YC Has Perfect Batting Average Going Into the All-Star Game

YC Has Perfect Batting Average Going Into the All-Star Game

The yield curve (YC) has a perfect record since 1955!
Will it affect the next presidential election?

The MLB All-Star game is one week from today.  No player in history has ever had a perfect batting average at the All-Star break.  No one.  Ever.

The yield curve has been in the game since 1955 and has “correctly signaled all nine recessions since 1955 and had only one false positive, in the mid-1960s, when an inversion was followed by an economic slowdown but not an official recession,” according to the Federal Reserve Bank[i]. A perfect record  predicting recessions.  Sounds like it might be worth knowing about.

See the red line below and how it is flatter than the others, in particular the yellow line?  The yellow line shows rates as they were a year ago and is a normal yield curve meaning longer term bonds pay more interest than shorter term bonds.  The red line is the current yield curve.  Short term rates on the left side of the line have increased significantly while long-term rates have remained nearly constant.  The curve is flattening.  When the left side of the line rises above the right side, the yield curve is then inverted.

bonsupermarket1

Source: bondsupermart.com

Economists focus mostly on the spread between the 2-year US Treasury and the 10-year US Treasury to define an inversion.  Here’s what the yield curve looked like at this time in 2006, two years before the Great Recession invited us to the party.  Notice how the red line dips slightly from the 2-year mark to the 10-year mark?  That is the classic definition of an inverted yield curve.

bondsupermarket2Source: bondsupermart.com

What makes the yield curve move?

In short: The Fed.  The Federal Reserve Bank sets one rate and one rate only: the Federal Reserve Bank Discount Rate.  Until 2008 banks rarely used the Fed “Discount Window” so the rate was purely academic – except for the fact that is drives the global macroeconomy.  That’s right – nearly all economic activity globally takes its signal from this one obscure rate that historically has rarely been used.

The “Great Recession” was triggered by the Fed raising the Discount Rate 17 times, 25 basis points or 0.25% at every Fed Meeting or every other meeting for two years.  This is what it looked like:

fred pic

Source: fred.stlouisfed.org/series/INTDSRUSM193N

Then the Great Recession “hit” and the Fed raced to lower rates then held them at record low levels:

fred pic2

Source: fred.stlouisfed.org/series/INTDSRUSM193N

Notice how rates remained low for nearly a decade?  And now are marching back upward?  The Fed meets July 31, September 25, November 7 and December 18 this year.  Four more opportunities to increase the Discount Rate on top of the seven increases in the last two years:

ychart

Source: ycharts.com/indicators/us_discount_rate

The minutes from last Fed meeting in May 2018 reveal the Fed’s thoughts on the direction of interest rates:

“It would likely soon be appropriate for the Committee to take another steptranslation in removing policy accommodation”

Translation: We are increasing interest rates

The Fed pushes the short end of the yield curve up and if macroeconomic conditions do not cause long term rates to rise in sync, a recession results.  Long term rates are not rising so a couple more Fed rate hikes should be all it takes to invert the yield curve.  And given the one to two year precursor effect of an inverted yield curve, the timing of the next recession is likely to coincide with the next presidential election cycle.  What fun!

Test on this on Friday.

What does this mean for you?

Adjust your company’s spending, hiring and investment plans now while you still have time to plan.  Planning on building a new plant to double output?  Might want to put that on the back burner.

Consumer discretionary spending usually declines in a recession as does business spending.  Hiring and expansion get put on hold and employers lay off employees.  Banks tighten up lending because they can’t make as much on long-term loans as they can on short-term loans.  Mortgage lending decreases because home buyers have to pay a higher mortgage payment as a result of higher interest rates.  Riskier assets tend to get punished disproportionately.  Anything in an oversupply condition will be especially hard hit – excess inventory gets extremely hard to move.  On the other hand, less expensive consumer discretionary alternatives typically outperform during recessions.  Going to the movies is much cheaper than a European or beach vacation.  Alcohol sales also tend to trend up.  Maybe the cannabis legal states will see an uptick, who knows, it’s possible.

Most important: Call Vertical Capital Advisors.  We will harmonize your business plan and strategies with the market.

 

* * *

ABOUT VERTICAL

Vertical Capital Advisors is an Atlanta-area boutique investment banking firm built on creating tangible value for our clients, serving clients in just about every industry.  Our clients are both capital growers and capital allocators.  How can Vertical help your firm maximize value?

 

Joe Briner
Managing Director
Vertical Capital Advisors LLC
briner@verticalcapitaladvisors.com
866-912-9543 ext 108
678-591-0273

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[i] www.frbsf.org/economic-research/files/el2018-07.pdf

Here Be Dragons!

It is said that ancient mariners’ maps bore legends that warned of mythical dragons beyond the horizon that would destroy any vessel venturing into their waters.

dragon-map

Many economists today feel the same trepidation that sailors of generations long past must have felt as their ships sailed beyond the known limits.  Our own Federal Reserve has minted oceans of money, trillions of dollars, out of thin air.  Our national debt stands at levels unimaginable just a handful of years ago.  Some say that our national debt is the dragon that will devour us.  By most measures, it appears that could be the case.  However our national debt is not a democrat or republican issue.  It’s a government issue – a government on a decades-long spending bender:

fed-debt-by-president

Source: truthfulpolitics.com

Yes, debt could be a dragon.

