September 21, 2018
By Steve Blumenthal
“I am writing this on the tenth anniversary of the 2008 financial crisis in order to offer the perspective of an investor who navigated that crisis well because I had developed a template for understanding how all debt crises work. I am sharing that template here in the hope of reducing the likelihood of future debt crises and helping them be better managed.”
“As an investor, my perspective is different from that of most economists and policy makers because I bet on economic changes via the markets that reflect them, which forces me to focus on the relative values and flows that drive the movements of capital. Those, in turn, drive these cycles. In the process of trying to navigate them, I’ve found there is nothing like the pain of being wrong or the pleasure of being right as a global macro investor to provide the practical lessons about economics that are unavailable in textbooks.”
– Ray Dalio, A Template For Understanding Big Debt Crises
“I have developed a template for understanding how all debt crises work!” Put everything else aside, this matters. A must-read for policy makers and anyone who hopes to not only survive but also prosper in the years immediately ahead. If you are not familiar with Ray Dalio, he is one of the great investors of all time. His firm, Bridgewater Associates, manages more than $150 billion. What is Dalio’s objective with sharing his team’s work with you and me? Frankly, to do good.
You may be familiar with one of his themes, “the beautiful deleveraging.” The other is an ugly deleveraging. The urgency in his message is to help policy makers understand how the economic machine works, how debt drives business cycles and how, over many years, debt accumulates to a point that something must happen. My co-portfolio manager, John Mauldin, calls it “The Great Reset.”
There are short-term debt accumulation cycles that you and I are most familiar with and there are long-term debt cycles that few of us have ever seen. But if you carefully study and plot history, you can better see them. And that’s what Dalio is sharing with us. A template that we can use to make better decisions and place better bets.
“My curiosity and need to know how these things work in order to survive them in the future drove me to try to understand the cause-effect relationships behind them. I found that by examining many cases of each type of economic phenomenon (e.g., business cycles, deleveragings) and plotting the averages of each, I could better visualize and examine the cause-effect relationships of each type.”
From Dalio’s book:
After repeatedly being bit by events I never encountered before, I was driven to go beyond my own personal experiences to examine all the big economic and market movements in history, and to do that in a way that would make them virtual experiences—i.e., so that they would show up to me as though I was experiencing them in real time. That way I would have to place my market bets as if I only knew what happened up until that moment. I did that by studying historical cases chronologically and in great detail, experiencing them day by day and month by month. This gave me a much broader and deeper perspective than if I had limited my perspective to my own direct experiences. Through my own experience, I went through the erosion and eventual breakdown of the global monetary system (“Bretton Woods”) in 1966–1971, the inflation bubble of the 1970s and its bursting in 1978–82, the Latin American inflationary depression of the 1980s, the Japanese bubble of the late 1980s and its bursting in 1988–1991, the global debt bubbles that led to the “tech bubble” bursting in 2000, and the Great Deleveraging of 2008. And through studying history, I experienced the collapse of the Roman Empire in the fifth century, the United States debt restructuring in 1789, Germany’s Weimar Republic in the 1920s, the global Great Depression and war that engulfed many countries in the 1930–45 period, and many other crises.
My curiosity and need to know how these things work in order to survive them in the future drove me to try to understand the cause-effect relationships behind them. I found that by examining many cases of each type of economic phenomenon (e.g., business cycles, deleveragings) and plotting the averages of each, I could better visualize and examine the cause-effect relationships of each type. That led me to create templates or archetypal models of each type—e.g., the archetypal business cycle, the archetypal big debt cycle, the archetypal deflationary deleveraging, the archetypal inflationary deleveraging, etc. Then, by noting the differences of each case within a type (e.g., each business cycle in relation to the archetypal business cycle), I could see what caused the differences. By stitching these templates together, I gained a simplified yet deep understanding of all these cases. Rather than seeing lots of individual things happening, I saw fewer things happening over and over again, like an experienced doctor who sees each case of a certain type of disease unfolding as “another one of those.”
