Good morning / evening. I hope that this winter season is going well for you and your loved ones.
Before I get started, please know that, related to Covid-19 financial woes, and the extreme, political division within the U.S., I do have a heart. I know how much people are hurting. There has been considerable pain, despair, death and devastation as a result of this horrible situation. When I started writing this edition, I made a lasagna and a salad to take to my dad, who tested positive for Covid-19. By way of update, (one week later), my dad is feeling much better and he got a negative test (a few days ago now). So here's to a continued recovery for him and certainly anyone you may know who has been touched by this thing.
It goes without saying that this is an absolutely unbelievable period in our country's history and in world history for that matter. Many of the realities we're living under seem more like fiction described by George Orwell novels than reality.
I am simply being clinical in my observations and I am sometimes candid for many reasons because I firmly believe that being direct, candid and transparent should be some of the hallmarks of good, honest communication and thus essential to good relationships.
With all of that out of the way, let's dive in...
During this edition of Insights, we'll be covering:
- Capital markets (both credit and equity markets);
- The current debt binge and the loud refrain of noisy distractions about politics, inflation hypotheses, hype-news,
- A review where we are & where we may be headed and why you may want to build positions in stocks like Kinder Morgan and Kroger (0.2X sales looking for 0.3X sales);
"Think lightly of yourself and deeply of the world." - Miyamoto Musashi (16'th century Japanese philosopher)
January 2021 hike along the Appalachian Trail in North Georgia mountains (picture above)
The Credit Markets in the United States are currently functioning as well as they are due to the heavy-hand of government. Presently, they more closely resemble credit markets in Japan and China where their economies function as 'command economies'.
Equity markets, on the other hand, in several instances, are like the Wild West with folks like myself wondering, "Is anyone from the government (at the Securities Exchange Commission), actually working, overseeing and supervising?" Easy example: Gamestop (NYSE symbol: GME), and a few other names. The proliferation of non-regulated cyberspace like we saw back in 1999-2000 in AOL chat rooms (today it's Reddit boards), and the: (you may as well call it) 'pumping and dumping' of shares is what I would call typical, end-of-the-cycle market bubble behavior. (Not calling it here, I'm just saying it seems like approximately where we're at in this credit-mania cycle). Let's remember why stocks like this one have received all of the initial attention to massively short them to begin with: the business model, profitability, and sustainability of the company are all in very, very serious question. That's not a criticism of GME, it's just a fact. This current phase of retail investor manias feels much like what happened in China between 2012-2015.
Even casinos have rules
"In October 2012, Bank of China chairman Xiao Gang warned that the shadow banking system was starting to resemble a "Ponzi scheme", with loans based on "empty real estate" that would never generate enough return to repay investors. In April 2015, when the Shanghai market had already risen more than 70 percent in the previous six months, the state-run People's Daily crowed that the good times were "just beginning". The amount Chinese investors had borrowed to buy stock equaled 9% of the total value of tradeable stocks - the highest level of debt-fueled buying for any stock market in history. On some days, more stock was changing hands in China than in all of the other stock markets of the world combined. Two-thirds of the new investors lacked a high school diploma. In rural villages, farmers had set up mini stock exchanges. Some said they spent more time trading than working in the fields. The Chinese economist Wu Jinglian once said that Chinese stock markets "are worse than casinos because even casinos have rules."
The rest of the story
"In June 2015 the stock market started to crash, and in contrast to early 2008, the government intervened aggressively this time - for example, by ordering investors not to sell and threatening those who did sell with prosecution. But Beijing was unable to stop the market's tumble, and as the Shanghai market lost more than a third of its value within a couple of months, the widespread belief that Beijing's authoritarian government could produce any economic outcome it wanted suddenly shifted [bold emphasis mine]."
---- from The Rise and Fall of Nations - Forces of Change in the Post-Crisis World - Ruchir Sharma
QUESTION: Is there a widespread belief that the U.S. government can produce any economic outcome it wants?...
