Recession Watch

The Stay Invested portfolio was DOWN today: $403.48 (-0.37%)

Overall GAIN/LOSS YTD: +$5,754.275 (+5.60%)

Start: $102,717.24

Current: $108,471.51

Our benchmark index, the S&P 500 is UP Year-To-Date +11.91%

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

(daily performance is updated after the close, early blog posts typically show the previous days performance)

"Wall Street is the only place where people show up in a Rolls-Royce

to get advice from someone who took the sub-way.”

― Warren Buffett

Recession Watch?

I saw on CNBC News where Credit Suisse Global CIO Michael Strobaek said, "a recession is coming — but it won’t be ‘right here, right now’". Ummm, wow that's powerful. I guess an earthquake is coming to California, but it won't be right here, right now. Any number of scary things can be predicted with that kind of logic. In all fairness, Mr. Strobaek did explain himself further, logically, much more so than the headline did. My beef isn't with Mr. Strobaek, it's the headlines that are intentionally meant to create fear and unfortunately I see this everyday in the financial news. What's more unfortunate is that a few of these spill over into the daily news.

To be clear, I personally do not see any indication that we are about to plunge into recession. Is the economy in the U.S slowing? Yes it is. Will the U.S. economy reverse course and grow again? Yes, it already is. A slowing economy doesn't mean 'no growth', just less growth than we had before. Can we have even more growth than we've had in the past two years? Yes we can, it just takes a little more time for the inputs from earnings, new tax laws and capital investment to work their way through the system.

The Yield Curve?

"But what about the inverted yield curve"? I've written about this before in Yield Curve Yawn and other posts. Let's clear up some things.

First, the yield curve commonly cited is wrong and is not an 'accurate' predictor of recessions. It doesn't matter what patterns you think you see in the charts or how many times they cite the 10 year treasury vs the 2 year treasury, it's wrong. The only metric that works accurately with Dr. Harvey Campbell's theory on the subject is the 90-day note vs. the 5 year treasury. The shorter duration more closely matches the U.S. business cycle and that is really important. Send me all the flame mail you want, I'm used to it now; but until someone says they read Dr. Campbell's thesis, understood it and now have their own research and thesis to present for critique by the world best economists, I don't care. By the way, the 2 year and 10 year have not inverted, so the financial news has taken to citing the 2 year vs. 5 year so they can say that it has inverted. See treasury rates here TREASURY RATES

Second, While every recession has been proceeded by an inversion of the yield curve, not every inversion of the yield curve has produced a recession.

Third, The rates must remain inverted for one quarter to be an accurate prediction. The 90 day vs 5 year inverted on March 6, 2019 when the 90 day note closed at 2.47% and the 5 year closed at 2.49%. These rates have been inverted ever since and today closed at 2.44% and 2.18% respectively. That's not scary, its just something to watch if you own stocks.

Fourth, the yield on U.S. treasuries is abnormally low, but unlike most of the world, the U.S actually has yield. There is a grand experiment taking place in real time and nobody really knows how it will turn out, so remain invested for all eventualities. For all we know the yield curve inversion may not mean anything this time because of the low rate environment we're in. I can't prove that out, but since we're experimenting I think it's reasonable to consider all possible outcomes; short of saying, "It's different this time".

Low Rates

So why are rates so low and can't seem to get a lift? The common chatter has been that the U.S just keeps selling tons of bonds driving the country further into debt...we're just swimming in foreign debt, they own us. Well that's a convenient scapegoat, blame politicians and foreigners, but the data just doesn't support it. China is the largest holder of U.S debt but their holdings have come down dramatically. Once 14% of all U.S foreign owned treasuries, China now holds just 7%. Japan is number 2. Who holds most of the U.S debt? We do, tax payers and Social Security. The Social Security Administration takes in more money then they need to pay out, so they buy U.S treasuries with the excess instead of hiding it under the mattress.