I did the research and developed this template with the help of many great partners at Bridgewater Associates. This template allowed us to prepare better for storms that had never happened to us before, just as one who studies 100-year floods or plagues can more easily see them coming and be better prepared. We used our understanding to build computer decision-making systems that laid out in detail exactly how we’d react to virtually every possible occurrence. This approach helped us enormously. For example, eight years before the financial crisis of 2008, we built a “depression gauge” that was programmed to respond to the developments of 2007–2008, which had not occurred since 1929–32. This allowed us to do very well when most everyone else did badly.
There are short-term business cycles (most of us know these) and there are long-term business cycles (few of us know these). All cycles involve credit (borrowing) and knowing where we are in each of the cycles can clue us in how we might better position our investment bets.
There are three sections in Dalio’s book (you’ll find a link to the free book in PDF format below): Part 1 is a big picture summary, Part 2 is more granular and Part 3 is a detailed showing of 48 cases in chart form.
Personally, the way I learn best is to write down what I’ve learned and do it in a way I can explain it in layman’s terms. Dalio does an excellent job of doing just that. So over the coming few weeks, let’s go to school and further our understanding of how economies work and debate our next moves.
If you know you had an advancing medical issue and could do something about it to avoid extreme damage, you probably would. But how do you know you have an issue if you and/or your doctor don’t know what to look for? Think of this as an economic physical of sorts… a pathway to profit from the forces of economic cycles. Hint: Long-term debt cycles are different than short-term debt cycles. If “beautiful” is unable to come together (increasingly my base case), “ugly” will result and it is something few of us have witnessed before. Let’s go into this loaded with data and a game plan.
Grab that coffee and find your favorite chair. I realize this can be complicated stuff so do know that I’m trying my best to share with you in a way that Susan and our children can better understand. I do hope you find the information helpful. Thank you for reading and please know I appreciate you spending your time with me.
♦ If you are not signed up to receive my weekly On My Radar e-newsletter, you can subscribe here. ♦
Included in this week’s On My Radar:
- Ray Dalio’s Template for Understanding Big Debt Crises — Part I
- Trade Signals — Bond Yields Breaking Higher; 3.07% Line in the Sand Revisited
- Personal Note — More Great Stories from Art Cashin
Ray Dalio’s Template for Understanding Big Debt Crises — Part I
First of all, and most importantly, you can download a free copy of Ray Dalio’s new book by clicking this link: www.principles.com/big-debt-crises.
I often get into lively debates with my team, clients and our advisor clients, and I enjoy them. I’m open to all viewpoints, but I must say far more weight goes to the person with real life experience. A young CFA comes to mind. Strong in conviction with no proven history and lacking the balance to self-examine where his views may be wrong. Lacking too few hits from the school of hard knocks and carrying way too much bravado, I give little weight to what he has to say. Put his two cents in the “doesn’t matter” column. On the other side of the spectrum is someone like Ray Dalio. Open, honest, self-reflective with $150 billion in the game. Put his two cents in the “matters” column.
Following, I do my best to share my high level notes from Part I of Dalio’s excellent book. Note that there are 65 pages to Part 1. Much to cover so let’s break it down over the coming few weeks. What follows serves as an intro and I encourage you to read the full section when you download the book. Ok, here goes:
Part 1 – The Archetypal Big Debt Cycle
I’ve previously shared with you my recommendation to watch Dalio’s 20-minute video on “How the Economic Machine Works.” It’s about how the economy cycles up and down. What follows is a review and a much deeper dive. It is important to understand the foundation of what moves the economy and at the core is income and credit (money you borrow and need to pay back at some point in the future).