Command Economy - (definition):
"An economy in which production, investment, prices, and incomes are determined centrally by a government."
Free Market Economy - (definition):
"An economy in which prices for goods and services are set freely by the forces of supply and demand and are allowed to reach their point of equilibrium with very little intervention by government policy."
Bosom buddies - The Fed and the US Treasury
The Federal Reserve and U.S. Treasury are soon to announce, I believe, unprecedented coordination aimed at reducing the inequality that the Fed has created with their insane monetary policy positioning. This monetary policy stimulus from the Fed has pushed up asset prices while at the same time doing very little for the broader economy. The push for fiscal stimulus from the Treasury comes as the reality sets in that the Fed has very little creative, firepower remaining to influence organic growth of the real economy.
Is there more the Fed can do to influence asset prices? Well sure; they can more aggressively buy more assets with the Fed's balance sheet, together with the US Treasury, they can re-institute interest rate caps on Treasuries and loans. Together, with the UST, they can do a lot more actually.
Fed Chairman Powell intimated (at a press conference in late January), that his Fed is not going to use monetary policy to pop asset bubbles (as in debt cycles of the past); rather, he's going to try to engineer the U.S. back to 'full employment'.
QUESTION: Do we need lower interest rates? Nope. The cost of credit is not the problem. Ultra-low interest rates are causing massive, mis-allocation of investment, debt-averse borrowers to borrow much more than they should; and those rates are penalizing traditional savers at the benefit of propping up zombie companies and municipalities. We have too much debt on our hands - and ultimately a bunch of what's gonna prove to be 'bad debt'. Too much debt, that's the chief problem.
"They've done almost all they can do". - Janet Yellen said of the Fed - November 2020 (WSJ).
"Central Banks, of course, do not want to admit their impotency at the zero bound." - Professor Kenneth Rogoff - Harvard University - from "The Curse of Cash" (his 2017 book)
A debt binge
"Never spend your money before you have it." - Thomas Jefferson - A decalogue of canons for observation in practical life
"The psychology of a debt binge not only encourages lending mistakes and borrowing excesses that will retard growth and possibly lead to a financial crisis, but also leaves a mental scar that can last long after the crisis has passed."
---- from The Rise and Fall of Nations - Forces of Change in the Post-Crisis World - Ruchir Sharma
I find that nowadays, the slow, careful, methodical, fundamental analysis done on the creditworthiness of a borrower (municipal or corporate), and certainly fundamental equity analysis is, at least temporarily, a thing of the past. We've entered a period of mania; a time that, instead of being characterized by careful, wise, decision-making, it's a gambling, casino-system filled with easy, quick platforms and apps on people's phones that allow them to 'get rich quick', (for now); and at some point in the maybe-not-too-distant-future, folks will wind up blowing themselves up financially. It's too easy. This is literally insane. I'll bet we've got ten to twenty years of wealth destruction in front of us. I'm serious.
"I think you can't assume that the next ten or twenty years are going to be as relatively stable as the last ten or twenty. I would think that the odds are greater for the potential for turbulence, for conflict - which then has implications." Richard Haass - McKinsey interview - "The World Tomorrow"
This is NOT GOING TO END WELL. I won't argue against the idea that it's expedient and easy and that fewer people will be hurt financially this particular hour or this week, but as for the intermediate and long-term...?... ugh...
"Financial leverage has always taken its toll on security values, and we are not convinced that this [next] episode will be an exception." - authors of 'Specific Standards for Bond Investment' - Security Analysis - by Graham & Dodd - Fifth Edition - page 467
Beating the dead horse on the interest-rate disinflation call?
