Saver Prison and Debtor Club Med – and next on the agenda: Helicopter Money 2017-2018
What the heck does that mean? Is this another example of cryptic, nerdy, investment advisory vernacular? Maybe. Let me explain after I give a brief update on what’s presently going on…
September is typically the most volatile month for the markets (20-30% more so), and we entered September with an already very low level of volatility. So it makes a lot of sense to see more volatility in September (even if we didn't have the election forthcoming). In addition, we've just experienced six straight quarters of overall earnings declines and eighteen months of the markets going nowhere, and with some heightened event risk re: Deutsche Bank stability being called into question, Brexit, the U.S., election, Italy's banking system, and of course, many other issues, to repeat: it really does make logical sense that we're seeing higher levels of asset pricing volatility. If you’re a client, I really believe that your portfolios are really, really well constructed and should be able to weather even periods of steep declines which I don't see on the immediate horizon despite recent volatility.
I am actually more of a buyer of stocks entering October and am neutral to lightly negative on most bonds this month rather than a seller (overall with the things we own and wish to own), thinking that the earnings vector will improve. Please understand, however, clients own a lot of corporate bonds that yield them in excess of 6% interest income per year and 3% per year in tax-free interest income per year, and in no way do I recommend selling those (it's a scarcity situation - that stuff isn't available (no supply)). I do not believe the slope of the earnings vector will be as positive as what bullish Street analysts are predicting, but I believe that earnings will improve in 2017-2018.
It has been a positive year for our equity positions and especially positive for our bond positions February-September following a rough October 2015-February 2016 time period. The bond coupon payments are of course there through the end of the year, but bond price performance is not likely repeatable in the short term due to finite pricing constraints. I expect the stock market correction to be rather shallow especially when the markets figure out that the Fed’s not gonna do much and in particular when the negative earnings path repairs itself.
The Senate cleared a bill Wednesday, September 28th, to fund the government and the federal response to Zika, avoiding a potentially embarrassing government shutdown just weeks before the election.
OK - Saver Prison and Debtor Club Med – and next on the agenda: Helicopter Money 2017-2018
When the Fed and every other monetary policy group around the globe embraces uber-accomodative monetary policy, to try to stimulate their economies, it can compress risk-free investment yields to near zero due to limited supply of said bonds and yields and incredible demand. And in many cases these yields are actually negative – this we know. This means that traditional savers who like to get some yield on their savings (imagine that), are penalized. Because of the global starvation for yield by investors, debtor companies (and as you know, nations), have tons and tons of access to debt (and at relatively low interest rates due to investor demand). So, savers get prison time and it’s Club Med for debtors.
“There Is No Alternative”. This means, savers and conservative investors have to go further out on a limb (from a risk standpoint), and invest in riskier and riskier stocks, alternative investments and other less liquid and risky investments because there are no alternatives.
Well, it’s more than possible that T.I.N.A. ain’t seen nuthin’ yet. T.I.N.A., and Helicopter Money are about to be tossed from the Helicopter.
The Helicopter refers to Milton Friedman’s (economist), and Bernanke’s (former Fed Chair), thesis that money dropped from a helicopter would incentivize people/companies to spend money instead of saving it.
Of course, we’re not talking about literal cash falling from the sky, but it might as well be. This helicopter money scenario is likely a 2017-2018 event(s). Many folks are of the mindset that the Fed is about to raise rates again – and they may – but don’t hold your breath. Just sit down before you read the rest of this. The Fed is not likely to raise rates again any time soon unless they intend to throw the investing public a total curve ball.
You see, in all likelihood, unless something significant occurs, The Fed is almost done raising rates for this particular credit cycle. Could they raise rates another 100 bps without causing a recession? Maybe. It’s looking like probably not, though.
You see, if you know me/read me at all, you know I’ve been saying really low rates for a really long period of time. You know what? I know we’re 8 years into this deal, but what if, this deal could last twenty plus years? Why can’t it? Did you know that there’s greater historical precedence for it to last that long than precedence for us to get back to normal rates?
Two things here:
- “When you are trying to figure out how much longer we will be stuck in this uber-low-rate environment, consider that from 1932 to 1964, the Fed funds rate did not cross above 4%, ranging from 0% at the lows to 4% at the highs for 32 years. We’ve just completed year #8, for some perspective.” September 6, 2016 – David Rosenberg – Economist – Gluskin Sheff
- There is precedence for the Fed and the Treasury to, together, guide the slope of the Treasury yield curve and to put a cap on Treasury rates. This was done from approx., 1947-1964 in the U.S., and the Japanese just announced that they were doing it, last week.
