Out of the Box: Preservation of Capital/Allocation of Capital
You read the headlines, “The Markets are going to Hell,” and “The Markets will be down 30% by Year-End” and “We are entering a Recession” and all of the rest of the dribble that comes floating along in the Press. Every time I see this stuff my eyes bob up and down and I stare at the ceiling. Now I have been seeing this garbage for more than four decades and I still stare at the ceiling, in wonderment.
“Always watch where you are going. Otherwise, you may step on a piece of the forest that was left out by mistake.”
-Pooh’s Little Instruction Book
Sure, we have had Recessions and yes, the markets go up and down, but major downside moves are not hourly or daily or weekly occurrences. So, today, I am going to anchor your expectations and while it is true that “past performance does not guarantee future results,” it is also true that being “data dependent,” as the Fed likes to quote so often, is part of the methodology to Preserve Capital and Allocate it.
Let’s begin with the U.S. Bond Markets:
|Index||3 Month Return Yield||Duration|
|U.S. Treasuries||+1.85% 2.49%||6.21 Years|
|Corporate Bonds||+4.58% 3.66%||7.49 Years|
|MBS||+1.90% 3.21%||5.34 Years|
|High Yield||+4.43% 6.17%||3.68 Years|
|Muni’s||+2.31% 2.39%||4.99 Years|
*All Data provided by Bloomberg
The most dangerous, of these credit sectors now, is the MBS market, in my opinion. The reason is that the 800 lb. gorilla, the Fed, has said that they are considering exiting this market and just buying Treasuries. If this comes to pass, in my view, the MBS Index may drop to negative numbers as spreads widen considerably to Treasuries. I would be considering your ownership of these bonds now before the Fed makes its final decision. Interesting enough, they bought no MBS bonds last week.
I also note that the best performing sector is Investment Grade Corporate Bonds. They are compressing in significantly to Treasuries and I take note of this, as should you. The yield spread here is 117 basis points and it would be hardly performing in this manner if we were heading into Armageddon. The hard data just does not support some type of forthcoming Recession, in my estimation.
Now let’s consider the Equity Markets:
|Index||3 Month Return|
*All Data provided by Bloomberg
There is certainly no indication here of any pending Recession either. I do note that here, the riskiest of the Indexes is outperforming, which is a somewhat different signal that is coming from the bond markets, but then the appreciation crowd is always moving somewhat differently than the more conservative yield buyers. It is just the nature of the two beasts.
”I must go forward where I have never been instead of backwards where I have.”
-My friend, The Bear
I would also like to note, today, what I consider to be the most troubling situation confronting the markets which is the May 23 European elections. No one is paying much attention to them but it appears that the Populists, the Nationalists, will either seize power or control a very significant amount of the seats. The old German/French coalition, which has run the EU since inception, is about to get broken, in my opinion. This is going to cause a huge amount of consternation in Europe and it will most certainly affect the markets as well.
Please hold on to your hats!
Mr. Pooh, and I, do not advise investing money in Europe presently, and neither does Mr. Trooper. You may simply ignore us all if you like. I am always delighted when someone does this. Then I get to use one of my favorite lines:
“I told you so,” and grin.
Mark J. Grant
Chief Global Strategist, Fixed Income
B. Riley FBR Inc.
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