Greetings! I hope that your spring and summer have gone well in 2019, and that it's been a healthy and prosperous year so far!
Well, well, well... where to start, eh? Does it seem to you that the world is a tad chaotic right now...?...
Let's start with a Thomas Jefferson quote:
"Do not bite at the bait of pleasure, till you know there is no hook beneath it." - Thomas Jefferson
My son and I were boating on Lake Lanier last week and we saw a 15 lb+ striped bass floating on the surface of the water. My guess is that the fish took the bait without knowing there was a hook beneath it, broke the line, and eventually wound up a floater (sorry to be crass here, but I felt this was appropriately analogous to folks being fully invested in risky assets right now).
Here's a little levity before we get into this edition of Insights (cartoon below).
By way of review from our last Insights:
- In January, I said that 10 year UST yields peaked in November 2018, and that they would go lower to move closer to their German bund counterparts, and they have (chart below is from February 1'st thru August 6'th, 2019 (last Insights published January 31, 2019)). Yields went lower 34.5%. That's a move.
We will have a recession (we're probably in a global one now). There's NOTHING the Fed can do (with their traditional policy tools at this point), to keep us from having a recession. Low rates ARE NOT the answer. The cure for a debt problem is not more debt.
- (Chart below illustrates spread between 10 year UST and 10 year German Bund)
- I asked if we were in / headed for a recession based on what the 5 year UST minus the FF rate relationship looked like.
- By the way, on this topic, it's not a matter of IF any more, it's simply WHEN (and it'll be soon if we're not already there, and it's global, not just local)...
- From January 2019 Insights: The credit markets told us loud and clear in December 2018 that the Fed has tightened too much. The Fed's talk about the "neutral rate", appears to be around 2.0-2.5%. Unfortunately, with the gargantuan amount of debt outstanding and with a culture and an economy so addicted to LOW interest rates, the Fed will most likely be lowering rates before the end of 2020 (maybe before the end of 2019)
- [UPDATE: Fed lowered FF rate by 25 bps in July 2019. They also lowered their perception of where the neutral rate actually is in July. Their next meeting is in September. They are most likely going to lower by 25 bps more, and there's a 50/50 chance they'll lower by 50 bps in September].
I said this and I believe it; I am a student of the credit markets and I know them fairly well. BUT, and I've been catching a lot of flack lately, I wish the Fed hadn't done anything in July. They didn't need to. There's time. By the way, it doesn't matter what I think they should do it matters that we read them right on what they're actually gonna do...
Why would I say that? Can't I see that the stock market is crumbling and the Fed HAS TO DO SOMETHING???
This is a chart (below), of Outstanding Commercial Real Estate Loans (YoY (end of July 18-19), in the U.S., which consists of Construction & Land Development Loans at all commercial banks.
QUESTION: Does it look to you like interest rates are restrictive to growth and should be lowered? Short answer: NO
QUESTION: Does it look like financial conditions were tight in July and needed to be looser? Short answer: NO
The Fed is scared of three things at present:
1) Another credit market freeze-up or "TIGHT 2.0";
3) Global recession.
Again, I say...BUY BONDS...(you tired of hearing me say it yet)...?...
The SCARCITY of higher quality, dependable bonds with above-market rates of return is SO prevalent. We've been long duration selectively for a while now and so new money can still buy the bonds we own, but they're bought with a lot lower yield now than our price entry-points.
"After the recent selloff global HY spreads are now relatively more dislocated, offering a tactical opportunity to earn a pickup in spread." Joe Keenan, Blackrock - August 8'th, 2019
Case in point:
El Paso Energy (wholly owned by Kinder Morgan), 8.05% to 2030 Senior bonds BBB-rated (non-callable), mostly with an 8-12% annual yield (varies as to when you became a client and when you put money to work with us), are up anywhere from 10-30% in value. I fully expect this credit to be upgraded in credit quality even during the next recession.
