data)

Philadelphia Federal Reserve Future Business Activity Composite Index - Fed 2023


The shaky bank situation will continue to unfold.  At the time of this writing, our Fidelity Government Money Market currently has a 7 day yield of 4.21% (before the 25 bps increase in the FF rate by the Fed this past Wednesday).  ** Caveat here:  please note that the Fed will likely be lowering the Federal Funds rate before the end of the year and so don't 'bank' on those yields long term.

We're in good shape even though it sometimes doesn't feel like it I'm sure.  I'm gonna guess that reasonable price discovery for bond prices won't stabilize for a little while longer now as spreads and volatility remain elevated for the next few months.  That's opportunistic though and a great time to put money to work in bonds.  


KB Homes:  #1 ranked National Homebuilder:  6.875% (fixed coupon), with a 6.25% YTM and matures in 2027.  The company that was founded in 1957 utilizes a Built to Order Model which aligns supply and demand and so it reduces speculative inventory.  They have 11% less overall debt than they did 5 years ago, have learned SO many things since the GFC in 2008 and therefore I think goes through the recession with only a one notch downgrade on their debt, and so let's score 6.25% per year for 4 years by being their bank.


Rates going lower just as I've said (not trying to sound like a know-it-all)

PLEASE REMEMBER:  interest rates ALWAYS go LOWER during recessions.  That's why I carefully get clients good bond yields during times of distress.

  In many ways, it's a great time to invest!  

In closing...

Question:  Does it seem like the economy likes higher interest rates?  Answer: NO.  Can central banks keep talking tough and pounding their chests and sayin' like a bully, 'yeah-yeah!' and continue raising rates in full earnest...?...  NO.  Look for a pause and lower rates on the horizon.  And also look for a LOT of theater out of DC as political leaders try to convince us that our kids are not going to have to work until age 72 and still may not qualify for Social Security because it'll be means-tested and if they're successful on their own, they'll be penalized.  That means you need a 'private pension', by the way.  Lots of stuff needs fixin'.  But, ironically, against that backdrop, is a capital market investing landscape that is in the process of becoming more reasonable (it was asset bubbles everywhere before this).  In November 2022, I said 'Bond Bull Market 2023-2024', let me revise that at this point and now with conviction say, Bond Bull Market 2023-2025.  Things are far from perfect, but at least we're on our way towards assets being more fairly-valued.  On that, I'll say...

Have a wonderful Spring!  

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, “NY Fed DSGE Model Forecast-March 2023”-Liberty Street Economics,"Fiscal Policy Under Low Interest Rates" - Olivier Blanchard; MIT Press, "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, 2021 – Dec 7, “The War on the West” – Douglas Murray – Broadside Books,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, "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 Studypodcast], 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, KB Homes Investor Presentation; Capital Structure page 23-First Q 2023, "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.