Hamster Wheel
Posted on Sunday, March 24th, 2019
The question we are getting this weekend is why did the market go down so much on Friday? – The answer is the yield curve. What is the yield curve and why should I care? Remember when you bought your first house. If you were like me you sat at a table or box in the house and counted change to see if you could buy a pizza. You buy the house and pay a $2000 a month mortgage because you think that in 30 years or so that $2000 a month will seem like nothing. You expect to be making 3-5 or even 10 times that. Your future is positively sloped. When the economy is healthy that is the yield curve in relation to the economy. People are expecting good things to happen and the curve is positively sloped.
An inverted (or negatively sloped) yield curve happens when the 3 month government t- bill yields more than the 10 year Treasury note. When the yield curve is inverted it means that the economy is not expecting good things to happen. The yield curve inverted this week from 3moths to 10 years. While an inverted yield curve does not predict recession it means we are teetering on the edge and about one good push away. It puts the economy on edge and it is usually the next bad thing that happens that puts it over the edge into recession. The San Francisco Federal Reserve has done research that, in their opinion, the 3mo -10 y inversion is the best predictor of recession. The next recession could be 6 months or a year away. Markets even tend to rise from the time of inversion until the recession hits. We are on guard for that as the signal t leave the party is when the curve begins to regain its positive slope. That is when recession hits and recessions are not kind to stocks.
The Federal Reserve is stuck in a trap. They are stuck on the hamster wheel of QE. They ease monetary policy and raise asset prices to engender confidence in the economy. As the economy regains its footing they attempt to drain the liquidity which lowers asset prices. They panic and promise more monetary heroin to the addicted markets. Round and round we go much as Japan has done since 1990 creating zombie companies and never getting off the addiction.
Bottom line – The Fed should let the market fail. Let zombie companies fail in an effort to not become Japan 2.0. End Result – They won’t. They don’t have the political will. The market and economy is addicted to the monetary heroin. The Fed does not have the political will to rip the band aid off and deal with the resultant fallout of lower asset prices and bankrupt companies. We are stuck on the hamster wheel of Japan 2.0. We need to prepare for the possibility that asset prices may not rise as they have traditionally. They may rise and fall – rinse and repeat. As asset managers it is our job to be contingency planners and right now we are planning for the hamster wheel. Sell assets as prices rise while buying them after the fall. A recession is coming we are ready.
Financials were crushed this week as the inverted curve hampers bank profits. FedEx warned that a global slowdown is under way and BMW confirmed that. It really is all about the Fed. Next week is important to see how markets react. Most of the S&P 500 companies will be in a blackout period and not able to buy stocks. Quant funds are right on the precipice of turning from long to short and that would put real pressure on markets. Large percentages of asset managers did not buy into this rally and were left behind. We think that they may be there to buy this dip. We can’t help but keep an eye on the December lows as they may be tested. We expect them to pass.
I think we aspire less to foresee the future and more to be a great contingency planner… you can respond very fast to what’s happening because you thought through all the possibilities, – Lloyd Blankfein
To learn more about us and Blackthorn Asset Management LLC visit our website at www.BlackthornAsset.com .
A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty. – Winston Churchill
Disclosure: This blog is informational and is not a recommendation to buy or sell anything. If you are thinking about investing consider the risk. Everyone’s financial situation is different. Consult your financial advisor.