Recessions And Yield Curve

“Davidson” submits:

Q4 hedge fund letters, conference, scoops etc


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Recessions require a period of excess speculation such that we have a rise in defaults. Recent history shows that it is credit card debt which defaults first. We also see a roll-over in retail sales, personal income, Temporary Help and Job Openings data.

The current condition is very different from the past. Speculation is relatively low as evidenced by the SP500 Value Investor Index while personal income is rising and defaults are falling.

One needs to use the broader context of the global market and the capital flows for which the US$ is a proxy of investor sentiment. We need to recognize that US investors have a history of being geared to anticipated returns while international investors are relatively inexperienced and geared to capital preservation versus their experiences with their own confiscatory governments. Now that global capital flows have become more liquid, periods of US$ strength which are periods of capital flows into US assets correlate to fear of confiscatory governments and changing trade dynamics which may devalue native currencies vs the US$. Culturally, these investors favor hard assets and fixed income priced in US$ and other Western currencies where property rights are stronger. The past 10yrs have seen record low Sovereign debt rates for US and Western countries and record low cash returns as global capital sought safe havens over returns.

This is a capital cultural clash which occurs today that has driven US 10yr Treasury rates down as capital flowed in. The historic signal of the T-Bill/10yr Treasury rate spread since 1953 is no longer the reliable signal for market tops and recessions it had been for 70yrs. We have to turn to the other economic data at hand to understand this. All other data not only signal continued economic expansion but even the potential for acceleration. This data is in stark contrast to recent price-trends to which many point as signaling recession. It is times like today which separate price-trend followers vs. Value Investors. Value Investors see opportunities while price-trend investors see risk and market correction.

I see decent investment opportunity today, but recognize that some lending dependent on short-term/long-term spreads will likely slow. The risk of recession is low as personal income and employment continue to rise. Success with tariff initiatives and efforts to ease onerous Dodd Frank regs will be positives.

No single indicator can ever call a market. Today’s market always has influences past markets never experienced which requires constant vigilance of fundamentals as they evolve. One must always be alert to when former indicators no longer have the influence they once had vs. new ones emerging in importance. Investing is a process of guessing the future knowing the past is an unreliable forecaster.

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