Hiking for most of us
Greetings! I sure hope that life is positive for you and your's during this season. I love hiking. I love backpacking. Hiking is such a wonderful exercise whether you're carrying a large backpack and you're out overnight for several days or even if you're just out for a brief, leisurely day hike.
When I first started backpacking as a boy in the mountains of Virginia, my first backpack was manufactured in North Carolina in a very small factory and it had an aluminum frame and material that could be torn with frankly, not that much effort. My current backpack has a greater capacity, weighs a lot less, is not easily damaged, is made of very, very high-tech materials and is manufactured in Vietnam. (For whatever that observation is worth)...
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Review before we get into this edition:
We highlighted the popular FAANGM stocks, the move in the 2 year UST, high yield spreads, the trade war and B&G Foods.
- FAANGM stocks: yikes (leave it at that);
- 2 year UST moved higher (chart highlighted down the page);
- HY spreads continue to widen (still narrow on an historical basis);
- China is losing so much business from its trading partners after being called out; the government is doing everything it can to prop its economy up.
What do you mean "we called them out?" There are cases abound concerning China's industrial espionage. Some may be true, some may not (example):
Click here: See (Second former GSK researcher admits stealing trade secrets) ..."another scientist who previously worked for Glaxo Smith Kline has admitted to conspiring to steal trade secrets from the company and pass them on to a Chinese rival."...
They (China), are again attempting to fix a debt problem with more debt. How's that working for you? The young professionals in China communicate that they know the China experiment is very, very unsustainable. At this point, I don't even believe the government economic statistics (like CPI and ISM data and growth info); I said this Trump "war" would be over in 6 months time, OR it would get "really ugly because of the downstream implications", so, whether it's temporary, or longer-term, we've definitely got a case of "ugly" on their hands.
- B&G Foods (symbol: BGS): The company sold Pirate's Booty (food brand), to Hershey and used the proceeds from the sale to pay down debt, the credit rating got raised and their common stock dividend is unchanged and the bond prices got a boost. Some clients own the 6%+ dividend stock and some clients own the 6%+ bonds.
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Hiking for the Federal Reserve
"After eight hikes since December 2015, the fed funds rate is now at the highest level since October 2008, just after the collapse of Lehman Brothers". Bloomberg - September, 27, 2018
What happens during/after a hike? Exposing and impaling?
"One currency that was dominating the headlines just a year ago about how it would end up replacing the U.S. Dollar as the world's major tradeable unit - we're talking about Bitcoin here - slipped below $6,000 yesterday as it reached the lows for the year. Bitcoin Cash has plunged 90% since last year's peak. As we have said time and again, there's never been a Fed tightening cycle that failed to expose, and then impale, the bubbles created in the prior phase of over-easing and excess liquidity. So look at what's happened to crypto, followed by Cannabis stocks, Emerging Markets and now the FAANGM growth stocks. The market for corporate credit, whether it be investment grade, high yield or the bloated CLO space, is next in line." Gluskin Sheff Research - David Rosenberg - November 15, 2018
If you didn't read the July Insights blog about the price to sales ratios on the FAANGM stocks, you can click here: More Inflation then Deflationary Bust and read it and see if you want to catch that falling knife now after this recent pullback.
The Fed's hiking sure is moving the 2 year UST (as we've been saying); that's one of the main spots along the curve to monitor
My research indicates that any time you have the 2 year US T increase by 300 bps (mid 2019 will roughly mark that move), you've always had credit markets get damaged and a recession typically follows shortly after
Update on the 2 year US Treasury yield
By the way, that yield is now 2.854% as of November 15, 2018
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Why does that 2 year UST move matter?
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Risk/Return trade-off is more important than ever
- We could be entering a "Market Stress Period"
- Global markets are not as non-correlated as they used to be
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I get asked this question a lot:
"What about Gold?"
Well, if you bought Gold in 1980 at the low and sold it before the crash in 2008, you broke even. By the way, how much income did you earn that you could later spend during those 28 years of owning that investment? Just ballpark...how much total income? None.
If you bought gold in 2011, you'd be selling it at a loss if you sold it today.
I am in NO way saying don't buy gold; just remember, it doesn't generate any income and it may go up and it may go down in value. Parenthetically here - it probably makes sense to have some physical gold tucked away (as an aside)...
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Working out with the right weights
Owning selective investments short term and others (very, very selectively), on the long end
As you think about working out during the cold months, think about the weights with which you're working out. There are SO many approaches to investing, there are literally more investment options like funds, etfs, and strategies than there are stocks and bonds in which to invest.