Stocks? Not emerging markets. Japan? Yes. Korea? Yes. Investing in partial positions into some US Industrial Corporations knowing that we're not investing in full positions but only small ones? Yes. Many stocks are gonna get whacked more. Too many folks are glued to their TV sets to say we've put in a bottom in capitulation yet. The Price to Sales valuations on some of the popular growth stocks within the S&P 500 are utterly ridiculous. Paying that much is just nuts. It's not that they're bad companies, it's that they're TOO EXPENSIVE. I can't rule out the possibility that if there's a "deal" (trade deal between China and U.S. (don't hold your breath)), that there won't be some whipsaw rebound higher for stocks, but the economic damage is done and we're most likely in a global recession now; but even if we're not, we will be.
And, let's not buy many, let's wait, but let's buy some value stocks in here:
Olin Corp (I like two of their BB+ rated bonds, too, with 5% yields), stock's (NYSE: OLN), now down -40%, trades at only 0.4 Price to Sales, pays a manageable 4.53% dividend, has around a 0.93 PEG ratio, has a healthy balance sheet, obviously has overseas concerns for sure and missed EPS by 4 cents recently, but I love that type of price entry point with that type of company that makes stuff that the global economy has to have and they're a top player in all of their businesses.
Update on composition of U.S. Household Balance Sheet
Let's just look at the composition of Total Debt Balance in Trillions of USD chart that the NY Fed released in May (this is not even looking at global figures, this is just the U.S.)
"The financing of bubbles is much more relevant than the type of bubble asset" - Marcus Brunnermeier & Isabel Schnabel - "Bubbles and Central Banks: Historical Perspectives" - Central Banks at a Crossroads - What we can learn from History
The asset bubbles are numerous. There's not just one and it's not contained to one corner of the globe. And the experts who studied bubbles throughout history concluded that the debt tied to the bubble is more important than the type of bubble asset (to repeat and paraphrase their above quote).
"The level of short-term interest rates within a country is even more difficult to define than the level of long-term interest rates because there are many types of prime short-term credit instruments, their rates differ widely, and they are often governed by banking legislation. The trends, however, are usually unambiguous. For the same reasons, short-term rates in different countries usually are not comparable, though trends in differentials can be stated with some precision." - A History of Interest Rates (4'th edition) - Homer & Sylla
Thanks to Dave Rosenberg, and his Economics team, at Gluskin Sheff, in Toronto, (chart below), you can see that this current version of the global debt bubble (Debt growth to Income growth), has eclipsed the bubble in 2007. And it DOES'NT MATTER that it's a different type of debt. Interest rates come down after these peak borrowing periods.
Debt as the illusion of growth
Please read Dave's quote here even if you read nothing of what I've written:
"For some perspective, we know that the mortgage boom in the USA, and China's discovering of leverage in the last cycle, helped propel outstanding global debt at all levels of society - household, business, and government - to $116 trillion at the 2007 bubble peak [and that was up] from $86 trillion at the peak of the 2000-2001 cycle [in 2019, it currently stands at $244 trillion!!! (emphasis mine)]. The increase in debt from cycle peak to cycle peak occurred with debt outstripping the income required to support that debt by a factor of five!" David Rosenberg - Chief Economist, Gluskin Sheff - August 7, 2019
Old, country music may have the answer
There's the world that the central banks live in and then there's the REAL WORLD
"Cowboys don't cry, and heroes don't die,
Good always wins, again and again,
And love is a sweet dream, that always comes true,
Oh if life were like the movies [FACEBOOK], I'd never be blue,
But here in the real world, it's not that easy at all,
'Cause when hearts get broken, it's real tears that fall."
- lyrics by Alan Jackson (Georgian country music singer "Here in the real world")
Historians are not going to be kind to the period of history we're living through right now.
Deflation. Inflation. Trade wars. Currency wars. High suicide rates. Severe gap between the have's and the have not's. The disintegration of western, Democratic ideals.
Real tears are gonna fall (credit markets will freeze up again and maybe sooner rather than later), and nobody's ready for it because of the low rates environment. The low rates environment doesn't apply to sketchy credits any more now, though. The credit markets are sniffing out issues...(see chart above ("Tight 2.0")), shows the calm before the storm) (LOOSE conditions just before TIGHT). I don't know if it'll be a run on Chinese banks, the prospect of Argentina defaulting on their debt like Russia did in 1998, or a series of large, corporate defaults, but the credit markets are not on good footing here.