If you earn $100,000 per year and you borrow $10,000, in simple terms you can impact the economy by spending $110,000. Your spending is stimulus to the economic system since your spending to buy something becomes somebody else’s income. The more you can spend, the better others do. The better they do, the more money they can borrow, the better the economy does. Like a rock tossed into the pond, borrowing and spending ripples through the economy. It’s good until we’ve borrowed too much. At some point, the money must get paid back. Up cycles are followed by down cycles. From the book:
- Credit is the giving of buying power. This buying power is granted in exchange for a promise to pay it back, which is debt. Clearly, giving the ability to make purchases by providing credit is, in and of itself, a good thing, and not providing the power to buy and do good things can be a bad thing. For example, if there is very little credit provided for development, then there is very little development, which is a bad thing. The problem with debt arises when there is an inability to pay it back.
- Generally speaking, because credit creates both spending power and debt, whether or not more credit is desirable depends on whether the borrowed money is used productively enough to generate sufficient income to service the debt. If that occurs, the resources will have been well allocated and both the lender and the borrower will benefit economically. If that doesn’t occur, the borrowers and the lenders won’t be satisfied and there’s a good chance that the resources were poorly allocated.
- I want to be clear that credit/debt that produces enough economic benefit to pay for itself is a good thing. But sometimes the trade-offs are harder to see. If lending standards are so tight that they require a near certainty of being paid back, that may lead to fewer debt problems but too little development. If the lending standards are looser, that could lead to more development but could also create serious debt problems down the road that erase the benefits.
So over time we have short-term cycles within economies and long-term cycles. Debt plays a very significant role in both. A lot of the desire for someone to borrow and a person’s ability to borrow depends on the attractiveness of interest rates. Over time, the individual earning $100,000 per year in income and borrowing $10,000 per year has borrowed as much as he can. Time comes when he has less income to cover the monthly interest and principal payments and he has less to spend. Since his spending is someone else’s income, the economy slows. Now, if he can refinance at lower and lower rates enabling him to stay in the game longer, the cycle gets stretched. But when the economy, because he and others borrowing and spending drives the economy, is overheating (and inflation pressure’s rising), the central bankers step in and raise rates to cool the economy from risk of too much inflation. Think of the Fed (and other global central bankers) as having a lever where they can lower rates to stimulate borrowing and expansion and raise rates to cool down and prevent inflation. From the book:
- Are Debt Crises Inevitable? Throughout history only a few well-disciplined countries have avoided debt crises. That’s because lending is never done perfectly and is often done badly due to how the cycle affects people’s psychology to produce bubbles and busts. While policy makers generally try to get it right, more often than not they err on the side of being too loose with credit because the near-term rewards (faster growth) seem to justify it. It is also politically easier to allow easy credit (e.g., by providing guarantees, easing monetary policies) than to have tight credit. That is the main reason we see big debt cycles. (emphasis mine)
- Why Do Debt Crises Come in Cycles? I find that whenever I start talking about cycles, particularly big, long-term cycles, people’s eyebrows go up; the reactions I elicit are similar to those I’d expect if I were talking about astrology. For that reason, I want to emphasize that I am talking about nothing more than logically-driven series of events that recur in patterns. In a market-based economy, expansions and contractions in credit drive economic cycles, which occur for perfectly logical reasons.
- To put these complicated matters into very simple terms, you create a cycle virtually anytime you borrow money. Buying something you can’t afford means spending more than you make. You’re not just borrowing from your lender; you are borrowing from your future self. Essentially, you are creating a time in the future in which you will need to spend less than you make so you can pay it back. The pattern of borrowing, spending more than you make, and then having to spend less than you make very quickly resembles a cycle. This is as true for a national economy as it is for an individual. Borrowing money sets a mechanical, predictable series of events into motion.
- Lending naturally creates self-reinforcing upward movements that eventually reverse to create self-reinforcing downward movements that must reverse in turn. During the upswings, lending supports spending and investment, which in turn supports incomes and asset prices; increased incomes and asset prices support further borrowing and spending on goods and financial assets. The borrowing essentially lifts spending and incomes above the consistent productivity growth of the economy. Near the peak of the upward cycle, lending is based on the expectation that the above-trend growth will continue indefinitely. But, of course, that can’t happen; eventually income will fall below the cost of the loans.
