Watch the bond market for a "sell-out" signal

Watch the bond market for a “sell-out” signal


There is always a collective groan in the classroom when the teacher changes the lesson to a topic that no student likes. In that sense, I’m sorry, but today I need to talk about the bond market. It’s been absolutely horrible this year. Let’s take a look at the 12-month Treasury and the excellent FRED database from the St. Louis Fed. The one-year chart is more revealing.

A year ago, the 12-month Treasury yield was 0.07%. Yesterday, since FRED data is based on end-of-day closings, that return was 3.92%. This morning the 1-year UST yield is trading at 3.96%. Extraordinary things.

That is the world we live in. Interest rates have gone from zero to sixty in the US faster than Joe Biden pretending to drive an electric car at the Detroit Auto Show, like he did yesterday. But it is Biden’s clueless cohorts at the Treasury and Federal Reserve that have caused this rise in interest rates. “Inflation is temporary” was possibly the dumbest sentence ever uttered in Washington, a city known for its goofy expressions.

The “floor” of interest rates has risen, and that makes any purchase that requires financing -cars, houses, etc.- marginally more expensive. In the US economy, we see less being sold. Final point. According to TD Economics:

For the first eight months of the year, sales (U.S. light vehicles) totaled 9.0 million units, down 15.3% from the 2021 year-to-date measure.

Oh. That’s a recessive contraction. That’s where the American economy is at these days. A recession with high inflation rates. Stagflation. That’s bad for stocks, especially those that are perceived as growth names, especially Big Tech.

It’s not too late to get rid of them. The joy I feel in seeing shares of Meta Platforms (META) drop as low as $150 in today’s trading (although they have rallied a bit) and seeing those shares fall to five-year lows is boundless. It couldn’t happen to a nicer guy than Zuckerberg. Plus, being forced to sit by while a clueless commentator on financial TV snorted stocks while wearing a pair of Oculus VR headsets this summer makes it all the more enjoyable.

But how do you preserve your capital? Well, I submitted one of my many model portfolios to attack stagflation. PREFS has fallen 2.97% since its inception, and the 6.63% annualized return on that portfolio (before investment) easily covers that gap. That spreadsheet is free for everyone because it doesn’t include rollover trades, which I post behind the paywall on my site, Honestly, the only emotion you’ll see from the 10 fixed income names on PREFS is… a lack of emotion. That’s it exactly what you want when building a portfolio with the goal of preserving capital.

I’ll go to one more graph from the FRED database. As I always tell my clients, it is not the absolute level of rates, even though they are now incredibly contractive, that needs to be focused on, but spreads. High yield spreads, as measured by the BoFA, have actually narrowed a bit and stood at 4.74% yesterday, having jumped to 5.8% in June.

It’s not Katie-bar-the-door in corporate fixed income markets. There is still money to be made, cautiously and through exposure to companies that are generating significant free cash flow, most of which are in the energy sector.

The teacher will end the class now. It’s not 2008, but growth stocks will continue to take a beating whenever there is new data (like Tuesday’s CPI) that shows the inflation juggernaut hasn’t been tamed by the undynamic duo of Feckless Yellen and National Shame Powell. So bonds and preferreds remain attractive, on a relative basis, but keep an eye on the bond market for a “sell-out” signal. the stock market is forever the last to know. It was 2008… and no one wants to get a failing grade on their retirement savings.

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