April 1, 2022
By Steve Blumenthal
“I’ve missed more than 9,000 shots in my career. I’ve lost almost 300 games.
Twenty-six times I’ve been trusted to take the game-winning shot and missed.
I’ve failed over and over and over again in my life. And that is why I succeed.”
– Michael Jordan
Stepping up the plate with a perfect seven-for-seven batting record is the grand slugger of all time: Tommy Two Ten. The doubters are saying he’s going to strikeout. It’s a tough bet to make.
An inverted yield curve describes the unusual drop of yields on longer-term debt below yields on the short-term debt of the same credit quality. Usually, the yield on longer-term debt is higher due to the fact that holders of longer-term debt have taken on more risk. An inverted yield curve is unusual and has occurred just six times since the 1970s. A recession has followed each signal.
The yield on the 10-year Treasury fell to 2.331% yesterday (Thursday, March 31, 2022), while the yield on the two-year Treasury was at 2.337% at one point in late trading. After a brief inversion, both yields were basically trading at 2.34%. Officials are going to video review to make the call. Early this morning, the 10-year is trading at 2.40%. The two-year is at 2.31%. It’s too close to call.
Wait a minute, the coach is calling in a pinch hitter: Tommy Two Ten is steaming. Famous for putting a stake in the heart of his opponent’s economy, he is now nose-to-nose with his legendary manager. Tommy is giving him the business. Powerful Powell is pointing to the bench. Not today Tommy, not today.
Check out the red arrows in the following chart. They point to the six times when the two-year Treasury yield was higher than the 10-year yield. Recession followed each inversion (gray shaded areas in the chart). The “we are here” arrow is pointing to yesterday’s level. Powerful Powell is looking to the sky with hands held in prayer, he’s trying to keep Tommy Two Ten on the bench.
And there is big money on Powell’s bench. He could sell some of the Fed’s massive $8.9 trillion in bond holdings to help re-steepen the yield curve. Late in the game with much at stake, the tension in his organization is high. Jerome Powell and team Fed are in a tough spot. Oddsmakers are betting on Tommy.
When an inversion does occur, it’s important to note that the time delay between an inversion and a recession tends to be anywhere between 12 and 24 months. Six months has been the shortest and 24 months has been the longest. We can only know after two negative quarters of GDP growth. Q1 2022 will report positive growth. Therefore, at best the official start date will be the end of Q3. It’s a look back thing so we have to do everything we can to look forward. The 2-year vs. 10-year spread is about the best we’ve got. Why does this matter? The reason is the market declines on average ~ 36% and waiting too long will be too late.
For the life of me, I can’t see why one would put money into low-yielding Treasury bonds or high-grade corporate bond funds. Trade them, yes, invest in them, no. In the inflation fight of his life, Powell is likely to raise the short-term Fed Funds rates another 1% over the next few months. Inversion is unavoidable.
Each week, I try to share something that is On My Radar and that will be meaningful for you. I can’t think of anything more important this week in terms of economic signaling than an inverted yield curve. Given the unattractive yields, my advice is to point your needle in a different direction. Next, I share a few ideas with you on how to harness optimism and opportunity. Optimism in the form of high single-digit over low single-digit high-grade bond funds.
Trade Signals follow below. The Zweig Bond Model is back in a sell. And baseball season starts in a week. Spring is here! Good luck to your favorite team.
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A Few Alternative Ideas
Compliance reminds me that what follows is not a recommendation to buy or sell any security. I want to give you a sense of what we are seeing and investing in without giving specific names.
Our industry is heavily regulated, and there are accreditation requirements for certain investments. For a quick background, my business is twofold: we work with a select group of independent advisors providing turnkey asset management platform services, and we are a “multi-family office” working with high-net-worth individuals. Our job is to bring investment ideas and structure to the people we serve.
We source our investment ideas from our network. Relationships we established over many years. Following are a few ideas we utilize.
