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© 2016 by Clay Baker all rights reserved

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The New Red Scare?

January 12, 2018

Mother's Little Helper portfolio was UP today +$780.67 (+0.75%)

Overall GAIN YTD: +$3,612.95 (+3.61%)

 

Our benchmark index, the S&P 500 is UP +3.51%

http://money.cnn.com/data/markets/sandp/

 

 

 

 

"If the 19th century belonged to Britain, and the 20th century to the United States; 

Then the 21st century will surely belong to China.

My advice: Make sure your kids learn Chinese."

- Jim Rogers (co-founder The Quantum Fund)

 

 

I made my buys for the year on December 28, 2018, see the new portfolio here (Click Here).

 

China Dumping U.S. Bonds?

Yesterday the markets went nuts when a rumor about China 'slowing the purchase of US treasuries' hit the street.  Stock were selling off hard at the opening.  By the end of the day the story evolved into 'China is dumping all their U.S bonds'.  The story had the patriotic cry of the 1950's Red Scare I recall from my middle school history books.  I'm on the opposite side of this one.  Even though I think the story is a bunch of malarkey.  I think it's a good thing for the Chinese to dump their bonds, here's my case.

 

The Fed is unwinding their $4.3 trillion balance sheet which will cause rates to go up.  Everyone is calling for 3-4 rate hikes in 2018, but I think they'll only raise 2 times because clearing even a portion of their balance sheet will do the rest.  The problem is there is a huge amount of money in the bond market, a lot of overseas money.  China won't stop buying our bonds, as much as I think it would actually help us if they dumped them all; they won't, we need each other to maintain artificial currency valuations.  They want the Yuan to be the international currency of trade and we want the dollar just slightly weak enough to boost exports.  All that debt they buy has the effect of doing that.  Yesterday when investors freaked out over the Chinese bond scare millions of shares sold at the opening; the Chinese own $1.2 trillion in US Treasuries.  Basically you can think of China as Uncle Sam's private banker.  As much as I'd love China to dump their U.S bonds, it's all talk.  Nothing changed yesterday.

 

Short Bonds

In a post from last year I offered up an idea for anyone concerned about the bond market, buy the TBT and some gold using the GLD fund.  The TBT is a 2X Ultra Short fund that bets on bond yields increasing.  This is an inverse investment.  As bond yields go up, bond prices come down and the TBT goes up.  Gold is the hedge against all uncertainty, so if the bond market suddenly starts collapsing, a position of 5%-10% of a portfolio in gold provides a good hedge.  I like the GLD because it owns physical gold so you don't have to.  I'm going to make a change to this years portfolio to test this idea by selling some shares of our index funds and re-balancing the portfolio with some gold and a position in the TBT.  With those positions and our index funds we are prepared for just about anything.

 

The Freaking Yield Curve?

Portfolio managers have been freaked out over the fact that there is no inflection in the yield curve, that you are almost getting the same return for short-term treasury's as you are for longer term. That's a flat yield curve, typically this is a leading indicator of a recession.  But only if the Fed raises rates too quickly (Like Greenspan did), loan demand falls, the economy stalls and we get thrown into a recession.  But that's at much higher rates when leverage, both consumer and corporate are at highs or over leveraged.  If a huge debt holder like China starts dumping longer-term Treasuries won't the inflection in the yield curve show up immediately?  That's positive with low rates.  Why? Because that looming threat of an unpredictable recession goes away; we know exactly what's going to happen and when.  Rates go up to a level where banks can make more money lending.  I wish the Fed would dump its $4.5 trillion treasury position to do the same thing and beat China to the punch.

 

I Want To Hate This Market!

Here's what I don't get.  How can we be worried that if longer rates don't go up we might go into a recession, but if they do go up, there might be a slowdown.  This is the chatter coming off Wall Street.  Seriously, are we arguing with ourselves?  Besides, even if any of this happened, the rise in rates will be so small it won't matter, except for the fact that banks will make more money by lending more.  Look back at the double digit teen rates that investors worked with in the 70's and early 80's. 

Investors made a lot of money in that environment, high interest rates aren't necessarily a harbinger of doom.  Rates need to go a bit higher to spur loan growth and that will be good for stocks.  The big banks start reporting on tomorrow and I'm guessing we'll hear that loan growth is slowing.

 

Last month, the big story was lack of inflation.  The Fed has done a pathetic job of trying to hit their 2-2.5% inflation rate, so now they are discussing changing their model.  Low inflation means lower wages or no increases, and no pricing power will put some companies out of business.  Not every company can keep raising prices like Apple does and keep expanding their market share.  Ultimately that should mean that banks can't raise rates in that environment.  What happened last month, the banks, JP Morgan in particular, rallied the most!  Stupidity is raining on this market.  Investors can't have it both ways.

 

In my most suspicious mind I come to the conclusion that all of this is noise, intentionally perpetuated on retail investors to get you to dump your stocks.  It's the crisis du jour.  Why? Because fund managers are long bonds, international money is long bonds and everyone is light on stocks and they're missing out.  Those folks need to buy stocks for their portfolios.  If a scary story about China, Yield curves, low wages, or whatever is all it takes to get you to dump your stocks then fine they'll try that.  If they're successful then prices will fall because if you sell, then the algorithms sell and the index funds sell to balance and the institutional investors who are trying to sell this 'Chin