Meaning Of the Bond Mkt Inversion..
 

10 yr Treasury is at 3.42%
3 Mo Treasury is at 4.27%
FED Funds is at 3.82%

The inversion of the FED funds and 10 yr Treasury has never happened before.

Which means people are putting money into the long term bond because they have no confidence in the economy going forward..This is also to be seen in Equities, equities will rally but before long the wall of worry stalls out the rally.

The Animal Spirits have dun spoken..they have no belief nor hope that the economy is going to get better. The spirits are worried about dark days ahead..from Dimon to Munger and every body in between.

There are ill winds blowing..people do not tend to notice things until the package has been delivered.. So Amazon Prime has already dun delivered this package it is here and is on the doorstep.

But-But...our fearless President says all is peachy-keen with the economy.
Shouldn't we believe him?

Seriously...I was wondering when you'd post about the inversion...but the mixing in of the fed funds rate is a new twist.

Actually, we've (Cindy & I) been nervous since the first of the QE's...

I get it. Investors think that the Fed will reduce rates in the future (and we may have a recession).

Better question is this: where to put cash now?

Seems to me the game now is to try to hang on to what you've got. (edit) And..."may" have a recession??? Can you name a time when there was an inverted yield curve and a recession didn't follow? Then toss in the Feds rate thing...well, scary stuff.

There are various yield curve inversions to watch. I tend to watch the 2Y/10Y. Some people watch current vs forward yields.

Regardless of your preferred measure, the message from these inversions is that a recession is very likely to start in the coming year.

I’ve been expecting a recession for most of the past year. I’m thinking starting mid to late 2023. But the exact timing isn’t that important.

By now I think a 2023 recession is consensus, or nearly so.

The question now, in my opinion, is whether it is a mild recession (like 1990, 2001) or a severe recession (like 2008). Because the implications for earnings are different.

Consensus S&P 500 EPS is currently about $220 for 2022, $230 for 2023. Both have been dropping, about -5% over the past couple months. That implies +5% EPS growth in 2023 (from $220 to $230).

S&P 500 EPS never goes up in recessions. In the very mildest of recessions, so mild they might be called mid-cycle slowdowns, EPS may be flat. In a typical recession, -10% or so. A severe recession produces -20% or worse.

So, the yield curve inversions predict a recession, a recession means EPS flat to -20% year over year, so 2023 S&P 500 EPS should be more like $180-$220 if 2022 actually comes in at $220. Midpoint of that range is $200.

Stock valuations go down into recessions. The very bottom in price/earnings may come a little before the recession starts, or during it.

Currently S&P 500 NTM (next twelve months) P/E is in a 15-17X range (low end in October, high end now in December). If that P/E goes back to 15x, on $200, that implies S&P 500 at $3,000. Which is about -25% from here.

That is probably toward the worser end of reasonable scenarios. The more cautious Street strategists are saying a 3,000-3,500 range. A very mild recession could means something like 17x $220, or $3,740. That is probably toward the bester end of scenarios.

Anyways, the scenarios, at least the ones I feel are reasonably plausible, all point to something below where we are now.

Interesting. For a variety of reasons, 2023 is certainly shaping up to be grim.

(It does seem like the inversion has happened before, no?)

http://forums.pelicanparts.com/uploa...1670477279.jpg

Yes, MAY.

one thing I have learned with certainty is this: when the whole world thinks something is an absolute, it often isn’t.

I saw huge evidence of this pre2008. I ignored my instincts. That, was a big mistake.

I listen to the contrarian opinions.

Contrarian opinions now are describing a much grimmer scenario than just a stock market crash: implosion of the debt market, compete lock up of the financial system, no more cash available, no more electronic transactions…
They also say to buy silver…

raising rates just aids to inflation making it be stronger and last longer
and causes more harm to the people who have the least
while adding to the gains of the 1%

TAX THE 1% TO LIMIT INFLATION

TAX THE CORP-RATS WHO RAISE PRICES

at least the taxes can pay down the debts of the nation
by hiking bond rates they just add debt to no gain for the nation

I do spend a lot of time worrying about what was the consensus view but has now become a contrarian view: inflation recedes quickly, the US economy has a "soft landing", Fed stops raising sooner or starts cutting rates. This would be good for 99% of Americans, of course, but I'm not positioned for it.

I don't spend much time worrying about what Aurel describes.