- In “bubbles,” the unrealistic expectations and reckless lending results in a critical mass of bad loans. At one stage or another, this becomes apparent to bankers and central bankers and the bubble begins to deflate. One classic warning sign that a bubble is coming is when an increasing amount of money is being borrowed to make debt service payments, which of course compounds the borrowers’ indebtedness.
- When money and credit growth are curtailed and/or higher lending standards are imposed, the rates of credit growth and spending slow and more debt service problems emerge. At this point, the top of the upward phase of the debt cycle is at hand. Realizing that credit growth is dangerously fast, the central banks tighten monetary policy to contain it, which often accelerates the decline (though it would have happened anyway, just a bit later). In either case, when the costs of debt service become greater than the amount that can be borrowed to finance spending, the upward cycle reverses. Not only does new lending slow down, but the pressure on debtors to make their payments is increased. The clearer it becomes that debtors are struggling, the less new lending there is. The slowdown in spending and investment that results slows down income growth even further, and asset prices decline.
- When borrowers cannot meet their debt service obligations to lending institutions, those lending institutions cannot meet their obligations to their own creditors. Policy makers must handle this by dealing with the lending institutions first. The most extreme pressures are typically experienced by the lenders that are the most highly leveraged and that have the most concentrated exposures to failed borrowers. These lenders pose the biggest risks of creating knock-on effects for credit worthy buyers and across the economy. Typically, they are banks, but as credit systems have grown more dynamic, a broader set of lenders has emerged, such as insurance companies, non-bank trusts, broker-dealers, and even special purpose vehicles. (again, emphasis mine)
- The two main long-term problems that emerge from these kinds of debt cycles are:
- 1) The losses arising from the expected debt service payments not being made. When promised debt service payments can’t be made, that can lead to either smaller periodic payments and/or the writing down of the value of the debt (i.e., agreeing to accept less than was owed.) If you were expecting an annual debt service payment of 4 percent and it comes in at 2 percent or 0 percent, there is that shortfall for each year, whereas if the debt is marked down, that year’s loss would be much bigger (e.g., 50 percent).
- 2) The reduction of lending and the spending it was financing going forward. Even after a debt crisis is resolved, it is unlikely that the entities that borrowed too much can generate the same level of spending in the future that they had before the crisis. That has implications that must be considered.
This next section is important!
Can Most Debt Crises Be Managed so There Aren’t Big Problems? Sometimes these cycles are moderate, like bumps in the road, and sometimes they are extreme, ending in crashes.
- In this study we examine ones that are extreme—i.e., all those in the last 100 years that produced declines in real GDP of more than 3 percent. Based on my examinations of them and the ways the levers available to policy makers work, I believe that it is possible for policy makers to manage them well in almost every case that the debts are denominated in a country’s own currency. That is because the flexibility that policy makers have allows them to spread out the harmful consequences in such ways that big debt problems aren’t really big problems.
- Most of the really terrible economic problems that debt crises have caused occurred before policy makers took steps to spread them out. Even the biggest debt crises in history (e.g., the 1930s Great Depression) were gotten past once the right adjustments were made.
- From my examination of these cases, the biggest risks are not from the debts themselves but from a) the failure of policy makers to do the right things, due to a lack of knowledge and/or lack of authority, and b) the political consequences of making adjustments that hurt some people in the process of helping others.
- It is from a desire to help reduce these risks that I have written this study. Having said that, I want to reiterate that 1) when debts are denominated in foreign currencies rather than one’s own currency, it is much harder for a country’s policy makers to do the sorts of things that spread out the debt problems, and 2) the fact that debt crises can be well-managed does not mean that they are not extremely costly to some people.
