bond market

When Will the Next Recession Arrive?

© Can Stock Photo / iDesign

We know the economy, like the markets, goes up and down. It expands and contracts, as naturally as the tides come in and go out, or day gives way to night. Although much in life is unpredictable, it seems worthwhile to consider where we might be in the economic cycle.

The collapse of one or more of four major economic sectors has long been a factor in recessions. Home building, auto sales, capital investment by business, and inventories have been susceptible to booms and busts. Currently, three of these remain below long-term averages while auto sales seem to be at a sustainable pace.

LPL Research recently examined the Leading Economic Index and concluded that ‘plenty of gas remains in the tank’ for a growing economy. The index is based on ten separate data points, which we find have a history of usefulness: average weekly manufacturing hours; average weekly new claims for unemployment insurance; manufacturer’s new orders for consumer goods and materials; the Institute for Supply Management Index of New Orders; manufacturer’s new orders for nondefense capital goods excluding aircraft orders; building permits for new private housing units; stock prices for 500 common stocks; the Leading Credit Index; the interest rate spread (10-year Treasury bonds less federal funds rate); and average consumer expectations for business conditions. We concur with LPL Research.

The bond market gives us hints about the possible direction of the future through the yield curve, which remains pointed in the right direction for continuing expansion. So the fundamentals for continuing economic growth seem to be in place.

Do we have worries or concerns? Shoot, yes. The world is an uncertain place. There are political risks as long-standing relationships with our allies change, and potential new rules about trade and taxes promote uncertainty.

As long term investors, we do not need to fear recessions—we need to be ready to take advantage of any bargains that may result. We have taken steps to try to mitigate risk, although there are no guarantees against unwanted and unexpected volatility.

Bottom line: we expect continued growth in the economy, but we will try to be ready for anything. If you would like to discuss how this applies to your situation, please write or call.


The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.

Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price.

Investing in mutual funds involves risk, including possible loss of principal.

Stock investing involves risk including loss of principal.

Government bonds and Treasury bills are guaranteed by the US government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value.

The Biggest Stampede Ever?

© Can Stock Photo / afhunta

We think it every day. We’ve written it scores of times. We’ve said it thousands of times. We believe it is the most valuable principle we follow: “Avoid stampedes in the market.”

In our view of the world, a stampede has two criteria: large money flows in, and irrational pricing. For example, in the technology boom of the late 1990’s, very large money flows went into technology stocks. Some were new issues that had no business, no earnings, only a plan. Others were real businesses, but priced five or ten times what they would have been in more normal times.

(We usually speak of stampedes rather than bubbles, because ‘stampede’ connotes herd behavior that is an integral part of the process.)

The flight to safety, or money pouring into the supposed safety of fixed income investments, has reached historic levels. The large money flow satisfies one criteria of a stampede. What about the other one, irrational pricing?

The government of Italy recently issued fifty year bonds. A very few years ago, Italy could barely sell bonds due to the well-publicized economic problems of Europe and the systemic flaws of the Euro common currency. Italian bonds, of course, are denominated in euros. So investors in the bonds issued by a country thought to be going broke a few years ago, denominated in a troubled currency that was born only fourteen years ago, will not get their money back for fifty years.

In a sane world, what ridiculously high rate of interest would be required to persuade you to buy these bonds, if you could even be convinced at any price?

How about 2.85% per year? That is where the bonds were issued. It seems every bit as ridiculous as the most over-priced dot-bomb stock of the tech wreck. Both criteria of a stampede have been met, in spades.

We are working hard to understand the threats and opportunities presented by this stampede. We believe it is the key issue in the markets for the years ahead. If you are interested in how your situation might be affected, please write or call.


The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price.

International debt securities involves special additional risks. These risks include, but are not limited to, currency risk, geopolitical and regulatory risk, and risk associated with varying settlement standards. These risks are often heightened for investments in emerging markets.

When the Tide Goes Out

© Can Stock Photo Inc. / RobGooch

A lot of money talk uses words that evoke water: liquidity, a wave of buying or selling, money sloshing around. We have described large sums of money going into a particular sector as a tsunami.

The extreme actions taken by central banks around the world, instead of goosing economic activity, have actually caused people to become more cautious, spend less, and save more money. The primary effect has been a huge increase in demand for supposedly safe bonds and other fixed income investments.

In our lifetimes, there have been several investment manias that featured large sums of money pouring into a single sector or type of asset. The real estate boom of the early 2000’s is fresh in our minds. The technology and growth stock boom of the late 1990’s grew into a classic bubble.

The biggest financial tsunami in history is the one we are in right now: the rush into bonds. Bloomberg recently reported on the International Monetary Fund’s concern over the global $152 trillion debt pile. The key for us is to understand how this happened: people and institutions demanded bonds in unprecedented quantities. Interest rates reached extremely low levels as the tsunami of money flooded the fixed income markets.

The market will supply whatever is demanded. Companies that didn’t need money borrowed, simply to lock up financing for years or decades ahead at the most favorable prices in history. Some consumers are taking on mortgage debt at the lowest interest rates ever just because they can. Governments around the world see little cost to borrow, so finance their deficits.

The global debt pile is like a coin with another side. That other side is the unparalleled tsunami of money into bonds and fixed income. Investors who believed they were being prudent have ramped up their holdings in the supposedly safe kinds of investments.

Some say you cannot spot a bubble when it is happening. We disagree. What cannot be known is when the bubble pops. To get back to our water words, we can’t know when the tide will go back out.

We believe that bonds will be punished severely in price when the tide goes out. There will be collateral damage to bond substitutes and other income investments. And other assets may rise in price, as money returns from the bond bubble and goes back into other, now-neglected sectors. Peril and opportunity go together.

This issue is the key to the investment markets for the next few years. We know that opportunities and threats are always present, and you know we’ll be working hard to sort out which is which. If you have questions about how this applies to your situation, please write or call.


The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price.

Because of their narrow focus, sector investing will be subject to greater volatility than investing more broadly across many sectors and companies.