Some weights (investments), to consider (these are not a blanket recommendation for everybody, just a real example):
- Gap Store bonds mature 2021 YTM 4.3%
- Hercules Preferred debt (owned by Ashland Chemical), matures 2029 YTM 6.3%
- Energy Transfer (natural gas), floating rate bond 7.5%
- Honda Motor Corp stock (ADR), 3.44% dividend (payout ratio of 16.72% (sustainable)), and price to sales of 0.4X
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Corporate bond prices getting more volatile
Nearly half of companies in the S&P 500 have high debt that looks vulnerable to rising rates. Corporate balance sheets matter a lot at this point in the cycle.
Corporate profit growth has been robust (with the help of the non-repeating tax cuts), but is overall projected to slow.
Though there's been some widening in corporate high yield bond spreads, the spreads are not wide enough based on the amount of leverage in the average corporate bonds that are trading out there. This makes many of them (not all of them), expensive, and those spreads should widen closer to the norm at some point in the near future.
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Stuff on sale
As corporate bond prices occasionally get less expensive, like Resolute Forest Products' 2023 bonds did with the lumber tariff fiasco, my pencil is sharp and I have my laundry list of investments I want to invest in. In many cases, clients are up 20-40% in these bonds and the corresponding yield is 15%+. However, you MUST have a sell discipline when you do this and it's not often that we have the kind of opportunities to put money to work like this. But we're entering a phase, I believe (see chart above), that there will be more and more similar opportunities. Resolute bonds (bloomberg price chart below)
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OMB is the "new" OMG!
Office of Management & Budget > Oh my goodness!
The Federal debt load is projected to rise by $10 trillion over the next ten years. This is a ticking time bomb...
Federal debt & spending versus income from taxes
"Today's tax cut is tomorrow's tax increase" - Author unknown
Federal debt (chart below)
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Federal spending (chart below)
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Federal receipts: (Less money coming in) Corporate income taxes (chart below)
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What about the other main consumers of debt? Households and Corporations...?...
Total Household Debt update
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Update on Total Nonfinancial Corporate Debt
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What happens when the 30 year mortgage rate in the U.S. goes through 5%?
The last time this happened was 2011 (mortgage rate going through 5%)
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Well, because homes become less affordable, the inventory increases and there's less sales activity as a result.
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Distribution cuts to consider (not our clients)
SO Budweiser's stock is down 31% YTD and they just cut their dividend in half. It got a little airplay, but not much. Get this: the company has $100 Billion in debt. You read that right. $100 B. They'll save $4B the first year by simply cutting the dividend. That's gonna take a while.
General Electric cut their dividend to a penny a share. They plan on selling A LOT of assets. This may sound dramatic, but GE could wind up needing a lifeline from the US Govt the way Chrysler did back in 1979 and they could also go the way of the Penn Central Transportation Company (bankrupt), in 1970. You shouldn't play around with debt. People get hurt when they are irresponsible with debt.
I don't even know how to quantify for you how much bad debt there is. Let's say this (globally)...60%? That's a guess and it's ROUGH, but it's maybe about right...
"No sooner did I take office in 1979 than I was called upon to help implement the congressional decision to prevent the collapse of an American industrial icon. The Chrysler Corporation was on the brink of bankruptcy. Congress created a three-man committee to oversee a rescue." p.122 "Keeping at it - The Quest for Sound Money and Good Government", by Paul Volcker.
So I have a question for folks that are suggesting that the next ten years are gonna look like the last ten with respect to capital markets assumptions:
IF roughly 43% of the total return in the S&P 500 (that's the contribution dividends made to the S&P 500's total return over the last ten years), is from dividends, and on average, those dividends start to get reduced, who's to say that the recovering, subsequent, dividend payout growth rate for the next ten years will look like the growth rate of the last ten?
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Current investing landscape (cont)
The increase in volatility across all asset classes means risk is being re-priced across the board.
The bond market is signalling three things to me:
1) The yield curve, at least temporarily, is shifting;
2) Inflation, even if it is late cycle, has a more semi-permanent tone to it;
3) HY Spreads in 2019 should continue to widen;
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BUY MUNICIPAL BONDS
We are BUYING BONDS (selectively and some are full positions and some are maybe only half-sized positions (dollar-cost averaging))...
Municipals look extremely attractive. Not all states and not all issuers. But one of the only group of borrowers that didn't lever back up on debt after the last recession was, in large parts, municipalities.
For example, we're investing in DFW (Dallas / Fort Worth), Airport Bonds with a 2.7% yield to worst at the 2022 call and a 4.4% yield kick out to maturity in 2040 if they're not called. And they have a 5% coupon so IF the 10 year moves to 4% and the 30 year UST moves to 6% the price of the bond won't get trashed. (Even if I'm wrong, we only bought half a position, so we can buy the other half if the price tanks (BTW - that'd be incredible because it'd mean the yield was REALLY attractive)).
