August is usually a quiet month, except when some exogenous event occurs. This August however, people were trying to create exogenous events. Frankly, this is disconcerting to me and many market professionals.
On August 14, the equity markets took a steep dive – about 3% – when the yield curve on the short end briefly inverted. That brought out of the woodwork non-rigorous financial and non-financial pundits who screamed at the top of their lungs that we are heading to a recession. It was the financial equivalent of yelling fire in a crowded movie theater. Recall that we experienced a similar “inversion” earlier this year.
A quality analyst would have told you the truth:
- A typical yield curve inversion is caused by the lending (i.e. supply) side of credit. In other words, banks make lending determinations based on deteriorating financial conditions. What is now occurring is that the US Dollar (Treasury) yield curve is being bought aggressively by foreign investors. Thus, it is demand that is shaping the yield curve. The reason is quite simple; one that I have talked about quite often in My Gut Feeling – yields in the sweet spot (i.e. 10 years) of the yield curve in Europe and Japan are negative. For example you lend the Government of Germany 100 Euros today and get back, for example 95 Euros in ten years. Sounds crazy? It is the truth. In the US the 10-year Treasury is selling at a yield of 1.5%. So, hedge funds and sovereigns are playing the carry trade. Here is how it works. One borrows money in Germany at -3/4% for 10 years and invests it in the US at 1.5%. They earn 2.25% for 10 years for a total of 22.5%. The risk is that the Euro does not devalue by more than 22.5% in that 10-year period. That is a pretty safe bet. Frankly, foreigners will be driving our yields down further. This is one reason why the FOMC should cut rates sooner rather than later.
- If you were to assume that the US yield curve is inverting, that is only one variable in a multivariate analysis of what constitutes a recession. It would be like saying that if it rains then you will have a car accident. Many people have car accidents in the rain. It is a higher risk that an accident occurs in the rain than a dry day. You might have a car accident in the rain, but there are many other factors associated with a car accident. As to recessions, in addition to an inverted yield curve, we need to see at least two consecutive quarters of negative GDP growth (that’s not likely), several months of job losses (also not likely as there are more jobs available now than can be filled) and other indicators such as LEI (Leading Economic Indicators), Consumer Sentiment and tax collections. So, based on all that, we are not entering a recession.
Nobel Prize winner Paul Samuelson is known to have said that declines in U.S. stock prices had correctly predicted nine of the last five American recessions. I learned firsthand when studying under another Nobel Prize winner, Robert Shiller (when he was teaching at the Wharton School of Business) that economists are great at explaining the past but horrible at predicting the future.
What really gets my blood boiling is when people are hoping for a recession, purely because of their political bias. I am not making this up. HBO show host Bill Maher, who has a large audience, is hoping for a recession to get Donald Trump out of office. I would show the clip from his show, but it is so foul mouthed that decorum prohibits me from doing so. Maybe his multi-million-dollar annual contract would help Maher weather a recession. However, recessions are no joke. People lose jobs. Businesses close. Homes are foreclosed upon. Cars are repossessed. Retirements are postponed. It causes divorce rates to go up. And, sadly, people commit suicide. Shame on Maher for pushing the intellectual and morally bankrupt narrative that we need a recession.
Also, former Federal Reserve official Bill Dudley published an opinion piece in Bloomberg last week writing that “There’s even an argument that the election itself falls within the Fed’s purview. After all, Trump’s reelection arguably presents a threat to the U.S. and global economy, to the Fed’s independence and its ability to achieve its employment and inflation objectives. If the goal of monetary policy is to achieve the best long-term economic outcome, then Fed officials should consider how their decisions will affect the political outcome in 2020.”
This statement from Dudley was so egregious that he was chastised from economists of all political persuasions. Lawrence Summers, nephew of Paul Samuelson, Secretary of the Treasury under President Clinton and former President of Harvard University, delivered a strong rebuke to Dudley. Summers said that Dudley’s op-ed “might be the least-responsible statement by a former financial official in decades.” And that Dudley has “the worst case of Trump derangement in the financial world.” Adam Posen, a former Bank of England official said that Dudley’s commentary “feeds conspiracy and it was totally irresponsible to talk that way…” Finally, Minneapolis Fed President Neel Kashkari, in an interview with NPR in Jackson Hole, prior to Dudley’s op-ed, said that “One of the things we’ve learned in America and all around the world is that when the central bank plays politics, it leads to really bad outcomes over the long run for the economy.”
Look, if you don’t like President Trump, vote him out of office. If you don’t like the stock market, divest. However, don’t play with other peoples’ lives with reckless commentary.
As for me, I get paid to make clients money and manage risk. As I last wrote on August 6, I sold my hedges. On August 14, I put that cash to work. By the way, from the close of August 14 to the end of the month, equity markets in the US made up for lost ground on that August 14 “fire sale.”
My niece and her boyfriend spent the holiday weekend with my wife and me up here at Lake George. The TV in their room did not have any streaming device. So, I went out and bought a Roku stick. It made sense since I have been accumulating ROKU stock now for several weeks.
As we enter September, we will still have more of the tariff and trade nonsense to deal with. Furthermore, September is the weakest month of he year. Earnings won’t kick in for a few weeks. However, the A-teamers will be back at their desks and trading will be normalized. Interestingly enough; the Jewish High Holidays begin at the end of the month, perhaps setting the table for end of the quarter market softness. So we might get some nice trading opportunities in September. After taking a few weeks off from publishing my commentary, expect to hear from me more often. September is a big month for company’s stocks to go ex-dividend. Hence, I have encouraged clients to add money to our Dividend Strategy.
Lastly, it is hurricane season and Dorian is approaching the US coast. To my many relatives, friends and clients in its path – stay safe and dry.
Disclosure: At the time of this commentary Scott Rothbort, his family and/or clients of LakeView AssetManagement, LLC was long ROKU – although positions can change at any time.
Scott Rothbort is the President & Founder of LakeView Asset Management, LLC, a registered investment advisor specializing in high net worth private wealth management. For more information on investing with LakeView Asset Management, LLC call us at 888-9LAKEVIEW or request more information by clicking on the contact button on the top right-hand corner of the website. LakeView Management, LLC is a Nevada LLC, with its principal office located in Henderson, NV and branch office located in Millburn, NJ
Scott Rothbort is also the publisher of the LakeView Restaurant & Food Chain Report, a newsletter focusing in on food, restaurant, beverage, and agricultural stocks. An individual subscription to the newsletter can be ordered at www.restaurantstox.com
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