You (America) just got what you voted for...enjoy.

Capitalism and the accumulation of wealth in all forms will always trump politics.
The greatest transfer of wealth and real property to the next generation is underway from the 2nd generation of those that arrived & thrived in this country decades ago.

We didn't fall into a Global Depression, had a ripping bull market in practically everything - equities, houses, vintage cars - for almost two years there, and recessions are a normal and necessary part of the economic cycle.

FINALLY SOMEBODY GOT IT>>WE HAVE A WINNER>http://forums.pelicanparts.com/support/smileys/ura.gifhttp://forums.pelicanparts.com/support/smileys/ura.gifhttp://forums.pelicanparts.com/support/smileys/ura.gif

Where to invest money...the place with the least risk is in..........

3 Month Treasuries...at 4.27%....you only have a 3 month horizon of risk then you get paid back you money plus interest. Break you investment into 4 parts, keeping one part always in cash, and each month put in one part for the next three months. When the first part comes due roll it over..repeat

Treasuries are the high ground in the flood and are the last to go...and with only 3 months of risk attached.


Everything else is very volatile and has huge downside risk.

the contrarian opinion is that the economy is doing fine.

i dont think it is, but the consensus is that we are currently, already in a recession, and have been since spring 2022.

Printing needless trillions and trillion of dollars will do that every time.
But math says it can’t be “free.”
The question is what is the cost going to be?

Now we are talking..

I saw the direction the USA was headed in 1980, and where it was going to lead to.

In 08 it had come to fruition..and since it has been all on life support..so I have been contrarian all along..

Now if ya told somebody that the USA was going to go under in 80 they wouldn't be able to stop laughing at you and if they did they would lock you up in the puzzle factory. In 08 99.9% thought it was fixable...they could not conceive that the unspeakable had happened...now it is here and people are waking up...

Truth is that you already have nothing, except for a Bernie Madoff sheet of paper with a whole bunch of zeros after the number...and RE will be greatly diminished and ill-liquid because no one will have the money nor credit to purchase or pay rent.

If the debt mkt crashes, there is no reset...there will be no structure to reboot...only once the chaos subsides and the dust settles will you be able to start over from scratch...you will be at ground zero..


PS: I have never been a joiner, a believer nor a follower...I have always thought for myself and acted in my own best interest.

I WAS WRONG ABOUT IT BEING NEVER. But delightedly so in that every time there has been an inversion of FED funds and 10 yr note the economy has fallen off a cliff.

Note what was happening to the 10 yr after 2020..it was climbing rather precipitously....investors were pulling out or had no buyers...so the FED had to step in to support the USD particularly in the foreign mkts by raising interest rates..the low rate environment is no more they have printed and borrowed too many USD

Now the intrinsic value of the currency has hit the asphalt and the American peoples free low interest rate and inflation rate ride is over...now the FED is unable to dot hat ..and the American people are going to have to start paying retail for their std of living.

The pinch for the American people has just begun..you already have nothing and you ain't gona be happy.

The Financial markets are so complicated and intertwined it can make your head explode. Some will look at it as an opportunity, some will cash out and run for the hills. Generally it is best to look at someone who has been there and done that, Warren B is an example, if you have cash, there is an opportunity coming. If you are over extended and in debt up to your eye balls, it's going to get rough. If you have loans on shat you don't need or cannot afford , liquidate.

The Gubment put the Fed in this mess with Covid lock downs, but the FED should never have dropped the rates to .25%. It was a double whammy, free money times 2. If you have cash, make sure it is secure and insured, if you own stock, make sure the companies you own are not over leveraged because they will take a hit also.

As far as the curve, it only indicates that the market is thinking this blow over or we won't be around in two years.

Not for me...

I disagree with most of this...it is missing parts... You have to take into account when Buffet and under what circumstances he was investing... in a time of unprecedented prosperity...that dynamic and circumstance no longer exists..which skews your analysis.

The American people via their government and credit cards...over spent for decades culminating is a shyte hits the fan moment in 08..the response was to switch to the credit tank of the public treasury and intrinsic value of the nations currency..to create the MOTHER OF ALL BUBBLES a SOVEREIGN DEBT BUBBLE. That string has about played it self out..they can not kick the can down the road no mo.

The FED thinking in 2020 was to throw everything they had including the kitchen sink into the fire to stabilize a seized economy. THERE WAS NO TOMORROW, if they couldnt' stabilize...they would gone to 10T or more if they needed to...they were going all in.