NOW HERE'S THE GOOD NEWS!...
This WILL BE OPPORTUNISTIC!
In July of 2018, I said we'd have more inflation, and then a major deflationary bust. We're in that deflationary bust period right now.
You have to have a game plan and you have to be nimble and not rigid and even though it's critical you know your economic history, you can't play by the old playbook.
What do Churchill and Trump have to do with historically low interest rates?
Does this quote (below), seem like something President Trump would say about the Chinese during this current (2019), trade war?
"What kind of people do they think we are? Is it possible they do not realize that we shall never cease to persevere against them until they have been taught a lesson which they and the world will never forget?"
It's not Trump on the Chinese; it's Winston Churchill, on the Japanese, from 1942.
Government bond yields are headed lower, at least for the time being, and now are lower globally than they've been in 120 years.
"The last time global bond yields were this low, Winston Churchill was being captured, and then escaping, during the Anglo-Boer War." - Steve Goldstein - Marketwatch - Aug. 9'th, 2019
Question I've been fielding:
"What's the Fed going to do?" Drop rates. The only question is are they going to wait and be patient or are they going to be in crisis mode when they do...
Below is a chart with an estimate of how much I think the 10 yr UST will go down off of its peak from November 2018 (property iR Research, LLC), so I don't believe that the 10 yr will go negative during the next recession, but I wouldn't rule out the possibility. HOWEVER, I DO believe that there will be at least one AA+ rated corporate issuer and at least some front end parts of the UST curve that WILL go negative in the next recession. Whether or not it happens sort of doesn't matter, but the VERY IDEA that it COULD, should make all red-blooded capitalists throw their hands up in the air and tell Congress and the President, "Enough monkeying around without touching entitlement spending. You HAVE to address entitlement spending. If you don't, we're a European / Japanese hybrid in a few short years"
Another question I've been fielding:
How much of the stock market index move off of the bottom is the Fed's 'Magic'?
About THIS much...
The state of our business
I met with a prospective client recently who was interviewing me, considering hiring me to help them manage their wealth and they showed me several statements with managed funds and I asked them: "So what do you know about these funds, ETFs, these strategies?" Answer: "Nothing, really. Just that that's what my guy has me in."
Okay. I get it. Advisors are the experts and advise and manage the wealth and clients are responsible for making the wealth. Makes sense to me - however, this is dangerous. Nearly two years ago I was doing research on one of the most popular investment company's international funds (will remain unnamed), and I discovered that there were negative yielding bonds in more than one of their institutional portfolios. Do you want that? Do you know if you own any or not? Should you care? Also, do you know what the Price to Sales ratio is on your largest holdings? This stuff matters...
Just something to think about.
In closing, I lost my mom to cancer since the last edition of Insights. I owe so much of who I am as a human being to the mother and person she was and I miss her. I dedicate this edition to her. I love you mom.
Thank you so much for your business / interest in our company and how we can serve you and your family. I have a great job and people like you make it possible.
Have a wonderful day!
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, NY Federal Reserve, St. Louis Federal Reserve, Atlanta Federal Reserve, San Francisco Federal Reserve, 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 and analysis), "Expansionary Monetary Policy Can Create Asset Price Booms - remarks prepared for the Shadow Open Market Cmte Mtg", Nov 2012 (Professor Michael Bordo Rutgers Univ & Hoover Institution, Stanford Univ), "Monetary Policy & Asset Valuation", "Trade War to Hurt Corporate Profits, Growth & Consumers", Erik Norland - CME Group (Aug 8,2019), 2018 working paper NBER (Francesco Bianchi - Duke University), Quarterly report on Household debt and credit released May 2019 (NY Fed Research & Statistics Group), The Economist, S&P Global Market Intelligence, Moody's, Vickery Creek Capital Mgmt, LLC Proprietary Research, iR Research, LLC