I am not trying to solve for a single, macro-economic result, (as in ultra-low forever interest rates), but I think you should know...interest-rate inflation is not just around the corner. You're living through the Japanification and Europeanization of the American economy. IF Atlanta Fed President Rafael Bostic is correct in his 'forecast', and the Fed may be hiking interest rates by mid 2022 (that would be great, btw, because it would mean the economy was strong, Covid-19 was beginning to be a thing of the past, and tapering of bond purchases by the Fed would coincide), you should know that the peak in that interest-rate-raising cycle would be very, very low historically. Last time, in April of 2019, the Fed got the effective Fed Funds rate all the way to a whopping 2.42%. There's been SO much new debt added to the system just since then. The next peak in the Fed Funds rate might only be able to get to half of that level this next time. Why? Because the amount of debt within the economy cannot sustain a significantly higher interest expense cost without the economy rolling over into recession and requiring yet more stimulus from lower interest rates (other stimulus). The economy is so fragile and in such dire need of cheap money that it's literally like a junkie who's addicted to drugs who can't go more than a day without some drugs (sorry to be so graphic).
When the pandemic is behind us, we will be left with a ton of debt issues to have to deal with; that will equate to an increase in financial instability, low growth, and low rates at least until we close the huge output gap we have on our hands.
So in the most general sense, as an investor, trying to secure higher investment interest income on one's investments should be priority.
I bet that many readers are going to think to themselves again that I'm beating the dead horse with the interest-rate disinflation "call", but I have to remind everyone that the over-indebtedness on virtually all balance sheets is, in fact dis-inflationary, not inflationary.
I will concede, of course, that due to the pandemic, and big disruptions in the supply chain, that there are serious shortages on certain goods.
Shortages in certain goods categories don't bring about higher interest rates when the Fed's controlling the yield curve
The picture below is a view of the bicycle aisle at my local WalMart. There are no bicycles. There's an amazing, high-end, bike shop near my home that has nearly an identical inventory shortage and they deal in $5k+ bikes and their shelves look almost just as bare.
This temporary supply-demand disruption doesn't mean inflation in interest rates is just around the bend, though.
Components of CPI (Consumer Price Index) (Source: Advisor Perspectives-Doug Short-Jan2021)
Rents matter more
So....the entire Recreation slice of the above pie amounts to 5% when the Rent component is 42%. Rents matter more.
And rents are rolling over due to at least two reasons:
- Affordability with low interest rates for homes (though this may be short-lived at this point in a peak-ish housing cycle), and home prices (which have been on fire in many instances), are not measured in the CPI;
- Too much over-build in multi-family real estate and government-led rent and eviction moratoriums to where many landlords are not collecting rents;
How can you embark of an inflation cycle when households represent 74% of spending in the USA and they're deleveraging in a big, big way (paying down debt either with their own funds or with government checks), and they're saving at such a big rate? Credit on spending (not including margin debt), is contracting, not expanding.
In other words, just because you cannot find a bike, don't think that means substantively higher interest rates. A spike, yes.
How much of a spike?
The 10 yr UST could go to 2% from 1.1%, but it could (50/50), just as easily go to zero. Even now. I'm very serious.
"Inflation is not what companies want to charge but what consumers are able and willing to pay." - David Rosenberg - Chief Economist - Rosenberg Research - February 1, 2021
With interest rate risk spreads this drum-tight and artificially so, we should see some widening before the end of 2022 IF the Fed and Treasury will allow the natural market dynamics to play a bigger (more normal) role. But, the timing of that...?...I wouldn't bet on that...
Okay, okay, but what about the practical side of inflation?
A buddy of mine texted me two nights ago after going to Kroger and spending $142 on what he deemed "nothing". I get it. There's plenty of practical inflation. For sure. And watch out for it in energy. That's gonna hit people when they least expect it. There could be years of inflation from the energy part of expenditures. Also, the BLS (Bureau of Labor and Statistics), only assigns a 1.579% weighting of the total household expenditures on college and tuition. Well, my wife and I are pretty soon gonna have two in college and that weighting in our budget won't amount to 1.579% I can tell you that.