- The key to handling debt crises well lies in policy makers’ knowing how to use their levers well and having the authority that they need to do so, knowing at what rate per year the burdens will have to be spread out, and who will benefit and who will suffer and in what degree, so that the political and other consequences are acceptable.
There are four types of levers that policy makers can pull to bring debt and debt service levels down relative to the income and cash flow levels that are required to service them:
- Austerity (i.e., spending less)
- Debt defaults/restructurings
- The central bank “printing money” and making purchases (or providing guarantees)
- Transfers of money and credit from those who have more than they need to those who have less
Each one of their levers has different impacts on the economy. Some are inflationary and stimulate growth (e.g., “printing money”), while others are deflationary and help reduce debt burdens (e.g., austerity and defaults).
- The key to creating a “beautiful deleveraging” (a reduction in debt/income ratios accompanied by acceptable inflation and growth rates, which I explain later) lies in striking the right balance between them. In this happy scenario, debt-to-income ratios decline at the same time that economic activity and financial asset prices improve, gradually bringing the nominal growth rate of incomes back above the nominal interest rate. (SB note to Susan – incomes are growing faster on a percentage bases than to cost of the interest rate on borrowed money. If our income is growing at 4% per year and the base lending rate is 2%, we can afford to pay off our debt better than if the interest rate was higher than the rate at which we grow our annual income.)
- These levers shift around who benefits and who suffers, and over what amount of time. Policy makers are put in the politically difficult position of having to make those choices. As a result, they are rarely appreciated, even when they handle the debt crisis well.
Short-term cycles occur over time. Recessions eject some of the bad borrowers, corrections occur and defaults rise. We’ve had at least one or two every decade since the 1950s. But eventually, short-term debt cycles lead to long-term debt cycles. Meaning, we’ve amassed too much debt and when interest rates get down to zero, the traditional level of lowering rates has lost its effect and something new must be invented.
What Dalio is urgently trying to point out is that we are dealing with what happens at the end of long-term debt cycles and policy makers need to wake up and smell the coffee. We are at a point of significant consequence: there will be winners and losers.
Let’s continue: Dalio and team studied 48 big debt cycles that included all cases that lead to real GDP falling by more than three percent in large countries (what he calls a depression). They divided the affected countries into two groups due to two different outcomes (deflationary depressions and inflationary depressions). This matters in terms of how you might place your bets… remember that Bridgewater is in the business of making money:
- Those that didn’t have much of their debt denominated in foreign currency and that didn’t experience inflationary depressions, and
- Those that had a significant amount of their debt denominated in foreign currency and did experience inflationary depressions. Since there was about a 75 percent correlation between the amounts of their foreign debts and the amounts of inflation that they experienced (which is not surprising, since having a lot of their debts denominated in foreign currency was a cause of their depressions being inflationary), it made sense to group those that had more foreign currency debt with those that had inflationary depressions.
This next paragraph is important:
Typically debt crises occur because debt and debt service costs rise faster than the incomes that are needed to service them, causing a deleveraging. While the central bank can alleviate typical debt crises by lowering real and nominal interest rates, severe debt crises (i.e., depressions) occur when this is no longer possible. Classically, a lot of short-term debt cycles (i.e., business cycles) add up to a long-term debt cycle, because each short-term cyclical high and each short-term cyclical low is higher in its debt-to-income ratio than the one before it, until the interest rate reductions that helped fuel the expansion in debt can no longer continue.
The chart below shows the debt and debt service burden (both principal and interest) in the US since 1910. You will note how the interest payments remain flat or go down even when the debt goes up, so that the rise in debt service costs is not as great as the rise in debt. That is because the central bank (in this case, the Federal Reserve) lowers interest rates to keep the debt-financed expansion going until they can’t do it any more (because the interest rate hits 0 percent). When that happens, the deleveraging begins. While the chart gives a good general picture, I should make clear that it is inadequate in two respects: 1) it doesn’t convey the differences between the various entities that make up these total numbers, which are very important to understand, and 2) it just shows what is called debt, so it doesn’t reflect liabilities such as pension and health care obligations, which are much larger. Having this more granular perspective is very important in gauging a country’s vulnerabilities, though for the most part such issues are beyond the scope of this book.