After the fact the consequences are that the USD and Bonds are on shaky ground. Where the FED had to support the USD particularly in foreign markets and against a nascent inflation.. The FED is in CHECKMATE because any which way that they move there are negative consequences. Which all lead to DEMAND DESTRUCTION.

So the crisis that you asked about in 2017 is here..look at the number of things that have went south this year at all levels.

My opinion has changed somewhat since 2017. I am a pessimist much like yourself when it comes to markets and investing. The thing I have realised is that it is a lot like a board game now, let's say Monopoly. There are so many levers the US Government/FED can pull from thin air that it really is just a game. In the end if the financial system crashes, I could see an agreement where all economies (IMF) just print money and wipe all debt off the board, basically a reset or a redo with new rules in place. If this happens, there is a possibility of a reversion back to the gold standard or something thereof. The shift started in 2016, 2020 just sped things up.

Following up on the contrarian view I described above, I think that scenario would go something like this:
1. In early 2023, the shelter component of CPI rapidly declines to zero-ish (as 2022’s declines in house prices and rents feeds through to CPI), goods CPI remains benign, and the remaining services components of CPI ease (not completely clear how this happens, unless employment and wage growth weaken meaningfully, but whatever), thus total CPI eases to around the Fed’s target, on a monthly annualized basis anyway.
2. The Fed thus stops its tightening before significant further damage is done to the economy (another 100 bp or so).
3. There is thus no recession, just a mid-cycle slowdown akin to 2015-16. 2023 becomes one of the yield curve’s false alarms (there have been some for the 2Y/10Y, and even for the FF/10Y there may be a first time for everything - the events of the past couple years have been unprecedented in many other ways).
4. SP500 EPS for 2023 settles around $220-ish (i.e. flattish to 2022) and SP500 EPS for 2024 looks like $240-ish (i.e. growth resumes at 8-10%).
5. SP500 NTM P/E rises to 18X-ish (i.e. about where it got to in 2017, coming out of the 2015-16 slowdown.
6. SP500 price heads to 18X $240 = $4300-ish (i.e. about +9% upside from here).

This does not require EPS growth in 2023 or Fed to start lowering rates.

How plausible is this scenario? Something I’m thinking about a lot. I’ll be kind of pissed if it happens, as my positioning will be wrong, but I suppose that is a Grinchy reaction to possibly sparing the country a recession.

Edit: Since this scenario uses NTM (next twelve months) P/E, the hypothetical 18X would be applied at the end of 2023, on hypothetical 2024 EPS.

^^^ I like your reasoning.

Interesting.
But I don’t think #1 (“thus total CPI eases to around the Fed’s target”) is very likely by early 2023.

I always enjoy reading John's analysis. Me .... I'll just be winging it like I have ever since I graduated college back in '83 .... and back then....

Times were tough I tells ya ;)!

Not kidding...

^^^
Those slide rules were hard to read...but they worked.:)

https://media.gettyimages.com/id/171...HxzfLff3JFhjk=

Before my time ;). Though we couldn't use calculators in college, I did have access to some awesome computers at the Research Triangle back then .... and no jobs anywhere for most :(.

Perspective....

My first year of college....they built a new computer building.
The computer took up the whole second floor. Our terminals, on the first floor, had slide cards to communicate with the computer. 1972

In '78 I used punch cards too... then things changed "a wee bit" fairly quickly and never stopped :)

I think that is vital to the rosy scenario.

The Fed’s top priorityl is to kill the inflation dragon. No Fed since the 1970s has let inflation get out of control, this Fed doesn’t want to go down in infamy. The FOMC governors would prefer not to drive the economy into recession, but recessions are normal and not the end of the world, so they absolutely will take a recession if that is the cost of avoiding a repeat decade of stagflation. Powell is a big fan of Vockler and has made it very clear that higher unemployment, falling housing prices, a bear market in stocks, are all things he is willing to cause, if he has to.

So if annualized monthly inflation is still well above their target (meaning, month over month trend above 0.3% or so (which annualizes to 4%) I believe the Fed will not let up on the rate hikes and other tightening.

Unless, of course, something big and very serious “breaks” in the US financial system, since financial system stability is an even higher priority than controlling inflation. But I think the Fed is pretty confident in its ability to fix breakages - in 2008 and 2020, it proved itself very capable at crisis response.

