February 26, 2021
By Steve Blumenthal
“The ratio of the price of copper to the price of gold
is a great inflation indicator. Copper has rallied a great deal
while gold is slightly down. This tells us the U.S. 10-Year Treasury
should be at 2.25% right now.”
– Jeffrey Gundlach,
Founder, DoubleLine Capital LP
Rates are spiking… In the past seven months, they’ve gone from 0.62% to 1.52%.
- July 31, 2020: 0.62%
- December 31, 2020: 0.93%
- January 31, 2021: 1.08%
- February 25, 2021: 1.52%
Markets tumble when rates rise…
The following chart plots the 26-week change in the Moody’s Baa Bond Yield. The idea is to measure the direction in corporate bond yields. When rates rise, it costs corporations more to borrow. That affects earnings.
I’ve inserted red arrows into the chart. The bottom arrows show when the 26-week change crossed above 6 (the upper dotted green line). The top arrows show where the Value Line Index was at that time. With data back to 1965, the evidence suggests that markets struggle when rates rise. We are nearing the problematic signal line.
Gundlach said the 10-year should be at 2.25%. Our friends at Ned Davis Research peg the number at 1.95%.
Another indicator Gundlach points to is the seven-year moving average of nominal GDP, which suggests the 10-year should be at 3.50%. One has to wonder when the Fed attempts to aggressively implement yield curve control, but I must say it has been close to a straight line up since I called it “The Sell of a Lifetime for Bonds,” last May.
The government is spending $8.1 trillion per year (they say they are spending $6.6 trillion, but it comes to $8.1 trillion when you add in the off-balance sheet items). That’s 40% of U.S. Gross Domestic Product. Worse, $4.6 trillion of that $8.1 trillion in spending is borrowed (and thus added to the debt pile). And massive stimulus is coming in the form of Biden’s $1.9 trillion COVID-19 package and future infrastructure spend. That debt will never be paid back.
This is not bullish for the dollar. A declining dollar is inflationary, especially given our dependence on global manufacturing. The cost of goods to U.S. consumers will rise. Supply disruptions (chips to steel) are inflationary. Transitory? In the short-term, maybe––maybe not. In the not-too-distant future? Inflation.
Inflation and a rising dollar are bearish for the extremely overvalued U.S. bond and equity markets; however, a declining dollar is bullish for emerging markets (especially Asia and agriculture-heavy emerging markets) and for commodities.
The next chart shows the ratio of commodities versus the S&P 500. It depicts the commodity super cycles of 1969-1975, 1999-2007, and the likely start of a new commodity bull market.
Note the broad swings. This sure looks like a “buy when nobody wants it” moment.
I wrote last May, “Deflation now, inflation later.” I have many people telling me inflation is still a ways off. I could be wrong, but I think it’s coming faster than we think. “Yes, Steve,” I hear you arguing, “there remains a large COVID-19 created output gap. The current whiff of inflation is ‘transitory.’”
Yes but… I’m a price-based guy. The inflation evidence is stacking up.
I remember when 25 of 25 Wall Street analysts were predicting a rise in interest rates in 2019. They were all wrong! All of them. My favorite Zweig Bond Model signal was right (again). Price behavior. Watch price behavior!
Inflation warning signals are firing. Here is a look at NDR’s Inflation Timing Model. It is signaling “moderate inflation” and heading towards “strong inflation.”
Oh, But the Big Guy, Despite Surging Yields, Remains Unbothered by Inflation
Jerome Powell made clear during his second day of congressional testimony that the central bank had no plans to step in and put a lid on rising rates.
Why it matters (from Axios Markets, February 24, 2021):
Higher U.S. interest rates and inflation expectations are already impacting the price of things like bank loans and mortgages, but Powell looks to be more focused on maintaining a positive outlook.
- That could mean rates have much further to go.
Be smart: Though Treasury yields remain historically low, they have risen at a historically fast pace so far this month, and in 2021, as markets price in more government stimulus and recovery for U.S. consumer spending in the second and third quarters.
- Despite the clear move in markets, Powell reiterated that he does not expect to see materially high inflation in the near term and that he does not expect to take any policy action should inflation metrics move above 2% this year because that is likely to be “transitory.”
One level deeper: Powell’s laissez-faire outlook on inflation was backed up by Fed vice chair Richard Clarida during a speech in Australia.