Critics of reduced government spending often say that our absolute level of debt is not a concern because our GDP and income have increased greatly over the years however when we look at our national debt as a percent of GDP, the picture is not much prettier.  Notice how it is now the highest it has been since the Great Depression?  Could be a dragon!

percent-gdp

Source: https://deutscheam.com/en-us/thought-leadership/cio-view/article/debt-curse-or-blessing?kid=disp.CIOView201610.outbrain_us.ad.focus

The real dragon in the room is deflation.  After nearly a decade of printing mountains of money, the US Federal Reserve and Central Banks the world over are not only out of bullets, they have barely kept the deflation wolf from at bay.  As we have written about in previous posts, the velocity of US money has slowed as all of the fiscal stimulus has become lodged in corporate balance sheets in the form of debt used to fund enormous stock buy-backs.  Very little investment has found its way into new property, plants, equipment or employees.

Think about it: doubling the national debt in eight years has produced a gasping patient.  With the Fed starting to soak up liquidity, the edge of the horizon is in sight.  When GDI and GDP (gross domestic income and gross domestic product) slip into negative territory, THERE BE DRAGONS!  The deflation dragon – the worst of them all!

gdi-in-us

Source: Author & unknown artist & http://www.telegraph.co.uk/business/2016/10/19/fed-risks-repeating-lehman-blunder-as-us-recession-storm-gathers/

The point?  Gather up all of the liquidity you can muster.  You probably have between a month and six months to gird your loins before the deflation dragon appears and when it does, it will likely thrash the markets for two, three or even four years – or more.  Who really knows?  We aren’t getting into this downturn on the well-worn path of the 60’s, 70’s, 80’s, 90’s and even early 2000’s.  This time we have invented a whole new breed of beast.  At the nadir, you will be able to acquire quality income-producing assets at once in a lifetime prices.  But don’t buy too early.  Channel Rothschild, JP Morgan and Joe Kennedy – buy at the bottom, after all of the liquidity that rushes into the market after the first wave is wiped out by the second and third waves.  Patience will be rewarded.

____________________________________________
ABOUT VERTICAL

Vertical Capital Advisors is a firm built on creating tangible value for our clients.  We work with clients in just about every industry.  And we work with both capital growers and capital allocators.

Joe Briner
Managing Director
Vertical Capital Advisors LLC
briner@verticalcapitaladvisors.com
866-912-9543 ext 108

 

 

Would you be willing to risk a 60% loss in order to get 2.85% interest from your bank?

Would you be willing to risk a 60% loss in order to get 2.85% interest from your bank?

Italy’s 50-Year 2.85% Bonds are 300% Oversubscribed – So what?

This week Italy began selling 50-year bonds paying 2.85% and they had three times more orders than they had bonds to sell[1].

“So what?” you ask.  “That means nothing to me”.

Or does it?

Bond buyers are generally a very bright lot.  They are probably the sharpest people in the business world.  They analyze every scrap of economic data continuously, day and night.  These hyper-analytical people are willing to commit money to an investment that has a very low yield for a very long time and whose host is in dangerous financial territory.  The Italian banking system is technically bankrupt as we wrote about in earlier posts and unemployment is over 20%.  We pegged Italy as one of the likely triggers for the next recession.

The country risks are readily apparent.  The interest rate risk is even greater. interest-rate-risk

You probably know that the price of bonds is inversely related to the rate.  As rates go down, prices generally go up.  As rates go up, prices fall.  The relative price to rate movement is determined by a bond’s duration which is a function of the rate and the time to maturity.  With a low rate, there is not much room to fall but a lot of room to rise.  And 50 years is an eternity in the world of bonds.  So if rates rise just 1%, these bonds are expected to lose 22% of their value.  Now the average rate for 10-year Italian bonds since 1991[2] has been a shade under 6%, let’s call it 3% higher than the 2.85% rate on the 50-year bonds.  Investors are willing to risk losing over 60% of the value of their bond investment in order to get a paltry 2.85% return and are in fact betting that interest rates do not return to normal, because if they do, and if they need liquidity, they will lose over 60% as sure as the sun will rise tomorrow.

italy-govt-bond

Forget Brexit.  It will be conditions like this that set off the next round of creative destruction.

So, would you be willing to risk a 60+% loss in order to get 2.85% interest from your bank?  Of course not.  Why are billions of dollars flowing into these bonds, then?  Because there is no alternative.  Investors are starved for yield.  They would rather risk the devil they know over the devil they don’t.

Fortunately, we have found a few brave capital allocators who are willing to seek higher returns from unknown enterprises like yours because they have the intellectual capital to analyze your business plan and make a rational determination that the expected return is higher and the risk is lower than Italy’s 50-year 2.85% bonds.

 

________________________________

ABOUT VERTICAL CAPITAL ADVISORS

Based in Atlanta, GA and created to help businesses survive the devastation of the Great Recession, Vertical Capital Advisors is a firm built on creating tangible value for our clients.  We work with clients in just about every industry and we work with capital consumers and capital providers.

 

Joe Briner
Managing Director
Vertical Capital Advisors LLC
briner@verticalcapitaladvisors.com
866-912-9543 ext 108

[1] Reference: http://www.wsj.com/articles/italian-treasury-sounding-out-investors-on-50-year-bond-1473260474

[2] Reference: http://www.tradingeconomics.com/italy/government-bond-yield