If the Fed is truly data dependent, and we should take them at their word on this one, the data says to them, “do something grander to stimulate the economy.” Something like tolerating much higher levels of inflation without raising rates. Paul Krugman is publically calling for 10X current inflation level targeting. Bernanke wrote less than a month ago (Jackson Hole meeting), that he thinks the Fed’s balance sheet ought to stay huge for a long time to enhance financial stability. Former NY Fed governor, Jeremy Stein, (resigned in 2014 to go back to Harvard), suggests the same. Yellen and Brainerd (a voting member in 2017 and Clinton’s likely pick for Treasury Secretary), are working from and will be working from, the Bernanke playbook in 2017-2018. Bernanke delivered a speech in 2002 in which he stated this (Helicopter Money), would be an option should we find ourselves in the present position. Remember, 2016 is the weakest GDP growth year of the recovery.
The Fed governors who are calling for a Fed rate hike roll off the voting role at the end of this year and the folks that have a vote in 2017 are all considered doves (meaning no rate raises and more monetary accomodation). I don’t think the Fed will try negative rates – they know there is no evidence that that works.
Will the Fed bailout Student Loan debt? Maybe. Let’s say this – LIKELY.
Will the Fed and Treasury coordinate a hybrid monetary and fiscal “rescue” plan whereby they put a formal lid on Treasury rates while providing free money to citizens incentivizing them to spend money to stimulate the economy? Maybe. Let’s say this – LIKELY.
I am not kidding.
If you think what you’ve witnessed thus far is weird, wait til 2017-2018.
Debt levels are a constraint to future growth – period. There is a school of thought out there that disagrees, but it’s ridiculous. Rogoff’s and Reinhardt’s research was conclusive on this. Look at the European countries and their debt loads. Debt levels are a constraint to future growth – period. The Fed knows this. But what happens when the debts are forgiven? Theoretically, off to the races (from a growth standpoint).
Implications for investment planning and retirement planning
We have to be prepared for deflation, hyperinflation and in between.
This takes careful planning. Why do we have to be prepared for such wide, potential outcomes?
Because I may be wrong – goodness, do I hope I’m wrong? Yes!
Are we in a stock market correction? Yes. We are overdue one. I think it’ll be relatively shallow for what it’s worth, due to how credit spreads are behaving.
Are stocks expensive or cheap? Expensive based on just about any fundamental valuation metric.
Are bonds expensive or cheap? Most are expensive (see chart further down the blog post below “Chart 1 – High Yield…”)
Where are we headed?
We're entering a period (may be already there), of higher trade protectionism and greater nationalism perhaps at the expense of global trade, but with or without a Trump win, I believe that's occurring around the globe, and here in the U.S., and will have to be contended with by a President no matter whom that person is. While it is true, the markets sort of view Clinton as a 3'rd Obama term, I have to remind folks that she's been pulled much more to the left by her party at this point than where her husband was, and certainly when she first started the campaign and may have to do some of what she promised due to political pressure. She clicked off a couple for viewers during the debate: 1) free college; 2) higher taxes.
So we know a few things: 1) They're both gonna embrace large, fiscal stimulus measures (spending on infrastructure), his will be 1.5-2X what her's will be; 2) He says he will try to simplify some of the tax code (we'll see - that would be good), but will most likely increase annual deficits much like Reagan did initially; 3) They are actually both populist candidates - there are many economic policy positions that are actually very similar despite their seemingly vitriolic hatred of the other, and are, in many other obvious ways, VERY different.
There is the Market; and there is the Economy
There is 1) the market; and there is 2) the economy. In simplistic terms, the economy is most likely in the 7'th inning (though the last 10 indicators were negative and IF this is a Fed that is data dependent, they won't raise again this year). We’re not in a recession, but things are weak despite some positive spots like housing starts and some areas of the labor market.
The Fed may choose to save face and try to move the needle a tad higher so that they can have more to work with when they are managing from within a recession. The markets are most likely in the 8'th-9'th inning. The Fed may only be able to raise rates 2-3 times at 0.25% each time before they are done for the cycle. So the theme of much lower for much longer will be in play - unless major structural changes occur. As I see it, deflationary forces are popping up again just as the market is positioning for inflation.