- “We to a person are going to be patient, we are going to be very careful, and we are going to be very, very transparent of our intentions well in advance of any decision we might make in the future,” Clarida said.
The Fed is trapped!
Dr. Copper Is Hot
From Investopedia: “The term “Doctor Copper” is market lingo for this base metal that is reputed to have a “Ph.D. in economics” because of its ability to predict turning points in the global economy. Because of copper’s widespread applications in most sectors of the economy — from homes and factories to electronics and power generation and transmission — demand for copper is often viewed as a reliable leading indicator of economic health. This demand is reflected in the market price of copper.”
It also puts higher price pressures on the end consumer. Thus, it’s inflationary.
“I do believe in spooks, I do believe in spooks, I do I do I do…”
– The Cowardly Lion, The Wizard of Oz (here’s the clip)
It’s OK, though, there is much you can do.
For all of the reasons above, I was really looking forward to catching up with my friend Steve Cucchiaro from 3EDGE Asset Management. I had a chance to record a podcast with him, and I’ll share it with you next week after our compliance staff reviews it.
Steve has degrees from MIT and Wharton and has been managing money since 1994. 3EDGE is a global ETF investment strategist that allocates to equity, fixed income, commodity, metals, and cash ETFs based on where they believe they will earn return. A global go-anywhere strategy. Mauldin spoke about Steve in last week’s Thoughts from the Frontline.
Their investment process is quantitative. Imagine a massive database that stores 150 years of market valuations, yields, commodity prices, inflation, and currency prices country-by-country, across the globe. 3EDGE analyzes the cause-and-effect relationships that drive the global capital markets. They seek to allocate to the asset classes that will drive positive returns and use their proprietary model and collective experiences to skate to where the puck is going. (Full transparency, 3EDGE is one of the managers on the CMG Mauldin Portfolios Platform.)
Following are two charts Steve shared with me. If you think the first chart is shocking, wait until you see the second (“I do, I do, I do.”) You can find that paper here.
Overvalued Record – Higher Than the Spanish Flu Pandemic, Roaring 1920s, 1966 Bull Market Peak, 2000 Tech Bubble, and 2008 Great Financial Crisis
Speculation Gone Wild
I’ve been talking about record euphoria. Note the three red arrows at the bottom showing peaks in small trader call option-buying, and the three red arrows at the top pointing to where the market was at those peaks. Then, look to where small trade call option-buying is today. I’m speechless.
Today, everyone believes that the Fed has our backs. Everyone believes they will not dare raise rates. In 1987, the dollar was declining every day; interest rates were rising every day. Not to worry. What everyone believed that everyone believed then was that something called “portfolio insurance” had their backs. A threshold was reached, and the portfolio insurance trades kicked in. Everyone was on the same side of the trade doing the same thing at the same time. The market couldn’t handle the size and concentration of trades. It crashed. No monetary tightening, no recession. Crash!
Wisdom and experience whisper “Caution.” At the end of the Zulauf-Gundlach webinar, Felix said instead of portfolio insurance today, we have all the automatic algorithmic trading programs (machines trading) and they may kick in. His best guess is a nasty surprise may occur sometime between now and next year.
Bottom line: Stay nimble. With the Fed inventing new countermeasures after each crisis, hedge the left side of the V and be prepared to quickly buy the right side. Crisis, rescue, crisis, rescue. More than a few uncomfortable “V’s” are likely ahead. In there lies opportunity.
Skate to where the puck is going. New bull markets are forming in commodities, agriculture, and select emerging market exposure. It makes sense to add to these areas, though I can just picture your call with your client. They’ll look at the last ten years of performance and think you’re crazy. Trust me, you’re not…
OK, I’ll jump off my horse. I think I drank too much coffee this morning. Forgive me, as I’m perhaps a bit too wound up. Anyway, I do hope you find today’s piece helpful. Please reach out to me if you have any questions.
You’ll find the link to the most recent Trade Signals post below. Side note: my high-yield bond market signal moved to a sell signal yesterday. Historically, an excellent—not perfect—leading equity market indicator.
It did an excellent job pre-crash in 1987 (hypothetical model), 1991, 1998, 2000, and 2008 (all real-life trading). May be a head fake, but lights on…
You’ll also find a note about the great Warren Miller in the personal section below.