So these 'calls on inflation' 'that you hear in the media are so full of hyperbole and not investment-relevant unless you really get nerdy in the discussion. "Inflation is just around the corner", is not a smart way to analyze the current inflation/disinflation dynamics against your investment portfolio holdings.
Review of a few principles at this point in a crazy cycle
"If you want to be in the business of benefitting from the seven fat years, then you must suffer the seven lean years, too, even the catastrophically lean ones. We need free markets, but we need them to be principled." - Professor Emanual Derman - Columbia University - from "Models. Behaving. Badly."
A review of two of the ten rules of Investing from legendary analyst from Merrill Lynch, Bob Farrell:
"Exponential rapidly rising or falling markets usually go further than you think, but they do not correct by going sideways."
"Fear and greed are stronger than long-term resolve."
What does this mean for your asset allocation?
Think about your duration in your bonds, not only your stocks. Have a hold discipline with your bonds as well as a sell discipline due to credit and business risks, and dial in your time horizon with your stocks and shorten their duration. That's the opposite for investors but for the most part, we're not in an investor environment. It's a big-time speculation environment. Period.
In this environment, you want longevity and dependability from your yield, dividend stability and even growth from your stocks, and hard assets with yields that benefit from low interest rates.
Examples: Kinder Morgan and Kroger:
Kinder Morgan Inc (NYSE symbol: KMI; it's not incorporated as a Limited Partnership like many of their peers; instead a C-Corp), so pays regular, dividends (the equity that is (we own a lot of the company's bonds as well)).
At $14 per share and a 7.5% dividend which is scheduled to receive a bump of a 3% increase in 2021 over 2020, an investment-grade rated balance sheet, growing U.S. industrial demand, and really one of the most important natural gas midstream companies, I think this is a great core holding generating great income and priced at a reasonable price. I've watched the company pay down $10B in debt over the last five years as well in a very, very tough business.
- A practical solution for when places like California, because they're relying too heavily on renewables, needs natural gas to step in when renewables 'drop out' to avoid having to subject their customers to 'blackouts'
I have been bullish on their bonds for years now and have selectively and carefully acquired them at great yields and one of our biggest positions is their non-callable, 8.05% 2030 investment grade rated tranche. Thing is, most of the positions in client accounts were bought at significantly below par so the actual annual yield on the bonds is well over 10% in most cases. This is where duration is your friend; we went against the herd by extending duration at times when folks were saying, "rates are going higher, the bond bull market is over. Sell your bonds and buys stocks." Go ahead and buy some stocks, but sell your bonds 'whole-hog' (as they say)...?... Nope. Thing is...you cannot find bonds like this anymore outside of very distressed trading periods.
Example #2: (SO BORING...ugh)... KROGER!?! Seriously...
Kroger - the price you pay for an investment is SO important (price to sales is an important metric for me). I know, I know. Kroger is about as non-sexy as it gets and it's in the grocery business that is notorious for having slim margins. And, on top of that, Costco is 'wonderful'! And you know what? It IS. Seriously. I know that. It's just that it's 5X more expensive on a price to sales basis than Kroger. And Kroger pays almost 3X the dividend yield at 2.15% (which, I know, isn't that amazing; but against a 10 year UST yield of 1%, that's not bad).
Not looking for a home-run, just looking for the stock to trade up to a 0.3x sales level from its current 0.2x level
And with a market cap of only $25B, if the stock trades up to 0.3X sales to $39B; like it traded 2014-2016 (0.3x sales), that is a +50% return from here (I'm not forecasting a 50% short-term return for the stock, but with revenue and EPS projected to increase from here, their same store sales optics, their own private label brands sales doing really, really well, underperforming store closings continuing at a good clip, and they're already paying their people the government mandated minimum wage, it's more than a reasonable investment at these levels).
