Lloyds Intrepid Wealth Management

It's that time of year!

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Lions, Tigers, and Debt Ceiling Crises.

In 2011, we had a debt ceiling crisis similar to today's. There were bitter politics and fears that trillions in bond sales would push down bond prices and create inflation. But it wasn't a disaster.

Yields were falling in the lead-up to the crisis and continued falling afterwards. How could this be? Some possible theories:

1. The Feb bought all the excess bonds. Partially true.
2. Higher debt levels are long term deflationary because they lead to higher taxes and lower spending later. Partially true.
3. Uncertainty was resolved and bondholders received their principal and interest payments on time. Completely true.

Of course, today the Fed is implementing a much tighter policy compared to 2011. Fed funds are at 5.13% and they are not buying bonds via QE. That is the biggest uncertainty going forward as this problem is resolved.



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Segment Rate Update

For those of you who worry about such things, here is a chart showing the evolution of Segment Rates 1, 2, and 3 over the last eight years. If you notice, those rates fell when the economy decelerates or falls into recession.

A recession should pull down inflation, suppress interest rates, and help segment rates decline. Call is if you want to discuss.



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The rumors of the US Dollars demise are greatly exaggerated (~Mark Twain).

First, to push the US Dollar off of its pedestal, something else must replace it. Gold? There is limited supply and it's difficult to carry around. Bitcoin? The largest bitcoin banks that tie bitcoin accounts to the US bank systems have failed (FTX and Signature Bank).

Perhaps the Euro, Yen or Yuan? Our trading partners do not want to be the reserve currency because it directly opposes their mercantilist policies. Mercantilists want a cheap currency to facilitate trade and build a trade surplus. Only we Americans have been willing to make the sacrifice of a strong Dollar and trade deficit. The new reserve currency country must be willing to let their currency strengthen, let their industries be poached, and be prepared to enforce their rules with a competent military.

Since the financial crisis, our trade partners have consistently devalued against the US Dollar.



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Good news and bad news on inflation.

As the economy decelerated, we expected inflation to fall. With regards to headline or total consumer price inflation (CPI) that is exactly what we see. Headline CPI peaked in 2022 at 9% and fall to about 5% in the latest reading. That is the good news.

The bad news is that Core inflation remains stubbornly high. Core inflation excludes commodities like food and energy to give policy makers at the Federal Reserve a sense for the underlying long-term trend in inflation. Their favorite Core inflation reading looks at the inflation of personal consumption and is called Core Personal Consumption Expenditures (Core PCE). This is important because the Fed will be making policy decisions based on this data point and it is not falling like the other inflation readings.

How does this relate to the current situation? If the stock market is strong because it is anticipating rapid interest rate cuts, the Core PCE inflation readings indicate this may be an incorrect assumption and the Fed may hold rates higher for longer as they have promised.



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Bond markets rose sharply after the shutdown of Silicon Valley Bank. There is a massive movement of cash underway from the banking system to the bond and money markets. This will create ongoing problems for the economy because this type of depositor outflow sucks cash out of the banking system, preventing bank lending. We expect this to negatively affect mortgage, auto, and business lending, significantly impeding economic growth.



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Equities remain in a bear market that began in January 2022. It is our view that the bear market will continue until four key factors are aligned:

1. Inflation falls - Headline CPI fell 9% to 5%; Core CPI still strong 4.5%.
2. Employment falls. Labor market is currently strong.
3. Earnings fall. 2023 EPS estimates are down about 12% from 2022 peaks.
4. Interest rates fall. The Fed just raised interest rates this week.

So far, we have only seen modest weakness in inflation and earnings from the peak in 2022. Employment and interest rates are still rising.



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Our economy depends on bank lending to grow. When Fed policy or financial stress affect lending, the real economy responds.

We see a big uptick in tighter lending conditions. This is a direct policy goal of the Fed: raise interest rates high enough to slow lending, thereby slowing growth and hopefully slowing inflation.

If you'd like to discuss how to manage through this environment, please reach out to us [email protected].



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Wouldn't it be great if we had an indicator that combined the most effective LT market leading indicators? Well, here you go...

Our Bear Market Indicator combines 10y-2y Treasury spread, ISM Manufacturing Index, Inflation, Cyclically Adjusted PE (Shiller's PE), and Unemployment.

It shows we are past the peak, but not near the trough.



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GOOD PROGRESS ON INFLATION

Core CPI didn't improve, but headline inflation fell to 5%.



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ARE BONDS WARNING OF TROUBLE?

In recessions, the difference or spread between corporate bonds and treasury bonds is an indicator of financial market distress. In 1999 and 2007, these spreads were widening long before the economy turned down. Part of this was because of Fed tightening; when the Fed raises rates, it's a pretty public signal that the economy is going to slow with all the fireworks that entails.

That brings us to today's spreads, which are slightly wider than normal. Is this a precursor or just noise? The bank failures indicate it is NOT noise, in our view.