If a friend forwarded this email to you and you’d like to be on the weekly list, you can sign up to receive my free On My Radar letter here.
Trade Signals – 10-Year Treasury Yield at 1.40%
February 24, 2021
S&P 500 Index — 3,918
Notable this week:
If we believe the Fed has our backs, then we should expect low Treasury rates for a long time. However, the Fed’s “lower for longer” interest policy, coming $2 trillion in additional fiscal spend (and a potential $15 minimum wage hike), and coming infrastructure improvement legislation adds up to higher future inflation. The Fed maintains control of short-term rates (zero interest rate policy or ZIRP) but it is the longer-term maturities that are signaling concern. Rates are rising. Is some form of yield curve control coming (Fed buys longer duration Treasury notes and bonds to drive yields lower)? Likely if not already here. Inflation is their kryptonite. And pressure is building.
This week, the 10-year Treasury hit 1.40%. Absent pushback from Powell, yields will move higher. It’s getting interesting!
Copper gained 7% last week and commodities in general are rising. Focusing back on bonds; historically, if inflation is 2% and nominal trend growth in GDP is 2%, the 10-year government bond should be at 4%. GDP may be 3% in 2021 and, just yesterday (2-23-21), Powell, speaking to Congress, didn’t rule out 6%. This given all the stimulus and expected COVID-19 retreat. This is negative for bonds and negative for common stocks, not positive. And while the Fed may print and buy Treasury bonds, just how deep into their pocket will the reach to buy corporate bonds. Creative destruction you ask? At risk is the zombification of the U.S. capital markets. This is the trap the Fed finds itself in.
Next is a snapshot of the 10-year Treasury yield. After reaching a low of 0.39% last March, it is now challenging resistance at 1.40%. It should be at 4% today.
Each week, I post the Zweig Bond Model indicator. The Zweig Bond Model moved to a sell signal months ago. That was prescient. It remains one of my favorite fixed income risk-on risk-off indicators. Here’s the chart (rules in the upper left-hand side. Current signal highlighted in yellow.):
The Trade Signals Dashboard of Indicators follows.
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.
Click here for this week’s Trade Signals.
Personal Note – Powder Snow Freedom
“If you don’t do it this year, you will be one year older when you do.”
– Warren Miller
Warren Anthony Miller was born in Hollywood, California. As a young man he fell in love with skiing, surfing, and photography. At the age of 18, with the U.S. ten months into World War II, he enlisted in the U.S. Navy and served in the South Pacific. On Christmas vacation in 1944, he first filmed skiing with a borrowed camera in Yosemite.
After being discharged from the Navy in 1946, Miller bought his first 8mm movie camera. He and a friend, Ward Baker, moved to Sun Valley, Idaho, where they lived in a teardrop trailer in the parking lot of the Sun Valley ski resort, and worked as ski instructors there. In their free time, they filmed each other skiing to critique and improve their ski techniques.
In 1949, he founded Warren Miller Entertainment and began producing one feature-length ski film per year. He borrowed money to rent halls and theaters and charged admission to his shows. He showed his films near ski resorts, so that he could film the next year’s footage during the day, before screening the current film that evening. Before long, he was showing his films in 130 cities a year (Wikipedia).
My father had me and my siblings on skis at age 3. He’d lace up our leather boots and we’d click into Cubco bindings mounted to wooden skis. It was awesome. I was hooked.
As Warren famously said, “A pair of skis are the ultimate transformation to freedom.”
I love Warren Miller’s films and even more, I love his wit and humor. When I read through his bio, I must admit: I’m a bit envious.
Every year for the last 41 years, I’ve visited Snowbird, Utah. Dad first took me when I was 18. It’s time to book visit number 42. I’ll have my second vaccine shot by mid-March. If I don’t do it this year, I’ll be one year older when I do.
Late March and early April are coming into focus. Time to call the kids… and sneak away for some powder snow freedom.
Hope you are finding yours!
Have a great week,
Stephen B. Blumenthal
Executive Chairman & CIO
CMG Capital Management Group, Inc.
Consider buying my newly published Forbes Book, described as follows:
With On My Radar, Stephen Blumenthal gives investors a game plan and the advice they need to develop a risk-minded and opportunity-based investment approach. It is about how to grow and defend your wealth.
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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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