- A hedge fund that invests in short-term trade finance receivables and writes a specialty type of Chapter 11 bankruptcy filing protection insurance. For example, a small shoe manufacturer that sold 1 million dollars worth of shoes to Macy’s is at significant risk should Macy’s file Chapter 11 and not pay the balance due within the next 60 to 90 days. The merchants’ bank, the trucker who shipped the goods, owners, and everyone in that business’s ecosystem is in bad shape should Macy’s file. The critical period is over the next approx. 90-days, this fund guarantees the shoe company that if Macy’s Files within 90-days, the shoe company can “put” the receivable to the fund. The shoe company pays the fund a premium of ~ 3% for this protection. After 90-days, the fund keeps the 3%, and the contract expires. The fund cash flows quarterly to investors at more than 12% per year. The fund broadly diversifies its risk and has a unique edge to source new business. Companies don’t just wake up and file Chapter 11. We are betting the funds leadership team will see such risks coming and avoid the risk—no guarantees. Since the source of return is short-term, there is little to no interest rate risk.
- A two-year Reg A bond. First Lean, short-term construction lending. This company makes loans on existing real estate. For example, an assisted living facility may need to expand its memory care unit. Because of regulatory reasons, banks are less inclined to make construction loans creating an opportunity for specialty lenders. This particular firm makes the loans and remains active in the oversite of the projects. They are controlling payments to vendors, accounting, and collateral. First lean means they are paid first, and if there is a problem, they take over the property. Low leverage is utilized and well collateralized. At the end of the construction project, the borrower goes back to the bank and refinances its mortgage debt. This company also offers a maturity of fewer than five years that cash flows at 8%.
- A direct lending corporate income fund (business development company). The expected yield is 8% to 12% with quarterly liquidity. This fund issues senior secured floating rate loans directly to businesses. Banks don’t generally provide capital to this space because of regulatory and structural changes in the market, reducing the amount of money available to U.S. middle-market companies. The founders have 25 plus years of executive experience at firms such as KKR, Blackstone, and Goldman Sacs. The focus is on low leverage (less than 50% Loan to Value ratio) and substantial collateral.
- A private fund cash flowing at 7% provides lending collateralized by pharmaceutical royalties. Banks don’t understand the value of royalties as this niche sits outside the lending box in which they live. The fund invests in short-term loans tied to a spread over the base lending rate. This way, if rates rise, the yield on the fund increases. The loans are generally less than five years, well collateralized by the royalty asset.
Note: If your investment net worth is more than $5 million, more specialty funds are available to you. I like that many funds previously out of reach are available now to all investors regardless of wealth.
Not a recommendation for you to buy or sell any security. For information purposes only. If you have more than $500,000 to invest and are an accredited investor, email me at Blumenthal@cmgwealth.com if you would like to see what we have on the shelf in the CMG Mauldin Kitchen.
Trade Signals – Zweig Bond Model Sell Signal
March 31, 2022
Posted each Wednesday, Trade Signals looks at several of my favorite equity markets, investor sentiment, fixed income, economic, recession, and gold market indicators.
For new readers – Trade Signals is organized into three sections:
- Market Commentary
- Trade Signals — Dashboard of Indicators
- Charts with Explanations
Notable this week:
The Zweig Bond Model was in a buy for just a week. It moved back to a sell signal this week, signaling higher rates. Bouncing back from oversold conditions and a state of extreme investor pessimism the equity market signals remain mixed. The NDR CMG Large Cap Long Flat Index remains in a buy signal. Gold remains in a buy signal.
Click HERE to see the Dashboard of Indicators in Wednesday’s Trade Signals post.
Not a recommendation for you to buy or sell any security. For information purposes only. Please talk with your advisor about needs, goals, time horizon, and risk tolerances.
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Personal Note – Savannah, GA
“There are no failures, only feedback.”
– Joe Quartucci, E3 Wealth
Susan and I were in Savannah, Georgia, earlier this week. In the back of my mind when I travel is the thought of where I’d like to have a winter home. Savannah is on the list. Following is a brief history of the city [SOURCE].