If you'd like to discuss how to manage through this environment, please reach out to us [email protected].



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This doesn't look good.

As our new banking crisis begins, the banking system has started borrowing significant amounts of money from the Federal Reserve. There is a new program, of course, called the Bank Term Lending Facility. But make no mistake, this is an EMERGENCY lending program. We are expecting a very rough ride as we go through 2023.

Are you ready?

If you'd like to discuss how to manage through this environment, please reach out to us [email protected].



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INFLATION or STABILITY

Here is a chart every Federal Reserve member is reviewing right now. Inflation is falling, but it's still too high. At the same time, the financial system is cracking as banks begin to fail. All their choices are bad.

If you'd like to discuss how to manage through this environment, please reach out to us [email protected].



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REVOLT OF THE DEPOSITORS.

How long did the banks think depositors would sit on cash earning 0%? Apparently, a long time, because that cash was invested with minimal hedges out for long periods of time. When depositors withdrew money, losses needed to be recognized on bad investments. This is a re-run of the S&L crisis, when banks lost money borrowing short at high interest rates and lending long at low interest rates. This is an old way to lose money.

https://www.marketwatch.com/story/20-banks-that-are-sitting-on-huge-potential-securities-lossesas-was-svb-c4bbcafa



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20 banks that are sitting on huge potential securities losses — as was SVB SVB Financial faced a perfect storm, but there were plenty of other banks with high levels of unrealized securities losses as of Dec. 31.

The intuition behind Fed policy, bond yields and stocks is pretty straightforward. By measuring the difference between 10-year yields and 2-year yields (10y-2y) we get a calculated "spread". If the spread is negative, we call that an "inverted yield curve". And if you look at the history of the inverted yield curve, you know why stock investors are worried.

Each major recession and bear market in the last 30 years has been preceded by the dreaded inverted yield curve. Even 2020!

If you'd like to discuss how to manage through this environment, please reach out to us [email protected].



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Our economy is 77% based on services: government, health care, education, entertainment, finances, etc. Inflation remains high because the service economy is doing great, while the manufacturing sectors contract.


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The good news on inflation is that there is plenty of bad news #3.

Inflation continues to recede. This is good news because it implies the Fed will not have to raise rates significantly to halt the inflation cycle.

There is an ongoing debate about what inflation rate is the correct one to look at. Headline inflation, core inflation and core Personal Consumption (core PCE) inflation are each mentioned frequently in the press. In recent weeks, analysts have begun excluding annoying inflation numbers from rent and shelter to produce a new "super-core" inflation reading. You can't make this stuff up.

Amazingly, there is still an enormous gap between headline inflation and Federal Funds interest rates.

If you'd like to discuss how to manage through this environment, please reach out to us [email protected].



Our disclosure: https://www.lloydsintrepid.com/disclaimer2

The good news on inflation is that there is plenty of bad news #1.

Each Federal Reserve district publishes activity reports at various points during the month. In general, the trend continues down. In particular, the recent NY Federal Reserve district reading was one of the worst ever experienced (the NY Fed district covers NY, NJ and CN). There isn't much manufacturing here, but it is a very disappointing reading.

If you'd like to discuss how to manage through this environment, please reach out to us [email protected].



Our disclosure: https://www.lloydsintrepid.com/disclaimer2

The good news on inflation is that there is plenty of bad news #2.

Economic weakness is not just a US phenomenon. All the developed economies are rapidly decelerating as they experience high inflation and higher interest rates. What is also interesting is that the service economies (US and UK) are slowing as much as the export economies (EU and Japan). This is a global slowdown. (source: Institute for International Finance)

If you'd like to discuss how to manage through this environment, please reach out to us [email protected].



Our disclosure: https://www.lloydsintrepid.com/disclaimer2

Good news for the economy is bad news for the inflation fight.

We've had some remarkable good news over the last few weeks:

1. Good GDP in 4Q2022.
2. Good reports on Consumer Spending.
3. Exceptionally strong January payrolls report.
4. Strong new orders for all goods.

The problem with the good news is that economic strength implies higher inflation and Federal Funds rates for longer. That is going to gradually eat away at the economy's foundations.

If you'd like to discuss how to manage through this environment, please reach out to us [email protected].



Our disclosure: https://www.lloydsintrepid.com/disclaimer2

Some good news, but mostly bad news. It's a bear market rally.

Good news:
1. 2.9% US GDP growth in 4Q 2022.
2. Consumer spending is strong.
3. New Orders for all goods are strong in the US.
4. Japan's Central Bank resumed quantitative easing.

