When I think I have seen the depths of fecklessness from our current monetary policy regime, I often find an even deeper part of the pool. This morning it was a paper by two Fed employees entitled (Don't Fear) The Yield Curve, Reprise. Wow!
As readers know, I like to use rock references in my columns. Yesterday it was London Calling by The Clash. When you use a classic rock reference, it has to come from the heart. When the authors of the Fed paper inserted a "More Cowbell" heading into one of their exhibits - brilliant sketch with the brilliant Christopher Walken, to be sure - they cheapened the headline reference to Blue Oyster Cult's classic track.
More importantly, the authors try to make the claim that the inversion of the spread between the yields on the 2-Year and 10-Year US Treasury notes - which inverted for the second time this week after this morning's stagflationary non-farm payrolls report - does not have predictive value. Well, except for the fact that 2-10 inversion has preceded every recession in the past 50 years, I guess you are right. Here is a great graphic from the St Louis Fed's terrific FRED database that shows this phenomenon.
The authors would rather have you look at the spread of a synthetic measure they have calculated using, as they describe it, "six-quarter ahead 1-quarter Treasury rate and the 1-quarter Treasury yield."
This is yet another example of Ivory Tower technocrats trying to preach to us commoners. Ignore inflation, ignore the inverted yield curve. Buy stocks! Make Mark Zuckerberg even richer and more annoying!
That's what we get. Spin! Spin! Spin! Every administration does it, but I have never seen a group so consistently hapless as what the Biden Administration (to be fair, Powell is a leftover Trump appointee) has foisted upon us. It's not just that they twist things to fit their worldview, it's that on the grown-up issues, like oil prices, everything they say is wrong. Yellen and FOMC Chair Pro Tempore Powell (he hasn't been officially reconfirmed yet) seemingly have no natural checks and balances to their unnaturally misguided policy moves.
The yield curve inversion is the real deal. What the inversion is telling you is that there is a perception that there will be an economic slowing in the intermediate term. Interest rates are, at their core, the cost of money. Simple. If it costs more to borrow for two ears than it does for 10 years, the bond market is telling you that things will slow in the gap between those maturity dates. Very simple.
How does the bond market know this? Crystal Ball? Magic 8-Ball? Ouija board? No, it's easy. It's about the supply and demand for money. In recessions, demand drops significantly, and periods of rising interest rates have always correlated with tighter financial conditions, i.e. less supply. If you owned a bank you would know why. Less volume produces lower margins against fixed costs for any profit-making entity.
So, how to play this? Sell all your stocks today? It's not that simple. But, when figuring out what to sell, you can do intricate valuation spreadsheets (I do this for myself and my clients) or just remember what Justice Potter Stewart so notably said: "I know it when I see it." Is Tesla (TSLA) really worth more than the rest of the world's other automakers combined? No, of course not. It's about realistically valuing cash flows, not whether we think the CEO is a cool dude or not. I am sure Elon is cool. I don't care.
I seek cash flows and I seek to have them returned to me in the form of dividends. That was the genesis of my HOAX portfolio, and that is why it has returned 38.8% since its inception on December 23rd. I chose to benchmark HOAX against Cathie Wood's leaky (ARKK) - which has TSLA as its largest holding - and ARKK has fallen 33.1% since HOAX"s inception date.
She owns a bunch of overvalued crap names (Tesla actually produces earnings and cash flow; many of the other ARKK holdings do not) and comes up with weird, quasi-mystical reasons to justify those valuations. Then she publicizes those valuation calls on the ultimate cesspool of all media, Twitter (TWTR) .
That's the difference. Trust me, I am about to reach my 30th anniversary of following stocks professionally, and I have seen this movie before. Cash flow never goes out of style. At times, when higher-duration "techier" names draw all the attention, a wise investor simply adds more cash-flowing names at lower valuations, i.e. higher yields.
December was a great time to do that. Nothing has changed. Inflation kills companies that destroy capital and rewards ones that produce it. Apple (AAPL) does the latter, and so does Exxon (XOM) , but there is no circumstance under which the prove of an iPhone could double - with almost no corresponding increase in cost to produce - over 13 months. That's exactly what has happened to Exxon and that is why XOM shares have doubled in that timeframe... and why I still own XOM.
So, stick to companies that reward you from their positive cash flows. Leave the dreams to Cathie, the misapprehensions to the Fed and the classic rock references to me!