You can't be worried about one side of an equation and then be worried about the other. It's illogical and lacking in rigor but it happens all of the time and totally threw us off in today's session.
Let me explain what I mean so you can see how a bullish situation gets turned into a bearish one by those who want it both negative ways.
This morning we awoke to a story about how the Chinese, huge buyers of our Treasuries, are cooling to them. That freaked out people badly and millions of shares came in for sale at the opening because of the terrible implications of the Chinese perhaps dumping their $1.2 trillion Treasury hoard.
Now one of the principal worries of seasoned portfolio managers is that there is no inflection in the yield curve, that you are almost getting the same return for short-term treasurys as you are for longer term. That means we have what's known as a flat yield curve, something that is often a precursor to a recession. Makes some sense: the Fed raises rates too quickly, loan demand falls off, the economy worsens and we get thrown into a recession.
But, if a huge seller comes into the market and starts dumping longer-term Treasuries there will be that inflection and the flat curve will go away. That's positive because it removes the case that a recession is right around the corner. I am so adamant about this that I wish the Fed would sell off its gigantic treasury position which would accomplish the same thing. Plus, ever since President Trump was elected I have been calling for a fifty year half-trillion bond offering for Make America's Infrastructure great again. It would kill two birds with one stone, building new bridges and tunnels and allowing interest rates to rise.
So tell me, how can we be worried that if longer rates don't go up we might go into a recession, but if they do go up, there might be a slowdown because banks won't be making enough money lending money off your deposits. You mean to tell me both sides are bearish? That's just insane. Not only that but if you really believe that this is the case, I have bad news for you, the so-called sell-off in bonds and therefore concomitant rise in rates is so small that you need a microscope to see them. I got in this business when interest rates were at 14%. When they got down to 11% we were celebrating. Keep any rate scares in perspective. And let's make it clear, this isn't a be careful what you wish for story. We want rates higher. The loan growth in the country is slowing, something we will hear when the big banks start reporting on Friday. The more bonds the Chinese dump, the better.
Similarly we are hearing that inflation is heating up, particularly in Europe where the Germans have seen an 11% increase in yields since the year began. Put aside that German rates are so low that if you buy their bonds you can actually lose money. The operative term is inflation and how it is suddenly the big issue.
Do you know that just last month, the real worry was a lack of inflation? Yep, when we heard that there may not be enough inflation we recognized that perhaps the workers won't get paid more, that marginal companies might go out of business because of a lack of pricing power and that we can't raise rates like we thought we would, something that's terrible for the most important leadership group, the financials. When things looked terrible at the beginning of the session because of inflation scares, we saw the stock of JP Morgan (JPM) starting to rally. Other banks soon followed suit and they quickly turned around the market as they almost always do.
You can't have it both ways. You can't say: "Boo hoo! There is no inflation, let's sell stocks," and then say, "Boo hoo! There is inflation, let's sell stocks." Only a money manager who doesn't own enough stock and wants to show he does or one who needs the market to go down to catch up with the averages would ever say such nitwitted things.
Then there's oil. Now that oil is comfortably above $60 we are hearing about how dangerous these newfound prices could be for the consumer and for the corporations and how inflationary it might be. Every time oil is mentioned these days it is in the context of the breeding ground for inflation that is had become. It's a regular cliche that gets added now every time anyone mentions oil.
But a couple of years ago when oil was on its butt in the $30s and $20s all we heard was that if it kept going down it could take employment and bank balance sheets with it. We had endless fretting about how oil and gas declines were the next big negative. The economics of the once red-hot states of Texas and Oklahoma were in the balance. The big banks could have humongous losses. There were even some conference calls devoted totally to the issue of the danger of falling energy prices that also lamented how our independent oil companies would run out of cash and create a huge hole in the junk bond market.
What was needed? Higher oil prices, much higher, high enough to get drilling to accelerate, to put people back to work, to take the pressure off the banks and to eliminate the threat of looming bankruptcies. What was the sweet spot price where we would have a pick-up in construction, a resumption of drilling budgets that would go higher and an elimination of any of the biggest potential bankruptices?
How about a price north of $60? That level would be where employment picked up, the need for pipelines -- huge job creators -- would accelerate, the banks would be able to eliminate criticized loans and not have to put a lot of capital behind them instead of lending it to businesses, and oil companies would be able to do more than just break even if they drilled in more places than just the Permian in Texas. Plus, that mid-60s price wouldn't raise the price of gasoline at the pump so much it would crimp the consumer, especially because the new cars use so much less gasoline. So here we are with prices at last where we want them and what happens? We hear that we are dead men walking now that they have gone higher. You can't make this stuff up.
Sadly, I am used to these scare tactics. Other than the amazing Warren Buffett who counsels a long-term approach where things even out, and equities do well versus the bond market competition, most money managers want to talk about what can go wrong, even if it directly contradicts what they were hoping for-or at least said they were hoping for-another time. The Oracle of Omaha is so refreshing because he doesn't react with alarm to non-alarming things and has lived long enough and invested long enough to know that there's nothing wrong with buying stocks right here. I will go one step further. I am to the point where I actually want the Cassandras out there driving the market lower. Why? Because millions of people invest through index funds for their retirement and we don't want them endlessly on the sidelines because otherwise they are earning so little that, after fees, they may not even be able to beat what meager inflation we have.
The bottom line? Don't be careful for what you wish for. Embrace it when it happens and stop contradicting yourselves. It's embarrassing and you ought to take another job as an actor in a scary film or at least one of those people who jump out at you in theme parks' haunted houses when you most expect it.
(Editor's note: This story has been updated to correct the amount of U.S. Treasuries that the Chinese currently hold.)