Bad news:
1. Reports on the broad economy indicate weakness.
2. Reports on inflation, Fed policy and interest rates indicate higher rates.
3. Weak earnings reports for the broad market, specific industries, and Intel Corp.

https://conta.cc/3kWG0BG



Our disclosure: https://www.lloydsintrepid.com/disclaimer2

Market Update February 2023 - Some good news, but mostly bad news   Market Update - February 2023 Here is my Dad-joke version of an inflation meme. Please forgive me. During January, the stock and bond markets rallied as tax-loss selling evaporated and investors sta

For some reason, the YouTube algorithm thought I needed to see this today and I thought it was worth passing along. It is a Lou Holtz commencement address from 2021. It’s a good 10 minute break from whatever you are doing.

https://youtu.be/UcgxbEG2fIY

Feel free to pass along to someone who might enjoy hearing this.

For those who don't know Lou Holtz, here are the top 3 things I find fascinating about this coach and leader:

1. The infamous "Notre Dame clause" https://www.washingtonpost.com/archive/sports/1985/11/28/holtz-named-by-notre-dame/789febcc-41f6-411f-b27c-27d11dd6dd8b/

2. The famous list of lifetime goals: https://www.huffpost.com/entry/lou-holtzs-compelling-que_b_794675

3. His remarkable legacy as a Notre Dame Football coach: https://www.thesportsbank.net/college-fball/notre-dame/lou-holtz-part-1/

A most welcome distraction from the troubles of the day.

Rob

BEST SPEECH EVER: Follow These 3 Rules To Have a Successful Life ! | Lou Holtz Legendary college football coach Lou Holtz share with us the 3 rules you have to follow to have a successful life ! (and it's not complicated)Feel free to su...

Economic Growth Continues to Weaken

On December 28th, the Pending Home Sales report announced a decline of 38% from last year. Most of you are aware that mortgage interest rates rose along with other yields in the bond market. Housing is one of the most interest-rate sensitive industries in the United States and it is reacting as expected to the Federal Reserve's aggressive rate hikes.

Other economic indicators such as the Conference Board's Leading Indicator continue to weaken, while employment remains strong. The Fed is very focused on employment strength. This means that even if cyclical parts of the economy slow down dramatically, with strong employment the Fed will be reluctant to cut interest rates.

If you'd like to discuss how to manage through this environment, please reach out to us [email protected].



Our disclosure: https://www.lloydsintrepid.com/disclaimer2

Wounds That Never Heal

The analysts at GMO (Grantham Mayo Van Otterloo) produced an interesting chart they called "Wounds that never heal". They were trying to measure the time required for equity markets to achieve a long-term average real return of 6% after a bear market (real return means nominal return adjusted for inflation). By adding the bear market losses to bull market returns, you get a sense for how long it takes to get back to long-term average return expectations.

This is another way of looking at the time for markets to recover from a bear market. It also confirms that people who invest in stocks at market tops sometimes have to wait decades for the portfolio returns to catch up to the long-term averages that are initially hoped for. GMO's choice of a 6% long term equity return is significant because it is to what many financial planners use in their planning software.

This is a key reason why we are underweight equities at this point in the Fed tightening cycle. We sincerely hope to avoid the pain of capital losses and reinvest our bonds and cash at more attractive valuation levels.

If you'd like to discuss how to manage through this environment, please reach out to us [email protected].



Our disclosure: https://www.lloydsintrepid.com/disclaimer2

Long-term investors may have to wait a long time for the next market peak,

We talk to many investors that are confident they can stick with their portfolio as the current bear market evolves. It is great to be optimistic, but investors must understand that waiting for new market highs can take a long time.

Let's say you invested at the very peak of an equity bull market. How long would it take for the market to return to that peak and go higher?

This is not a trivial question. Most adults today only recall the 1980-2020 experience of falling inflation and low interest rates. In other periods of US market history, the time to make new market highs has exceeded 15 years.

If you'd like to discuss how to manage through this environment, please reach out to us [email protected].



Our disclosure: https://www.lloydsintrepid.com/disclaimer2

"History says the median number of years for inflation to fall below 3 percent is ten years, with a 60 percent percentile range of six to nineteen years! Clearly, the Fed and investors are not prepared for such a possibility."

Great article. This inflation episode may last a while.

https://mises.org/wire/history-shows-high-inflation-can-last-over-ten-years

Repeat after me: Don't fight the Fed!



Our disclosure: https://www.lloydsintrepid.com/disclaimer2

Great article on active managers. https://www.nytimes.com/2022/12/02/business/stock-market-index-funds.html

This is why we use index funds and asset allocation to manage portfolios.

Picking stocks and bonds is really, really difficult. Most portfolio behavior is determined by the asset allocation, so why not focus on that. That's what we do.

If you're wondering WHY these funds continue to underperform, that is a good question. Here are our thoughts:
https://www.lloydsintrepid.com/why-active-managers-fail



Our disclosure: https://www.lloydsintrepid.com/disclaimer2

Mutual Funds That Consistently Beat the Market? Not One of 2,132. No actively managed stock or bond funds outperformed the market convincingly and regularly over the last five years. Index funds have generally been better.