Whoa! That was my one-word response after checking Bloomberg's US Rates and Bonds page this morning. After the release of stronger-than-expected ADP Payrolls data, the bond market has plummeted.
After waxing poetic to my newsletter subscribers yesterday about the yield on the 10-year US Treasury note finally regaining the level at which it ended 2022, (3.88%) the bond market waved bye-bye to flatness and the yield on the 10-year is now quoted at 4.06%.
This represents a huge brake on the economy. Looking at that Bloomberg page, we see that the yield on the 10-year is now 113 basis points higher than it was a year ago today. That jump is dwarfed by the one year change in the 3-month T-Bill yield, which is a mere 348 basis points higher than its year-ago level. That is heady stuff.
That has a twofold impact on the financial markets. First, the general level of economic activity will slow, as anything that requires financing (houses, cars, etc.) costs much more on a monthly payment basis. Simple math. The less simple calculator is that assets that have long-duration - like speculative Tech stocks, for instance, or fixed-rate fixed-income securities - become less valuable as the present value of their future cash flows is discounted at a higher rate.
The stocks that have jumped this year - Tesla (TSLA) , Nvidia (NVDA) , Meta Platforms (META) , etc. - just became less valuable in the midst of a crashing bond market. Repricing an asset for that higher discount rate never apens immediately, but it does happen. The Nasdaq rally of 1H23, which still makes no sense to me, is now confronted with a much more difficult rate environment. At Excelsior Capital Partners, we don't own those stocks , anyway, but seeing them re-priced gradually would be preferable to a crash. Crashes hurt all asset prices, not just long-duration ones.
It is time to do your homework. Fixed-income names, like the preferreds we gobble up at ExCap, can work in a rising interest rate environment, but an investor needs to be very careful. My WYLD model portfolio, composed entirely of currently-floating-rate preferreds, is performing boringly, as it should in these markets, and throwing off boatloads of cash -WYLD's annual yield is now 10%, assuming reinvestment - which I reinvest in the same names. Those model portfolios are proprietary to ExCap and our clients, but the one WYLD name I have mentioned in prior Real Money columns, Valley National's preferreds, (VLYPO) still are attractive even after a 40% run-up in June.
Why is VLYPO still attractive? Because it pays a floating-rate quarterly dividend (VLYPO's annualized yield is 9.56% based on today's 3-month LIBOR peg of 5.54%; actual dividends are calculated/paid quarterly) and because at a recent price of $23.85, it is still trading below its $25 par value.
The six names I mentioned in my last Real Money column - PacWest (PACWP) , Gladstone Commercial (GOODO) and (GOODN) ,Tellurian (TELZ) , and CorEnergy Infrastructure (CORR-A) , in addition to VLYPO - are still attractive in a rising rate environment, mostly because they are trading at massive discounts to par for idiosyncratic reasons. I believe the market is misjudging the risks at these companies, and I will continue to buy those securities.
But, if you are a fixed-income security and you are not trading below par and do not offer a floating-rate feature, we at ExCap are just not going to buy you. Sorry. Further, if you are an equity that has undergone massive multiple expansion in 2023 based on fakakta notions about "AI" (I am looking at you, Elon) we are also not going to invest in your securities.
It is time to batten down the hatches. Watch how quickly this market can go from risk-on to risk-off. Take shelter in undervalued commodities, like crude oil, and the stocks of companies that produce them, like Chevron (CVX) and Exxon (XOM) . Otherwise, just be careful. Rising interest rates will hit every company, and with the yield curve still massively inverted, those impacts are magnified.
I try to limit the number of times per quarter that I utter the word "Whoa!" This morning was the first in 3Q23, and I am positioning our portfolios to ensure that it will be the last.