Some random political thoughts
The pandemic and a market that is not connected to fundamentals
The unbridled faith in the vaccine rollout 2.0 without a hitch along with the faith in the 'stimulus' infinity.0 saving the day is maybe a bit much. The markets pricing these two outcomes for sheer perfection may be unwise. I will say, however, that the herd immunity timing is important and anyone's guess between the end of the summer and into early 2022...?... who knows... and the new variants...?...
But, on the other hand, the improving therapeutics and vaccines may prove to be very promising and could be hugely positive down the road not just for Coronavirus but also other maladies. Lastly, the hyped-up bubble in green energy ETFs is no different than what we saw in 2000 with internet companies just before the dot.com bust.
Over the weekend, Congress voted precisely along party lines for the $1.9 Trillion stimulus plan and VP Harris cast the tie-breaking vote. This was just like Trump's tax cut back in 2017. Where's the bipartisanship? I think it's likely that the period between February 2021 and November 2022 is not going to be the "Blue Wave", that folks have talked about, but rather a form of gridlock. The midterms in 2022 may catch a lot of folks by surprise as several Democrats may be replaced with Republicans. This may usher in a heavier form of gridlock than this "gridlock-lite" (Rosenberg's term). In other words, tax hikes being legislated later in 2021? I don't see that happening... Republicans won't vote for them and Democrats facing re-election in November 2022 won't either.
End to the Tariff response? I sure hope so...
Trump’s former economic advisor, Peter Navarro's use of tariffs to deal with global trade imbalances was simply terrible strategy. Like it or not, some of Trump’s policies were business-friendly and economic friendly. We obviously couldn't afford a tax-cut when it came, but it came and that was coupled with less regulations. That period of less taxes and less regulations should be contrasted against what could be in front of us: a secular trend increase in both taxes and regulations (over the course of several years). Being tough on China for their intellectual property thieving practices was wise. Biden is expected to continue to be ‘tough’ on China (the jury’s out until he is 180 days in or so to see if that’s actually true, but he’s said as much). Let's hope that tariffs aren't the main tool this administration uses to deal with trade issues.
"The U.S. has been focused on soybeans and China has been focused on semiconductors and the next generation of technology." Danielle DiMartino Booth (former Fed Economist)
Honoring George Shultz
We lost a GREAT stateman in George Shultz, age 100, who passed away recently. What a brilliant mind and just overall quality human being. Believe it or not, people on both sides of the political aisle greatly admired him.
On page 202, in his chapter entitled, "Entitlement Reform At A Glance", from his book called "Putting Our House in Order", George Shultz said:
"Promote policies that encourage private pension plans." Now he wrote that in 2008, so I know, I know, that's SO yesterday and I cannot believe that he didn't instead recommend that the U.S. buy bitcoin (HEAVY SARCASM)...
Nearly everything's too expensive. Even most of our bonds and stocks are over-priced. But in nearly every case we shouldn't sell our bonds because we can't come close to replacing their yields. We've trimmed many of our Value stock names as many of their prices have run up closing in on the historical, median price target as they were ever so cheap before Covid and up until recently. They've been cheap for a reason (stability, but little to no top-line sales growth).
We own corporate bonds with 6%-8% coupons; the same issuers are issuing new bonds with 2%-4% coupons. In many cases our bonds have corresponding yields that are above 8% per year.
We own many 10 year municipal bonds with 4 & 5% coupons; the same issuers are issuing new bonds with 2.5% coupons. In many cases those corresponding yields are well above 3%. (Yields on similar munis are presently in the 0.43% range).
Maybe we should call this current stock market the 'DTB market': Draft Kings, Tesla and Bitcoin. This is an absolute casino.
* This is not a market for investors. It's purely a market for speculators (of the extreme order) - gamblers. Seriously.
I personally think it's a market you still want to be invested in, but it's VERY difficult to put money to work at present and it's important to hold plenty of cash.