Note the two black vertical lines in the above chart. They mark what Dalio believes to be the peak in the last two long-term debt cycles. These cycles tend to occur over 60 years or more and have done so repeatedly throughout history. Back to Dalio:
Our Examination of the Cycle
In developing the template, we will focus on the period leading up to the depression, the depression period itself, and the deleveraging period that follows the bottom of the depression. As there are two broad types of big debt crises—deflationary ones and inflationary ones (largely depending on whether a country has a lot of foreign currency debt or not)—we will examine them separately. The statistics reflected in the charts of the phases were derived by averaging 21 deflationary debt cycle cases and 27 inflationary debt cycle cases, starting five years before the bottom of the depression and continuing for seven years after it.
In developing the template, we will focus on the period leading up to the depression, the depression period itself, and the deleveraging period that follows the bottom of the depression. As there are two broad types of big debt crises—deflationary ones and inflationary ones (largely depending on whether a country has a lot of foreign currency debt or not)—we will examine them separately.
The statistics reflected in the charts of the phases were derived by averaging 21 deflationary debt cycle cases and 27 inflationary debt cycle cases, starting five years before the bottom of the depression and continuing for seven years after it.
Read this next section twice as Ray does a great job explaining how the cycles work:
- Notably long-term debt cycles appear similar in many ways to short-term debt cycles, except that they are more extreme, both because the debt burdens are higher and the monetary policies that can address them are less effective. For the most part, short-term debt cycles produce bumps—mini-booms and recessions—while big long-term ones produce big booms and busts. Over the last century, the US has gone through a long-term debt crisis twice—once during the boom of the 1920s and the Great Depression of the 1930s, and again during the boom of the early 2000s and the financial crisis starting in 2008.
- In the short-term debt cycle, spending is constrained only by the willingness of lenders and borrowers to provide and receive credit. When credit is easily available, there’s an economic expansion. When credit isn’t easily available, there’s a recession. The availability of credit is controlled primarily by the central bank. The central bank is generally able to bring the economy out of a recession by easing rates to stimulate the cycle anew. But over time, each bottom and top of the cycle finishes with more economic activity than the previous cycle, and with more debt. Why? Because people push it—they have an inclination to borrow and spend more instead of paying back debt. It’s human nature. As a result, over long periods of time, debts rise faster than incomes. This creates the long-term debt cycle.
- During the upswing of the long-term debt cycle, lenders extend credit freely even as people become more indebted. That’s because the process is self-reinforcing on the upside—rising spending generates rising incomes and rising net worths, which raises borrowers’ capacities to borrow, which allows more buying and spending, etc. Most everyone is willing to take on more risk. Quite often new types of financial intermediaries and new types of financial instruments develop that are outside the supervision and protection of regulatory authorities. That puts them in a competitively attractive position to offer higher returns, take on more leverage, and make loans that have greater liquidity or credit risk. With credit plentiful, borrowers typically spend more than is sustainable, giving them the appearance of being prosperous. In turn, lenders, who are enjoying the good times, are more complacent than they should be. But debts can’t continue to rise faster than the money and income that is necessary to service them forever, so they are headed toward a debt problem.
