Broker Check

The Chronicles of Reflation - Behind the DCurve 2.0

January 12, 2024

Greetings & Happy New Year!  I hope that your winter skies are bluer (even for this time of year); that you're toasty warm and that your health and relationships are strong.

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"In Winter, I plot and plan.  In Spring, I move." - Henry Rollins

"One kind word can warm three months." - Japanese proverb

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Reflation is the act of stimulating the economy by increasing the money supply, lowering interest rates, reducing taxes, and/or providing other stimulus seeking to bring the economy (specifically price level), back up to the long-term trend, following a dip in the business cycle.

This is approximately where I'd put our current economy on the cycle:

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Winter is here!  I just hosted a friend who moved from the U.S. to Wales, U.K., and we had a very nice time together and were able to get a nice mountain bike ride in on one of my favorite trails in western North Carolina.  I hope that you're enjoying this time of year.  I love winter.  I love the cold and the snow that often comes with it.

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"As sure as the spring will follow the winter, prosperity and economic growth will follow recession." Bo Bennett

"Remember - recessions typically begin two years after the very first Fed rate hike in cycles where the central bank inverts the yield curve." - David Rosenberg - Chief Economist, Rosenberg Research - January 8, 2024

April-May 2024 marks two years after the interest-rate-increase-campaign began.  There's nothing in the Bible, and nothing carved in stone that says that a recession will definitely begin during those two months or that it definitely will happen, but it helps to know a little history sometimes that's all.

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Ten years ago, almost to the day, I wrote in my Insights blog that, at that time, the Fed was behind the inflation curve.  Fast forward the tape 10 years later, and what do you know?  They're now behind the disinflation curve.  I also said back then, that based on my research, we'd see 4% as a Fed Funds rate peak.  Ha!  Little did I know the extent of the stimulus (freebies), that the 'policy-makers' would dole out (during the Covid 19 recession).  So, instead, we're assuming that 5.25% is the peak.  Is it?  Probably so...almost definitely...BUT... what if it's not?  What if the personal bankruptcy rate explodes, but the stock market and risk assets soar higher at the same time?  It's possible.  

I've been getting asked this question quite a bit the last few weeks.  "So do you think we're gonna have a recession?"

Answer:  Yes.  Do I know for sure?  Of course not. 

Why should'nt we, as investors, at least be prepared for recession when historically speaking, we've never had an economy evolve in the way our's has recently that hasn't led to a recession?

Why does that matter?  Well, because you can have a corrective, bear market without a recession, but you can't have a recession without a bear market and those sorts of bear markets take longer to recover from.  Those bear markets that are considered to be recessionary-bear-markets tend to be much rougher and much more difficult to climb out of also versus normal, corrective bear markets.

Remember, I said in August:  [click here for August Insights]   that "The economy cannot handle these levels of rates."  ´╗┐Regular people cannot handle these levels of interest rates.  Credit cards, small business loans, non-investment grade interest rates are currently priced quite punitively for indebted borrowers (in virtually every category)....EXCEPT investment grade borrowers.

This is a problem.  If Powell, is lucky, he won't have to raise rates more in 2024 or 2025 and the Fed won't have to 'brake the hands of the gamblers'.  You've heard me say this on the phone before; I'm not a fan of writing it, but with how mainstream legalized gambling is becoming, I figure, "Why not".  I.e.> Disney's gambling app called 'ESPN Bet', being introduced in November 2023, and Draft Kings, etc, etc....why shouldn't I write it and call it what it is (a symptom of a financial market backdrop>a veritable casino).  Fed Chair Powell has a seriously, seriously dangerous situation on his hands right now.

Enough preaching and back to the markets

Corporate bond spreads on investment grade debt need to be much wider and they're not.  This is a problem.  Powell's gonna either wait until he sees real damage in the economy before he begins lowering rates, OR, if, heaven forbid, he sees a reacceleration in risk assets in the economy (I'm not saying we'll get that, but he better hope we don't because he'll sort of only have two broad choices):

1) Wait and allow the lags to kick in and take hold for an extended period of time and create quite a bit of damage spreading to more of the economy;

2) Actually consider raising rates again (very, low probability but the possibility cannot be entirely dismissed);

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The bond bull market has just gotten started (there's MUCH more to come on this file in future Insights)

"Where is inflation headed?

In one word or less:  down."  - David Rosenberg - January 8, 2024

I completely agree with this statement.  As I've said since the beginning of this inflation episode:  "inflation has been the cure for inflation".

If the Fed begins to lower rates in April 2024, my research and approximate prediction is that they'll lower approximately 250 bps but if they wind up waiting until September of this year to later, they'll be forced to lower nearly 400 bps.  This means that by far, (no comparison), the best value is in bonds for the next two-three calendar years **(UNLESS), we get a really, sharp correction in risk assets that serves as a reset.