Reposition accumulation units into income units (think about your future income distribution rates)
To echo George Shultz's recommendation from 2008, my big recommend for 2021 is for folks to seriously consider capturing some gains from their stock portfolios and repositioning those monies into one particular 'private-pension-like' income strategy guaranteed by an A rated insurance company. The math within this construct is fantastic compared to what could be 'Pedestrian returns out of stocks and bonds over the next 10 years', (what Leon Cooperman recently said in an interview)...
Reminder: think about duration in your bonds, not only your stocks
Don’t let the issuer ‘clip’ your coupons (decrease them). Instead consider your call protection…and your coupon rates and thus your 'carry' in case I'm wrong with interest rates and we find ourselves in an environment with higher interest rates and your higher coupons you have will help you 'carry' on and you won't get walloped (because their coupons are low and the prices of their bonds will get hit worse in a upswing in rates environment), like many who have been buying new issues only and don't take the time to know the secondary markets.
Financials, Energy, Technology, Some Stay at home exposure, but also some balance in some 'back to work' exposure, Select Utility, Preferred stock, Hybrid preferred stock/bond characteristic, REIT BONDS (not stocks), Asia, parts of Europe, with low price to sales ratios and strong, dependable dividend payouts and strong positions in the marketplace like Intel, for example, and things like preferred stock from Prudential PLC (London), the global insurance company, pays a 6%+ Yankee dollar (US$), annual yield based on the current price.
With new money, I think you invest in 1/2 positions of income producing securities that make sense, sell risky investments, have plenty of cash, a security plan for your family and your possessions (because as I've said in the past, 'they're coming for your stuff' (the government is by way of regulation, taxation, and confiscation), plenty of life insurance, long term care insurance in certain instances, and get outside in some healthy air and exercise. Also, here's a gentle reminder to take the occasional fast from media. That's my take anyways.
Thank you, as always, for your business. I have a great job and people like you make it possible.
In closing, I thought I'd end with another humility quote:
"Humility is not thinking less of yourself, it's thinking of yourself less." - C.S. Lewis
Have a wonderful remainder of winter and beginning of Spring!
Jack Parsons CTFA, AEP
President & Chief Investment Officer
Vickery Creek Capital Mgmt., LLC
Sources: St. Louis Federal Reserve, NY Fed Research & Statistics Group, Blackrock, Fidelity Institutional Wealth Services, S&P Global Market Intelligence, Rosenberg Research, "Models. Behaving. Badly. - Why Confusing Illusion with Reality Can Lead to Disaster, on Wall Street and in Life" - by Emanuel Derman (Free Press), Jeffrey Gundlach, Bloomberg, CNBC, "The Rise and Fall of Nations-Forces of Change in the Post-Crisis World" - by Ruchir Sharma(W.W. Norton & Co), Peter Zeihan (Zeihan on Geopolitics) - "Life After Trump, Part V", WSJ, Forbes, "The End of Power" - by Moises Naim (Basic Books), "The Other Half of Macroeconomics - And the Fate of Globalization" - by Richard Koo (Wiley), Advisor Perspectives - Doug Short - "Inside the CPI - Dec 2020", The Economist, IMF, Bureau of Labor and Statistics, "Has MMT Infected Central Bankers" - Jan. 2021 - Thornburg Investment Mgmt, U.S. Treasury data, "Putting Our House in Order" - by George Schultz (W.W. Norton), "The Curse of Cash" - by Ken Rogoff (Princeton University Press), Scott Minerd - Guggenheim Partners, "Graham & Dodd's: Security Analysis (Fifth Edition-McGraw Hill), Arbor Data Science, Arbor Research, Jim Bianco, Lance Roberts, Advisor Perspectives, Factset, Marketwatch, Mauldin Economics, Dr. Lacy Hunt - Van Hoisington, Yardeni Research, Thomas Jefferson Foundation (Charlottesville, Virginia), Google, McKinsey & Co, Reddit, Gamestop, Walmart, Kinder Morgan, Kroger, Fifth Edition (McGraw Hill), iR Research, Vickery Creek Capital Mgmt., LLC