John I wasn't really paying close attention back in '83, but inflation was still not dead yet, job market was horrible, and I seem to recall a "double dip" back then too....

....and life was good :)

What I don’t get, and perhaps someone can explain it to me, is this:

1) How can the govt, over a couple of years, print and give away literally Trillions and Trillion of dollars, and expect that the previously existing dollars would retain their value? How can that not be viewed as hugely inflationary (or, said another way, devaluing of existing dollars?) Because in pretty much every discussion I read or hear, that is rarely mentioned. How can it be thought that raising interest rates a bit (from essentially zero) for a few months can so easily “erase” that Trillions of printing? (This is what made the Fed claim that inflation was “transitory” so mind boggling to me. Did they really believe that?)

2) 2008 was bad in many ways, but as far as contributing to inflation the govt response was a pittance. Wasn’t it less than $1 trillion, most of which was loans that were paid back?

3) I don’t view the Fed as capably handling 2020. What did they do that was so capable or smart? It seems like all they did was be a participant in an undisciplined free for all orgy of unnecessary and overdone printing and spending.

I’m mostly interested in understanding #1.

I was graduating from law school in ‘83 with a huge stack of rejection letters from every job I had applied for. Jobs were not easy to find at all, even graduating from a top 10 law school (UCLA). It didn’t help that my summer internship had been with NORML. The only reason I got a job was my college roommate’s dad was a partner in a San Francisco firm, and he got the firm to give me a chance.

I was personally unaffected by the 1990 recession (and didn’t notice any bear market), but practically every junior associate in my firm who was doing real estate law lost their job or had to switch to some other kind of law. By the middle of the decade, a fifth year real estate associate was worth his weight in gold because there were so few.

In the 2000 bear market and recession, analysts all around me were getting laid off, in the gentle Wall Street manner wherein a security guard walks unannounced into your office, takes your keycard, and escorts you out of the building immediately, you come back on the weekend under guard to retrieve your personal stuff. Of 9 guys in my group, only 2 of us survived. Most of the others never got back into the industry - careers over for good.

The 2008 bear market and recession were gruesome. Five of us had started a fund, we lost 50% of the seed money in 2007 and 2008 (we weren’t idiots - it was a US small cap growth product with maximum 5% cash allowed, so there was nowhere to hide), lots of guys I knew got blown out and most of them never got back into the industry. That bear market went on and on, the financial system almost did blow up, consultants would come visit us and tease “you guys are still here?”. We hung on, nailed the bottom in March 2009, flipped the whole portfolio to the most aggressive names we could find (F at $1, etc) and were up +100% that year.

2020’s bear market and recession could have been the end of my career, not to mention the start of a global Depression. I went out on my own on Feb 4, 2020 - and the following week I was reading about air quality and crematories in Wuhan, buying up masks and respirators, and watching the market do what it did. But things worked out just fine.

I’m looking at the coming recession or not-quite recession, with my money still being on the former, with interest. None of us can say we’ve seen exactly this movie before, but after you’ve been around the sun enough, the movies start being sequels.

If you want to get into the weeds, it’s not just the supply of money (M), it’s the velocity of money (V). In a recession, people and businesses get scared, stop spending, dollars sit hoarded in bank accounts instead of moving through the system buying things. So you can increase M in a recession without creating inflation, because V is collapsing . You’re actually trying to keep M * V stable, to avoid deflation. After the threat passes, and V odd picking up again, you reduce M.

As a practical matter, though, what really happened is that in a few weeks, 20% of Americans lost their jobs or were about to, more than 20% of American businesses were starting at collapse, the US Treasury market was about to collapse, the same was happening around the world, and inflation was the least of anyone’s worries.

The US government threw $4TR at the real economy to keep people eating, housed, in business, not doing a Grapes of Wrath Depression remake. Remember that a large percent of Americans don’t have even two months of expenses in savings, and that a large percent of American businesses have large amounts of debt that has to be rolled over every year or more often.

The Federal Reserve threw $4TR at the financial system to keep it from blowing up. Remember that funds, companies don’t keep that much cash around, when they need cash they sell Treasuries or similar safe securities, and when everyone in the world is trying to sell and no-one is trying to buy, even US Treasuries go no-bid, prices plunge in big gap falls, and falls in prices make more funds and companies desperate if not insolvent, triggers massive margin calls, and the whole thing goes into a death spiral.