Neither Trump nor Clinton will (on their own), be a catastrophe economically - the lack of tackling the structural issues confronting our country would be catastrophic enough. Either way, we're likely headed towards cost-push inflation and stagnation against a backdrop of a government controlled Treasury market (which is THE risk-free pricing mechanism against which ALL global risk is measured), and this HAS to change. The clinical and factual problem, is in fact, that Monetary Policy is a very blunt instrument. And so while it can work initially in a blunt, disruptive, visceral manner, there are many, many, many times where surgical instruments are necessary rather than blunt tools. That’s where the helicopter money comes in – they can be very, very surgical with it – they can target areas of the economy where they believe increases in spending will really move the GDP growth needle forward.
Why do you say we might get hyper-inflation on goods and services but risk-free rates not be materially higher for some time?
“Even though hyperinflation would be a boon to heavily indebted companies, depositors and lenders would suffer losses of equal magnitude. In effect, those who had saved for the future would lose their savings and grow more reluctant to spend money.“ Richard Koo – p. 135 - The Holy Grail of Macro Economics – Lessons from Japan’s Great Recession
Where are we in the business cycle?
“Peak autos usually means that we are 70% of the way through the expansion – the fundamental bull market does not end until the recession actually begins.” Economist David Rosenberg – September 6, 2016
Possible Brexit Scenarios (Source: Moody’s London)
I was on a conference call right after the Brexit vote and Moody’s in London said (that was then and of course things can change), that the “Brits are going to get what they want, but they’ll have to pay for it.” This is largely about immigration, the free movement of labor within the E.U., and of course, money (or the taxes Britian has to pay the E.U.).
So…what ARE you buying?
(With British accent)…”Well, alright then!”…
This is one of the several reasons why we’re now investing in Glaxo (symbol: GSK). The pound is finally getting pounded due to Brexit aftermath, making GSK more attractive, but beyond that, the dividend is 5%, and the stock is reasonably priced and around the same price it was twenty years ago. Notably, it’s 24% cheaper on a price / sales basis than Merck (has dreadfully underperformed for many years now), and the business seems to be turning ‘round. And GSK should see greater EPS growth from here.
Time to trim our Home Depot stock (which has run hard) since the recession ended.
Why are we investing in Cisco Systems (below)? Stock price trades beneath the earnings line and looks very attractive and pays a very nice dividend of 3.30% and growing.
We are investing selectively in 3% municipal bonds with high coupons and intermediate call protection, with intermediate-long term duration; in some cases taking only half positions to hedge against a possible rate-shock in case we’re wrong on the short term direction of Treasuries. We are investing in short-intermediate term corporate bonds with approx., 5%-6% OB yields, issued by industrials, technology, machinery, and select shipping companies.
Why we’re favoring equities and municipals Oct.-Dec., unless we see spreads gap open more (see chart below-*note: you want to invest in full earnest when the graph is higher versus lower because you obtain greater yields vs., during the (low-vol, low spread time)…
In addition, we’re investing some in floating rate, investment grade, U.S. based banks’ bonds.
From an equity standpoint, our exposure going into 2017 includes U.S., Large Cap Value, Aerospace and Defense, Financials, Technology, Industrials, Healthcare, Select Consumer Discretionary, Emerging Markets like New Zealand, Small Caps, Select Japanese equities, all with an emphasis of Growth and Dividend Income at a Reasonable Price.
SELL your REITS and INVEST in your home
Contrarian move of the year for 2017
This was posted to investment advisers in August encouraging advisers to invest heartily in REITs, not by Vickery Creek, but by a firm called, “Altegris”. I’ll take the contrarian position please. I’d like to invest in the next twenty years with the worse of the two. By the way, check out the chart below and look at the time period between June 08-Jun 09 (ouch)…The past best will lag. Mark it down.
“Over the past 20 years publicly-traded REITs have returned an annualized 11.23% total return and homes have returned 3.47%, or just a little more than inflation. Over these 20 years, REITs returned more than 7x (740%) while homes didn’t quite double (98%). Publicly-traded REITs have been one of the top performing asset classes and homes have been one of the worst over the past 20 years.”
I sure do hope that you, your family and your business / your retirement are all going splendidly well. Thank you so much for your trust and your business. I have a great job and people like you make it possible.
Last thing…I love this picture of Kevin Durant (from Rio Olympics 2016), with the American flag, don’t you?
Have a great end of summer and beginning of Fall.
Jack Parsons CTFA, AEP
President & Chief Investment Officer
Vickery Creek Capital Mgmt., LLC
Cited Sources: Gluskin Sheff, Haver Analytics, WSJ, Moody’s, Securities Research Corp., Advisor Perspectives (Market Commentaries), Bloomberg, CNN, Heritage Foundation, Richard Koo – The Holy Grail of Macro Economics – Wiley & Sons