- When the limits of debt growth relative to income growth are reached, the process works in reverse. Asset prices fall, debtors have problems servicing their debts, and investors get scared and cautious, which leads them to sell, or not roll over, their loans. This, in turn, leads to liquidity problems, which means that people cut back on their spending. And since one person’s spending is another person’s income, incomes begin to go down, which makes people even less creditworthy. Asset prices fall, further squeezing banks, while debt repayments continue to rise, making spending drop even further. The stock market crashes and social tensions rise along with unemployment, as credit and cash-starved companies reduce their expenses. The whole thing starts to feed on itself the other way, becoming a vicious, self-reinforcing contraction that’s not easily corrected. Debt burdens have simply become too big and need to be reduced. Unlike in recessions, when monetary policies can be eased by lowering interest rates and increasing liquidity, which in turn increase the capacities and incentives to lend, interest rates can’t be lowered in depressions. They are already at or near zero and liquidity/money can’t be increased by ordinary measures. (SB here – this is where we are today)
- This is the dynamic that creates long-term debt cycles. It has existed for as long as there has been credit, going back to before Roman times. Even the Old Testament described the need to wipe out debt once every 50 years, which was called the Year of Jubilee. Like most dramas, this one both arises and transpires in ways that have reoccurred throughout history. (emphasis above is mine – side note: I believe we are heading towards a Debt Jubilee)
Understanding the cycles can create “edge” or an advantage in investing. Let’s conclude this week’s first deep dive into Dalio’s important book. I hope your takeaway is a simple understanding of how the economy cycles. For a point of reference, I’ve taken you through the first 14 pages of the A Template for Understanding Big Debit Crises. Next week, we’ll look at the differences between the two main types of depressions: One is a deflationary depression and the other is an inflationary depression. Next week, we’ll start at page 15 and step forward to what we can do about this for our own portfolios in a concluding On My Radar piece (date to be determined).
Once again, you can find the link to the book here.
A quick aside, John Mauldin has coined the phrase “The Great Reset.” The end of the long-term debt cycle is essentially what he is talking about. It is important to note that there is opportunity in the message. John’s view is to allocate a core portion of one’s portfolio to what he calls “smart core,” which favors diversification to trading strategies versus diversification to traditional asset classes. A “participate and protect” investment strategy. Send me an email to email@example.com if you’d like a copy John’s The Great Reset white paper where he details his idea. John and I serve together as co-portfolio managers of the CMG Mauldin Smart Core Strategy. Of course, all investing involves risk. Past performance cannot predict or guarantee future performance.
Trade Signals — Bond Yields Breaking Higher; 3.07% Line in the Sand Revisited
S&P 500 Index — 2,909 (09-19-2018)
The Zweig Bond Model has done a solid job avoiding the bond market sell off. It remains is a sell signal again this week. And a rough week it’s been for long-term high quality U.S. bond funds and ETFs. Several weeks ago I wrote in On My Radar about “Why the Yield Curve is Flat and Why it May Steepen.” I referenced a piece written by David Kotok that discussed a tax code change that was set to expire on September 15. David said, “In fact, the curve may surprise them and actually steepen due to the expiration of this unique tax effect.” In English, he sees longer-term bond yields rising faster than short-term bond yields even in the face of continued Fed tightening.
I’ve been keenly watching for the move higher in rates, which is happening. Let’s revisit the 3.07% and 3.22% “Lines in the Sand” I shared with you in several posts over the last six months. Yields look to be breaking higher:
- Note the red circle right hand side of chart. Current yield is 3.08%. The 3.074% line has broken to the upside. This is an important technical line.
- Let’s keep a close eye on how yields behaves from here.
The yield on the 30-year Treasury Bond is important, as well.
- The line in the sand is 3.22%.
- Current yield is 3.237%. Same story as above.
- Let’s keep a close eye on how yields behaves from here.
Higher interest rates mean the cost of debt is higher. All risk assets adjust to rates. However, for now, our Ned Davis Research CMG U.S. Large Cap Long/Flat Index remains in a buy signal, Volume Demand remains stronger than Volume Supply… there remains more buyers than sellers is bullish for equities. Additionally, the slower moving 13-week over 34-week moving average trend signal remains bullish. Notable with the rise in interest rates, Don’t Fight the Tape or the Fed has moved to a neutral reading from a modestly bullish reading. Let’s keep watch.
For additional commentary, click HERE for the latest Trade Signals.
Important note: 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.
