The Line In The Sand

In my humble opinion, after being on Wall Street for 48 years now, all investments have a “line in the sand.” There are a number of ways in which it can be measured, but it is still there nonetheless. The calculation that I use, which I believe is the most accurate, is the average of the Consumer Price Index (CPI) and the Producer Price Index (PPI). This number is currently 7.25%, and no matter what investment strategy that you use, you are either ahead of inflation or behind it. It is one or the other.

End of story!

The problem that we all face now is that are very few investments or strategies that accomplish the goal of being on the positive side of this line. Equities for the last year, with very few exceptions, are nowhere close. Even with last Friday’s very pleasant run-up, for the last twelve months the DJIA is down -7.18%, the S&P 500 is down -16.72% and the NASDAQ is negative a painful -29.2%. All data according to Bloomberg.

Bonds haven’t accomplished the goal either. For the past year, according to Bloomberg, Treasuries were down -9.55%, Investment Grade Corporates were negative -12.39%, High Yield Corporates were down -8.35%, Mortgage-Backed Securities were -8.89% and U.S. Municipal Bonds were -6.83%. The yields on bonds, until very recently, haven’t accomplished my goal either, as they have been far under the 7.25% inflation number.

I do point out today that something has changed. Bloomberg now shows that the average yield on High Yield Bonds is 8.43%. There is the issue of “credit risk” to be considered here, of course, but at least one major investment sector gets the job done. Then, with the Bloomberg survey for our upcoming CPI at 6.50%, this sector may be even more attractive after the actual number is released on January 12.

I also point out another opportunity today. We have a completely flummoxed Treasury Yield Curve, with the highest yield being the six-month Treasury Bill, followed by the one-year Bill and the two-year note. Consequently, if you can find some short High Yield Bonds spread off of these three Treasuries, there are some opportunities to make some money, as the Yield Curve will eventually straighten itself out. Duration always comes to the surface after a period of time, and so, “credit risk” should be measured against the risks of duration when considering fixed-income investments.

It is clear to me, given the Fed’s announcements and actions, that the days of “easy money” and very low yields are over. I am not a believer in the “pivot” concept, but there will come a time when the Fed will stop raising interest rates, and so, at that point, our “line in the sand” will be much lower than it is today. “Pivoting” is not a necessity, in my opinion. Just stopping will be enough to have a very positive effect on both the bond and stock markets.

In fact, in my view, the Fed should just stop raising rates when the average inflation rate gets to 4.5-5.0% and gives the markets some chance to readjust. Some 2.0% rate is a lofty goal but is one that won’t be accomplished immediately, regardless of the Fed’s actions. The Fed, in my opinion, also needs to consider the cost of borrowing money, what the markets have done to people’s pension funds, and what they may do to corporations that need to raise capital or refinance. There are a number of “consequences” that the Fed should consider, and collateral damage to other segments of the economy are certainly one of them.

Then, there is also the change of control of the House of Representatives that may be a positive for the markets. I am not making a political comment here, but I think the days of “fast and furious spending” may also have ended along with the days of “easy money.” Throwing taxpayers’ money at each and every thing will not be as easy as it has been, in my opinion. I think this is an economic positive that will be help for both bonds and stocks, as our debt-to-GDP ratio must be brought under control.

Therefore, considering all of this, my forward outlook is turning somewhat more positive as all of these factors come into play. We are not out of the woods yet, but the trees are less dense and there appears to be some light ahead in the forest.

Original Source: Author

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