Over 2300% for Me & You

Did you follow that, our payroll taxes for Social Security are being used to buy U.S Treasuries, which means that those dollars end up in the general fund and spent. The Federal Government will one day have to pay that back to Social Security when they redeem their bonds which will mean raising taxes, or selling more bonds. It's kind of a silly system when you think about it. Why don't we each invest the excess ourselves into an index fund and save that for retirement? When I graduated high school in 1980 the S&P 500 closed at 116, today it closed at 2,805, a 2,314% growth factor; that's why I want my excess payments to Social Security to be invested in an index fund just for me. See we don't need a guaranteed wage, or guaranteed job or a Magic Money Tree (MMT), we just need to put the capital we do have to more productive use and curtail the practice of our government borrowing from itself with our money.

Two Kinds of Debt

The National Debt is broken down into two main types, Intergovernmental Debt and Public Debt.

Intergovernmental Debt is debt owed to 230 Federal Agencies and at $5.9 Trillion dollars its about 28% of the National Debt. Every agency that has more money than it needs from tax dollars uses the excess to buy treasuries. Social Security/Disability owns about 50%, Military and Retirement Funds own 20%, Personnel Management owns 16%, Cash on Hand owns 11% and Medicare owns a paltry 3%.

Public Debt of just over $16 trillion is owned by the public. Foreign governments and investors hold 30%, Individuals, banks, and investors hold 15%, The Federal Reserve holds 12%, Mutual funds hold 9%, State and local governments own 5% and the rest is held by pension funds, insurance companies, and Savings Bonds. While all foreign debt is the largest component at $6.2 trillion, China's portion is $1.18 trillion. For comparison, mutual funds own $1.8 trillion and other holders such as individuals, government-sponsored enterprises, brokers and dealers, bank personal trusts and estates, corporate and non-corporate businesses, and other investors own a whopping $2.4 trillion. Doesn't look like China is the bogeyman anymore, does it?

So when we look at who would get hurt the most if the U.S defaulted on its debt, its you and I because half or more of the National Debt is being held in our retirement trust.

So What's Keeping Rates So Low?

When the Federal Reserve raises interest rates they are impacting the short term rate that banks pay at the discount window. But long term rates like the U.S 10 year treasury is impacting by a whole host of market factors. But the one that looks to be keeping rates down right now are traders using swaps to hedge against the low rate environment that the Fed created. There are two sets of traders, 1) mortgage bond buyers, and 2) low volatility investors. Both of these groups are using derivatives markets, namely swaps to protect against losses. You remember swaps from the mortgage crisis and the movie The Big Short? When these groups bought interest-rate swaps they pushed US Treasury yields further down. “hedging activity from programmatic gamma sellers is likely to keep swap spreads very directional with rate moves,” said Sam Elprince of Morgan Stanley. That was a mouth full, suffice to say it's not China, it's not a lack of interest in U.S treasuries and it's certainly not a recession. The options market is driving down rates and that's likely to continue for a while until everyone has hedged their positions for the current market environment.

Stay Invested,

Clay

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Keep Me Honest

S&P 500 declines to 2,350 or more (1-3-2019)

Healthcare and Biotech sectors outperform (1-3-2019)

S&P reaches 3,000 by year end (1-11-2019)

CSCO reaches $60/share (1-18-2019)

VEEV reaches $145/share (2-14-2019)

CVS reaches $91.50 (2-27-2019)

Disclosure: I am personally invested long in some or all of these stocks or funds that appear in the Stay Invested portfolio and may purchase or sell shares within the next 72 hours. I am also invested in other stocks and funds that do not appear in the Stay Invested portfolio but may be mentioned or related to this article. It is not my intention to advise or encourage the purchase or sale of any security. I am invested long in these securities mentioned in this post:

CVS, CSCO, VEEV, STZ, AMZN, NVDA, BCRX, GS, BDSI, VEEV, VTI, GLD.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article. This article is not intended to offer investing advice, guarantee 100% accurate predictions, or to be interpreted as providing a personal recommendation.

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This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice.
This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities.

© 2016 by Clay Baker all rights reserved