We don't have to see a negative GDP print for calendar year 2024 to have a recession.  By my estimate, we could print +1.5 % GDP growth this year and still have a recession start Q1 2024 (we won't have data on when it starts if it does until two quarters after onset of the recession).

Employment data is SO misleading for folks at present.  The BLS is producing data that is 60% incomplete.  The respondents rate is currently less than 40%.  And the last few reads have shown government jobs and also strikers returning to work.  This is why it pays to interpret data and not just look at the headline number.  The car may look shiny and new, but there may be trouble 'under the hood'.  The 'trouble' seems to me to be that companies are trimming the average worker workweek by quite a bit.  Why does that matter?  Because the current, approximate, truncated work week across nearly every sector may equate to as much as a 1.5%-2% in unreported equivalent, higher unemployment rate.

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Private household debt is out of control and should peak and roll over pretty soon

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21.47% credit card interest rates?  That's the highest reading on record and that's old data (November 2023); are they higher?  Would Dr. Phil ask, "How's that working for you?"

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Here's an update on where we are with the bank prime loan rate:

 

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Bullish on U.S. energy through the end of the decade


Energy stocks are reasonably priced.  Period.  The 'magnificent seven" tech stocks?  Not so much.

January 11, 2024, Chesapeake Energy and Southwestern Energy agreed to merge creating one of the largest U.S. natural gas producers.  The deal is immediately accretive across all metrics according to CHK.  After the combination, the company will have one of the leading natural gas portfolios adjacent to the highest demand market, premium inventory, resilient cash flow, and an Investment Grade quality balance sheet.  The combined company will be uniquely positioned to deliver affordable, lower carbon energy to meet growing domestic and international demand. 

We invested in their senior bonds today, January 12'th, 2024, that are BB+ rated (positive credit outlook from S&P and Moody's).  These bonds yield 5.75% per year assuming the company doesn't call them in March of 2025.  If they do retire that tranche of debt by calling them, the yield to call is 9% per year from today's trade date through to the March 2025 call date.

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Campbell's Soup stock; NYSE symbol:  CPB looks compelling to me at current levels

Campbell's Soup's market cap is where it was 27 years ago.  It sports a healthy 3.41% common dividend which appears to be manageable through a cycle from current levels; the company has paid down their total outstanding debt by 50% over the last 4 years. 

They used that high-quality, balance sheet late last year to smartly purchase Sovos Brands (the owner of Rao's-one of the fastest growing brand in grocery stores today).  If we are headed into a consumer recession (I believe we are), defensive staples like CPB tend to be good places to be for the following few years.

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Sectors that I think are more reasonably priced than the popular tech stocks:  Defense, Aerospace, Utilities, Energy, Consumer Staples, Select, beaten down consumer discretionary stocks and bonds look good to me>like Kohl's senior debt at 11% per year and VF Corp stock (owner of The North Face), down 80% and trading with a price to sales ratio (assuming their sales are down YoY in the -30% range), of 0.6; I think VF Corp needs to eliminate approx $1.5B in annual expenditures-ballpark estimate-to keep their investment grade bond rating (just ballparking and approximating here).

REITs should offer very attractive value some time between 2024-2025 as we get much better acuity as to the timing and the contours of the Federal Reserve's rate-lowering-cycle.

By way of update, our FDRXX, Fidelity Government Money Market Fund currently yields 4.9%, down from a peak of 5.2%.  For what it's worth, Franklin Templeton, the investment firm with $1.53 Trillion in assets under management, is telling its clients to move from cash into bonds.  I tend to agree.

As I close, also by way of update, because market interest rates on reasonably safe investments are coming down, insurance companies that issue low-cost, private-pension-like annuities, are lowering their guaranteed interest rates and so now is the time to consider positioning some capital in one or more of these if they make sense for your particular pre-retirement or retirement income plan.

Until our next update, please have a wonderful rest of your Winter and start to your Spring!

I have a great job and people like you make it possible.  THANK YOU!

Yours,

Jack Parsons, CTFA, AEP

President & Chief Investment Officer

Vickery Creek Capital Management, LLC


Sources:  Bloomberg, WSJ, Marketwatch, CNBC, NY Fed Research & Statistics Group (Center for Microeconomic Data)-December 2023, St. Louis Fed, Atlanta Fed, San Francisco Fed, Rosenberg Research, Richard Koo (Nomura Securities), Fidelity Institutional Wealth Services, "Strategic Risk Management" by Campbell Harvey; ;Wiley & Sons 2021; "The Trader's Guide to Key Economic Indicators", Rich Yamarone - Bloomberg Financial Series (Third Edition);  “NY Fed DSGE Model Forecast-November 2023”-Liberty Street Economics, "Public Debt Sustainability:  International Perspectives", Poulson, Merrifield, Hanke, Lexington Books-Jan 2022, "Inflation is 'history' for the U.S., says veteran economist Steve Hanke (Johns Hopkins)-CNBC-July 13,2023, "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, 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