Opportunities are showing up in the corporate bond market and in the municipal bond market every week. Municipals are benefiting from strong fundamentals and even technicals and they're reasonably priced.
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A reminder about SELECTIVITY; ESPECIALLY in retail
Just like you don't want to own every house you drive by, you don't want all of your money in passive investments such that you own every house in the entire neighborhood. Selectivity is key. Being frugal matters and not paying too much for investments just like you wouldn't pay too much for a car or even a shirt, you shouldn't pay too much for investments. One case in point is Ross Stores. I am not sure if I've ever been in one before (I like Kohl's; don't own them currently, but will most likely invest in KSS again); and folks have made a lot of money on the stock in the last few years, but it's trading at 2.5X Price to sales. It probably ought to be more in the 0.6X range. So retail is fairly simple: it's mostly about same-store-sales and debt credit ratings.
So IF we were to see a global recession, look at the percentage of the rated retail space that might have their probability of default change. These are S&P Global Market Intelligence estimates (10-22-18). This is not suggesting that 23% to 30%+/- would experience default, but that that rough number would see a change in probability of default.
NOTE: (This is for illustrative purposes only and not a market call, a short sales suggestion or any recommendation for or against any security)
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Building and rebuilding, not just destruction for the sake of destruction (that's chaos)
Let's try to build and encourage our leaders to develop strategies to build and rebuild.
"What populism is really good at, as history shows, is destruction with no strategy of rebuilding." Gluskin Sheff Research - David Rosenberg - November 16, 2018
I am worried about where yields go during and after the next recession
This is an average move. Rosenberg's research has determined that on average, the 10 year yield declines 160 bps off of the peak and stays there for a while. Our corporate balance sheet deleveraging phase in the U.S. is gonna take a while (more to discuss on this in future 2019 Insights editions), and that concerns me based on where we are in the cycle and how low the ten year starting point is even if it were to get to 4% (let's say 30% chance now).
Why this matters...
The actuarial table for one of the insurance (acts like a private pension), industry's annuities has been shifter higher by 45 bps at age 65 which results in more income for investors of said strategy and with no annual fees. This is a big deal. I did some analysis for a client and the change actually resulted in $253,000 more in total income assuming income distribution from age 65-92. That's a lot of money and one of several benefits of higher interest rates.
If you're a fifteen year plus client or a prospective client
There are likely going to be some severe bumps along the way in the coming quarters, and that's okay. Risk has been suppressed and liquidity has been artificially propped up. Those days are over. The Fed is no longer pro growth. They will be again - but for now, they're not. For now, that pro-growth setting is a thing of the past.
If you are a prospective client, please ask yourself:
"How did my portfolios perform in the last recession?"
"How important is it for me to avoid a repeat of that performance?"
"Am I spending the right amount of my income? Can I afford to spend more, or should I cut back?"
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As a reminder, as we approach the Holidays, no matter if you're Warren Smith or Warren Buffett, watch your spending. It's a big deal. And if you're in the season of life I'm in, somebody's always watching (my kids and their friends). We can have more of an impact by our actions than simply by our words. What is it that one of my mentors has said to me time and time again? More is caught that taught...?...
In closing, I sure hope that some humility, kindness, grace, honoring attitudes, and respect for the rule of law is caught (and for that matter, taught!)
I sincerely hope and pray that you and your's have a wonderful Thanksgiving and Christmas / Hanukkah with your loved ones.
All the very best.
Here's to a successful, healthy, and prosperous 2019!
Yours,
Jack Parsons CTFA, AEP
President & Chief Investment Officer
Vickery Creek Capital Management, LLC
Sources: NFIB Research Center, Random lengths (wood products industry), "U.S. - Canada Trade Dispute", Bloomberg, Marketwatch, Thomson-Reuters, Fidelity Institutional Wealth Services, Blackrock, Resolute Forest Products, Gluskin Sheff, Goldman Sachs, JP Morgan, Doubleline Funds, Haver Analytics, Fierce Biotech, NY Federal Reserve, St. Louis Federal Reserve, Atlanta Federal Reserve, San Francisco Federal Reserve, Boston Federal Reserve, S&P Global Market Intelligence, Moody's, Five Star Professional, Atlanta Magazine, "Keeping At It - The Quest for Sound Money & Good Government" - book by Paul Volcker (Public Affairs, New York - 2018), American Equity Life Investment Company, Jack Merrion Research, Actuarial Standards Board - National Association of Insurance Commissioners, Vickery Creek Capital Management, LLC Proprietary Research, iR Research, LLC (est. 2018)
Disclaimer: Insights is for informative and educational purposes only. It does not serve as a market timing or security recommendation newsletter or any solicitation notice of any kind. It is strictly a way for Vickery Creek to communicate information to its clients and prospective clients only. It does not infer any guarantee of any security mentioned.