Almost every rich country - US, Europe, Canada, etc - that had the means to do the same did so. In the poorest countries, people went hungry. China and much of Asia resorted to intense lockdowns (what we called a lockdown in the US was amateur hour in comparison). The US and other Western countries are rich in money but not in social control, so we went the money route.

It worked. There wasn’t a global Great Depression, the financial system survived, most companies and businesses survived, etc. Maybe the dose given was too high, who knows, but the patient lives.

So now we have to deal with the after effects (over dose?), one of which is inflation. M went way up, V recovered, now M has to be pulled down.

The US govt is not really able to take back money it has given out, and even though the federal tap has been mostly shut off, a bunch of that money went to the states who are still handing it out. Things like China locking down and its effect on the supply chain, Russia invading Ukraine, have complicated things. Politics gets involved - it was involved in pouring the money in (remember Trump wanting his signature on the initial stimmy checks, to help with his re-election? and then Biden wanted his share of credit too?) as well. But the pandemic-driven excess in household bank amounts is being drawn down, it will probably be gone by mid-2023.

The Federal Reserve has a lot more ability to take back money. Driving the Fed funds rate from zero to 4% in less than a year pulls a lot of money out - house prices falling, bond and stock prices falling (something like $10 TR in stock market value lost in 2022, and a much larger amount in bond market value), companies less able to borrow, stupid crap like crypto and SPACs and NFTs imploding, now companies starting to layoff and freeze projects - and about $80BN/mo (about $1TR/yr rate) is also being pulled out via balance sheet run-off.

At this point, I’m not sure the money injections in 2020/21 are the most stubborn driver of inflation. They certainly drove house prices and rents up, but that is reversing quickly. The stubborn part now is labor shortages and rising wages. Some of that is people retiring early because their stocks went up or to trade crypto, but there’s other things going on.

I’m rambling, sorry, and phone battery about to die. Pick this up tmrw.

Edited: typos

If those dollars "go under the mattress" then they are not inflationary.

In 2008-9 I was counter the OMG QE-infinity!! freak-out because I saw that banks had already created that money (on their books). The QE created money covered that which had just evaporated(housing valuations) . So really, it replaced $'s to keep banks from failing.

And here we are now. On the heels of a global shut-down. Helicopter money to some extent and now a pull-back. - How many thousand IRS agents to claw money back? I digress... The US is not alone in Helicopter money. Other countries have been "printing" money as well. The US is not close to leading on that front (so I hear).

The big question is, where do those Trillions go?

We are sending tens of Billions to Ukraine. Does it circulate there? Does it get exploded in Russia? Does it come back to the US as corrupto-currency? Where does the money go? How much of it circulates? Because if it is not in circulation it will not drive inflation.

It seems to me that most of it (or at least a very large amount) was/is being spent.
I’m not talking about $2k checks that were mailed out.
Example: I know several people who have small business (5-10 employees) who got huge (now forgiven) PPP checks. In the $400-800k range. And the kicker is they were in businesses that didn’t need it, they had no decrease and likely an increase in revenue during Covid.
Someone gave me a link to a Govt site where you can look up the companies and amounts given, and I could see their names and amounts.
Which was shocking enough, but what was more shocking was the size of the list. As I recall it was thousands of pages long, with countless PPP loans of $10 million or more to companies you’ve never heard of.
Anyways, I saw how the money was spent by the people I know who received it. Lots of home improvements, construction, Pelotons, cars, jewelry and watches, etc.

That is interesting.

I do wonder how much the curve inversion is a head-fake. An effort to convince people that inflation will be just a blip - transitory, doncha know. Because when people think everything will cost more in the future, it does. (out from under the mattress it comes)

I expect tabs is right, buy the 3 month CDs to not go backwards as fast.

Thank you John and everyone.... interesting thread and perspectives by all! Personal situations vary, but what's the downside to buying long term CDs or Corp. bonds and locking into pretty decent returns over several years... assuming you're not broke, debt free, and have a pretty nice cushion against some long term inflation? The Fed might tighten a bit more, but I don't see it staying that way for years either .... moving back to 3.5-ish territory. I hope we NEVER return to the .25 Fed rates we had for almost two decades either.

Cheap credit - the opiate of the masses :(

Cold turkey is a beotch and here we are...

....and life is still good ;)

Very well said, I 100% agree with all of this.