Long-time readers know that I am a big fan of Ned Davis Research. I’ve been a client for years and value their service. If you’re interested in learning more about NDR, please call John P. Kornack Jr., Institutional Sales Manager, at 617-279-4876. John’s email address is firstname.lastname@example.org. I am not compensated in any way by NDR. I’m just a fan of their work.
Personal Note — More Great Stories from Art Cashin
I was not at my best the other day. I do try to “spin my disk high” as often as possible… what I mean is I wake up and consciously focus on holding a vibration of really positive energy. I know, way too new-ager perhaps but not a bad way to live life. To which, I love it when my daughter, Brianna, reminds me or mentions she’s spinning her disk high. Well, the other day was not one of those days until I received an email from Art Cashin. He shared the following stories and I just broke out in laughter. It was perfect timing… what I needed most. So a big hat tip and thank you to you my friend. You saved my day.
Two more great stories from Art:
In my very early days on Wall Street my income was rather small and I looked for other possible ways to seek fame and fortune. At the time, folk singers were very big – The Kingston Trio, Joan Baez, Bob Dylan, etc.
I formed a quartet and sang at bars and small clubs for a few months. Impatient, I talked our way into an audition with the Chairman of ABC-Paramount Records.
We sang four songs for the Chairman and Chief A&R guy. When we finished, the Chairman said, “You guys are really good! We just signed a guy from Atlantic Records. If he doesn’t work out, we’ll do an album and send you on a national tour.”
The guy from Atlantic Records was named Ray Charles – and that was the end of my singing career.
This next story is the one that helped me get my day back on track…
The Phone at Broad and Wall
Back in the days when smoking was acceptable in society, the NYSE had several “smoking rooms.” One was in the garage behind John Coleman’s post (No. 13). The smoking room had a large window looking down on the corner of Broad and Wall. Near the corner was a phone rack with four outdoor payphones. One boring day, one of the smoking room denizens strolled outside and copied down the telephone numbers on the payphones. Then the games began.
At first the boys would look out the window, spot some clerk or broker taking the air near the phones. They would dial the phone and when the victim picked up, they would spin some tale. Soon, the practical jokes were so well known that nobody from the NYSE would pick up the phone. No bother, there were plenty of tourists nearby.
There were hundreds of prank calls. One of the wackiest was when they called and some unsuspecting lady answered the phone. They told her that they were from Candid Camera. She was not the subject. A celebrity was about to visit the Exchange. The celebrity was delayed and they didn’t want the cameraman to run out of film. Could she please tell him?
They then told the poor woman that the cameraman was concealed in the mailbox on the corner, across the street in front of the House of Morgan. Could she go tell him and they would hold on.
Warily, the woman walked across the street, opened the lid and began talking into the mailbox. Bystanders stared, then stepped back fearing she was deranged. The crowded smoking room rocked with laughter.
She re-crossed the street and picked up the phone. “Had she delivered the message?” “Yes!” “What had the cameraman said?”
“Said? Why he didn’t say anything.”
“Lady, are you sure he was okay. He’d didn’t sound like he passed out from the heat did he? Could you go back over and make sure he’s alright?”
The hapless good Samaritan re-crossed the street and began talking into the box again. No response. Now she begins kicking the box hoping to hear something. Bystanders are now sure she is a nut. Laughter in the smoking room was so raucous they had to hang up the phone.
And then there was the dancing briefcases – but that’s for another time.
Can you just picture the brokers peeking out the window to pull their prank? I hope it lifts you as much as it did me.
I’m in NYC next Tuesday and Wednesday, again on October 4 and on to Chicago on October 10 and 11. A day at Baltusrol Golf Club and brainstorming with several of our advisor partners on October 2. I’m putting that one in the “spin the disk high” fun column as well as a coming trip to Penn State for the PSU-Ohio State football game on September 26. I hope you are spinning on high as well!
Enjoy your weekend!
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With kind regards,
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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