January 7, 2022
By Steve Blumenthal
“An optimist understands that life can be a bumpy road,
but at least it is leading somewhere. They learn from mistakes
and failures and are not afraid to fail again.”
– Harvey McKay, seven-time New York Times best-selling author of
“Swim With The Sharks Without Being Eaten Alive“,
and “Beware the Naked Man Who Offers You His Shirt.”
Both books are among the top 15 inspirational business books of all time, according to The New York Times.
It’s early Friday morning, coffee is in hand and I’m getting ready to write. Hard to believe it is early January; yet it is. A few fresh inches of snow fell overnight. It is quiet and peaceful in the house. With the sky clear and sun about to rise, I let our dog Shiloh out the back door, grabbed my iPhone, and snapped this photo. I smiled and thought, “It’s going to be a good day!”
If you are in Florida, Arizona, California, or even Puerto Rico (John Mauldin), keep your smiles to yourself. Yes, I wish I were there too.
Ok, let’s jump in. The Fed minutes where out this week and they were laced with tough love. You’ll find that commentary in the Trade Signals section below.
The bond market responded. Interest rates rose sharply with the 10-year Treasury yield going from 1.40% to 1.73%… challenging the March 2021 high of 1.76%. If that breaks, the next level is 2%.
The reaction from the Bond King (via Twitter):
When rates go up (as shown above), bond prices go down (as shown in the chart below). If you are long the popular Vanguard Extended Duration Treasury ETF (ticker: EDV) it was a -9% week.
If the “line in the sand” holds, as I suspect it may, the bond market is setting up for another strong bull market trade. I’m watching two key technical indicators: The weekly MACD technical indicator (red arrow bottom right in chart) moved to a sell (signaling higher rates, lower bond prices). The other is “Dr. Copper,” which I explain next.
“Dr. Copper” is insider lingo used in the commodities markets to explain price trends in copper’s ability to predict the overall health of the economy. This is due to copper being a fundamental raw material used as inputs in many industries and products.
- Generally, rising copper prices suggest strong copper demand and, hence, a growing global economy.
- When copper prices decline, it may indicate sluggish demand and an imminent economic slowdown.
If we have economic slowdown, bond yields decline, and bond prices rise.
Dr. Copper does not signal often. I share the chart with you today, as it is nearing an economic sell signal (bottom right-hand corner, next chart – signals occur when the lines cross). For years, I’ve also used the Zweig Bond Model to help me stay on the right side of the interest rate trend. It too is helpful in identifying major trends.
Please know this is not a recommendation for you to buy or sell any security. My point is to give you a sense for the extreme price movement that can happen in the bond market and share a few ideas that may help you navigate the path. Bottom line is it makes no sense to own bonds yielding 1.73% when inflation is 1%, 2% or even the 6% it is today. Don’t buy and hold bonds. They won’t help you like they did when you were paid for the risk. There are alternate ways to get yields in the mid-to-high single digits. For some active investors, it can be profitable to trade bonds.
The Fed is in a tough spot. They must fight off inflation. The Fed is ending bond purchases and is signaling they will raise rates in March (see this week’s Trade Signals titled, “Tough Love in Fed Minutes”). I think it is the right move. I think they are late to the decision, and I believe they have little breathing room.
U.S. debt is approaching $30 trillion and growing at $2 trillion per year. Blink, and by 2030, it will approach $50 trillion. Debt is a drag on future growth. Who’s going to pay the 1% annual interest charge on all that debt? The U.S. government is currently taking in $1 trillion a year in tax revenue. 1% on $50 trillion is $500 billion a year. Half of current tax receipts. The math can’t work.
My partner John Mauldin calls what is coming “The Great Reset.” The point in time where we are forced to deal with the debt and entitlement problems. Ultimately, higher taxes, reduced pension benefits combined with debt monetization sits in our future. John’s best guess is 2028. I think it may be sooner but really, we have no way of knowing. We both believe it is unavoidable.
John and I are finishing an update to his “Great Reset” white paper, originally published in 2017. Recently, John said, “When you’re up against the wall and they’re offering you your last cigarette, you start looking at all sorts of options that you would have never thought of before.” What lucky legislators and central bankers will be standing with cigarettes in their mouths? Of course, we will let you know when the updated white paper is available.
Recently, financial advisor Josh Jalinski, the “Financial Quarterback,” interviewed me and we discussed the markets, valuation, inflation, and debt. Below is a video of our conversation. I hope you find it helpful.
We’ll look at inflation next. As you’ll see, it is real, and it is a problem. But first, it’s worth checking in on Dr. Lacy Hunt again. He believes the current wave of inflation will prove to be transitory.
In Lacy’s third quarter Hoisington Review and Update Letter, he compared the current inflation shock to the inflation in the 1970’s and noted they are not the same. He said,
In the 1970s, the economy was beset by a string of such supply curve shifts primarily because of falling oil production. Then the inflation rate did not fall but continued to march higher. However, before Paul Volcker was made Fed chair late in the decade, the Fed actions allowed money supply to accelerate steadily. During the 1970s, unlike currently, the velocity of money was stable (although not constant).
As a result, the aggregate demand curve (C + I + G +X = M x V) also shifted steadily outward. This allowed the inflation from the supply side disruptions to become entrenched. Currently, however, the decline in money growth and velocity indicate that the inflation induced supply side shocks will eventually be reversed.