Savannah’s recorded history begins in 1733. That’s the year General James Oglethorpe and the 120 passengers of the good ship “Anne” landed on a bluff high along the Savannah River in February. Oglethorpe named the 13th and final American colony “Georgia” after England’s King George II. Savannah became its first city.
The city is absolutely beautiful. Its history runs deep.
Susan is serious about her morning coffee and on day one we walked along the river and found a coffee house that we returned to each morning.
On day two, Susan rented a car and drove a few hours northwest toward Atlanta to visit her eldest son, Tyler, a Marine stationed at the Robins Airforce Base. “He looked skinny,” she said. He’s been doing a fasting diet. Something I’m going to try. Tyler’s military commitment is up in September and he is not yet sure about his next steps. It sure is a joy to watch him, his sister, and his brothers grow.
I was fortunate to play Harbor Town Golf Links on Tuesday and the Deer Creek Course at The Landings Club on Wednesday. The Deer Creek Course will be the home of this weekend’s Club Car Championships for the Korn Ferry Tour. Great dinners, much wine. Hat tip to host Adin for the excellent wine.
My team and I were in Savannah for a due diligence trip sponsored by Skyway Capital. Skyway was introduced to us by our close friends at E3 Wealth, and it is part of a network that helps us source and vet different investment opportunities.
The Korn Ferry Tour represents golf’s second division, beneath the PGA Tour. Each year, the bottom 25 ranked players from the PGA Tour get relegated down to the Korn Ferry Tour, and the top 25 players on the Korn Ferry Tour advance up to the PGA Tour (I really think the PGA should market the concept better from a business perspective).
If you’ve watched Ted Lasso (a must-watch/pure happy pill) and/or are a fan of English football, you may know that there is a race to reach the top four in the standings, and yet another one to avoid being one of the bottom three teams relegated to the second division. For the teams in the second division, the fight to finish in the top three and get back to the English Premiership League is everything. Really, who wants to watch the teams at the bottom of the table? You do if you know how much is on the line. I’ve recently become an Everton fan and they are sitting one spot above relegation. They play West Ham at 9am Sunday.
Our hosts from Skyway Capital Markets sponsored the Club Car Championship Pro-Am event. My good friend Joe Quartucci and I were paired together with PGA pro Rob Oppenheim. Rob and his caddie JJ were engaging and a lot of fun to be with. Rob is 42 years old and married with two young children. Currently ranked 45th on the Korn Ferry Tour points list this season, he’s fighting for a top 25 finish to get back on the PGA Tour—where he’s played in the past. I’ll be tuning in and rooting for Rob this weekend, and the next, and the next…
Joe and I were talking about sports and life in general. Every person who has achieved will tell you how important those setbacks were in advancing their growth. The opposite of what we desire may turn out to be our greatest teacher. “There are no failures, only feedback.” I really like that! The message is don’t be afraid to fail. Sports provide so many failing opportunities within a tiny window of time. And what great feedback information: fail, fix, improve, and move forward. Great quote – Way to go, Joe!
Powell and team Fed are in the fight of their lives. They really have to fight inflation. They should have moved much sooner, but that is a moot point. Rates are higher, mortgage rates are higher, and a yield curve inversion is feedback. Tightening is in play to fight inflation. Firing the printing presses back up may delay the recession but will add further high octane fuel to the inflation fire. I can’t see the Fed doing that.
The greatest challenges create the greatest opportunities. There is always opportunity. What you and I do about it is up to us.
A special thanks to Roger, Mike, and Adin from Skyway Capital. It was a nice experience for me.
Thanks for reading. Wishing you and your family a great week!
Stephen B. Blumenthal
Executive Chairman & CIO
CMG Capital Management Group, Inc.
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Stephen Blumenthal founded CMG Capital Management Group in 1992 and serves today as its Executive Chairman and CIO. Steve authors a free weekly e-letter entitled, “On My Radar.” Steve shares his views on macroeconomic research, valuations, portfolio construction, asset allocation and risk management.
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