In this environment, Treasury bond yields could temporarily be pushed higher in response to inflation. These sporadic moves will not be maintained. The trend in longer yields remains downward.
Fundamentally, all signs point to a slowing global economy in the first half of 2022. Others argue inflation is not temporary. I like combining fundamental research with technical indicators. Dr. Copper is nearing agreement with Lacy. The weekly MACD for Treasury bonds is not currently in agreement (signaling rising rates). I share this information with you this week as I believe we are nearing an inflection point. If you have the chops for it, the bond market may be setting up for another great trade. Stay tuned.
One last very important note. Keep the intro quote top of mind. “An optimist understands that life can be a bumpy road, but at least it is leading somewhere. They learn from mistakes and failures and are not afraid to fail again.” Good advice for investing too.
I hope you don’t walk away from my misses with worry. We have lived through many recessions and some of us remember the 1970’s period of painful inflation. We will all survive just fine. Know that there are people who prosper in all sorts of economic and market environments. On My Radar is weekly free letter focused on global macroeconomics issues, economic cycles, the Fed, market trends, valuations with the goal focused on risk management and investment opportunities. There are always opportunities.
Grab that coffee and find your favorite chair but do cut back on the coffee this week. Prices are up 92%. Yikes!
Commodity Price Increases Over the Last Year:
2021 Was a Record Year for the Increase in the Cost of Rent
Latest CPI showed 3.8% Increase in Rents – Not Even Close
What Has Happened When QE is Taken Away (2008 – Present)
Number of Nasdaq Stocks Down 50% or More Is Almost at a Record – Bloomberg
- 40% of index’s firms have fallen by half from one-year highs
Trade Signals – Tough Love in Fed Minutes
January 5, 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 tech rout continued today (Wednesday, January 5, 2022). The Nasdaq fell well over 3%, while the S&P followed suit and dropped nearly 2%. The losses extended after the FOMC minutes showed chances for earlier and quicker interest rate rises, sending tech stocks lower on worries over growth and profitability.
Here is an update on the Fed minutes by Bloomberg’s Matthew Boesler:
Federal Reserve officials said a strengthening economy and higher inflation could lead to earlier and faster interest-rate increases than previously expected, with some policymakers also favoring starting to shrink the balance sheet soon after.
‘Participants generally noted that given their individual outlooks for the economy, the labor market, and inflation, it may become warranted to increase the federal funds rate sooner or at a faster pace than participants had earlier anticipated,’ according to minutes of the Dec. 14-15 meeting of the U.S. central bank’s policy-setting Federal Open Market Committee,
‘Some participants also noted that it could be appropriate to begin to reduce the size of the Federal Reserve’s balance sheet relatively soon after beginning to raise the federal funds rate,’ the minutes said. At the conclusion of the December meeting, the FOMC announced it would wind down the Fed’s bond-buying program at a faster pace than first outlined at the previous meeting in early November, citing rising risks from inflation. The new schedule puts the central bank on track to conclude purchases in March.
Fed officials were also unanimous in expecting they would need to begin raising rates this year, according to anonymous projections published after the meeting. That marked a shift from the previous round of forecasts in September, which had shown the FOMC at the time was evenly divided on the question.
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.
Personal Note – Denver, Florida, British Columbia, and Utah
“Skiing is a dance, and the mountain always leads.”
– Author Unknown
By the time this week’s letter hits your inbox, I’ll be halfway to Penn State moving son Kyle back into his apartment. One final semester ahead, then we celebrate both Kyle’s graduation and the completion of many years of tuition payments. Dad is really looking forward to that. We’ll have dinner and I’ll be turning back towards home. It’s a two-and-a-half-hour drive and I have a few podcasts ready to play for the ride home.
On Sunday, I fly to Denver. Son Matthew rented his first apartment. He loaded our old, beat-up Acura with golf clubs, ski’s, computer monitors, desk and chair and clothes. Hoping the bed we ordered arrives on time or else it’s the floor for Matt and a nearby hotel for me. The car is being flat-bedded out and should arrive before us. Fingers crossed. Do you remember how much fun it was moving into your first place? Young and ready to create.
Our plan is to take Monday off and drive up into the mountains to ski with my friend Mark Bishop. He lives in Winter Park and will show us around the mountain. I can’t wait.
A trip to Miami follows in February. Good friend Tom Lydon and his ETF Trends team is hosting their first ETF conference. A big event with several thousand attendees discussing all things ETFs.
In late February, daughter Brianna and I are flying to Calgary, Canada, renting a car and driving three hours to meet our hosts from Chatter Creek. They then helicopter us to a remote spot in British Columbia. We’ll spend four days cat skiing untracked powder. A skier’s dream.
Following Chatter Creek, I fly directly to Salt Lake City to attend the WallachBeth Winter Symposium in Park City. I’m checking in with you excited and happy.
On my dream board in my office is a Warren Miller quote Matt posted, “If you don’t do it this year, you’ll be one year older when you do.” Let’s just say I better hit the exercise bike to get ready for the trip. There is one more very funning Warren Miller quote a friend shared with me this afternoon, “Anybody that says they are a better skiing at age 50 than they were at 30 was probably not a very good skier at 30.” As much as I hate to admit it, all too true, says your humble 60-year old OMR author.
My hope is you are finding something that lifts your spirits. Life is too short. No matter what our age, passion and joy… let’s dance!
Wishing you the very best,
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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