This is called the Wendy Peffercorn allegory- There was a movie set in 1962 Los Angeles about a group of young kids playing neighborhood baseball called the Sandlot. This movie captured the innocence of childhood, how great baseball used to be before the analytics made it a bore, and it taught us the power of fearlessness. Michael Squints Palledorous, was a young man that was a part of the group and didn’t stand out in any athletic way, but one hot afternoon at the neighborhood swimming pool under the watchful eye of pretty lifeguard Wendy Peffercorn, Squints would embolden us all. He was a young man in love and was desperate to make his move so he climbed onto the diving board, waved to Wendy who waved back, and he jumped in and slowly sank to the bottom of the pool. He didn’t surface. Wendy Peffercorn sprang into action and dove into the pool and swam to the bottom of the pool and wrapped her arms around him and pulled him to the surface and then to the edge of the pool where they got Squints out and laid him prone on the concrete. Wendy Peffercorn, being educated in CPR, began giving him mouth to mouth. After about 6-7 breaths and with his pals cheering him on thinking he was about to perish, Wendy turned her head to check if he was breathing. Squints, opened his eyes and with a shit eating grin that only a man with a devious plan can wear, gave the sign that he was ok, actually more than ok. However, Wendy Peffercorn never saw his smile so when she proceeded to give Squints another mouth resuscitation, Squints pulled her in for a kiss. She grabbed him by the arm and kicked him out of the pool forever that day. Was it worth it? Every time Squints walked by the pool after that Wendy looked down and smiled. Squints ended up marrying Wendy Peffercorn and together they have 9 kids. The morale of the story is that if you want to marry the hot lifeguard and have 9 kids well then you have to make a move even if the consequences seem dire at first and backfire.
Inspired by Squints, I made my move last week and called recession. There aren’t many people that think this economy is poor, but I do. In fact, the average consumer is the most positive they have been in months. Consumer sentiment is picking up, but why the hell would I care about that? We explored many of the reasons for a recession last week ranging from yield curve inversion, leading indicator weakness, and layoffs. Just yesterday there were over 21,000 layoffs ranging from UPS to Comcast. China’s market is in freefall, the Fed is due to speak later today, and a third of the market cap of the S&P 500 seems to be releasing earnings reports this week. This is a busy week, but what we have to realize is how different this situation really is. Pundits on television love to mock people that say this time is different. I can be mocked and no one on tv evens knows me, so mock away and I will tell you why.
We can learn from history. For example, markets seem to start selling off before the Fed cuts rates and they bottom out while the Fed is lowering them. The labor market is the last major indicator to turn over. The manufacturing indices have been in a recession for months, the yield curve has been inverted at a record length, and it is starting to un-invert and that is when the market starts selling off.
However, it is most important to look at this in a unique way: treasuries and bonds have rallied in the last 3-4 months, but can they continue? Most people think that if the stock market sells off then money will flow into bonds and the yields will go down aka bonds make money and you get a yield. This has been what has happened for decades, and the 60/40 portfolio will be a shelter for the investor.
I am having my own Wendy Peffercorn moment. This would be what is different. When was the US debt to GDP been 125% and inflation was over 3% in peacetime? We saw in October that the long-term bond was having difficulty finding a buyer and Janet Yellen changed up the government bond sale mix. What if this trend continues or gets worse? We know the government has to sell way more debt this year than last and next year than this. This is the problem with the spending degenerates in Congress. Santa Ana’s debt soldiers are still marching. So let’s say the market is right and we have 6 Fed rate cuts because Powell is really nervous about the labor market which seems to be shedding jobs very aggressively in the last month, which might be why he verbally pivoted last month. If we cut 6 times or 1.5% that would take the Fed funds rate to 4% or roughly where the 2-year US treasury is. Normally there is 1.5% to 2.0% premium over the 2 yr bond on the 10 yr bond except on the way to trouble and since I have already called the recession let’s look at Mar 2007 to Mar 2008. The curve steepened from 0.02% to 1.9%. In Feb 2020 it was 0.17% and 13 months later it was 1.46%. The curve steepens and who is going to buy a long-term US treasury bond without significant yield when there are so many being issued? Long term yields have to go up! Jamie Dimon, the JP Morgan Chase CEO, has been warning about this for over a year calling for 6-7% 10-year yields. That means mortgages go to 9 or 10%, and we saw the housing market freeze at 8%, but to go back and through that level and even worse? It would break the housing market.
If you remember there were a couple days during the sell off of 2020 when it seemed the world was ending. The Fed had stepped in and was buying bonds with gusto and it didn’t matter. They kept buying and it didn’t matter. The panic was palpable. They finally started buying corporate debt, an unprecedented step, a most panicky step I would say. On March 23, 2020, the Fed showed it would bail out whoever and whatever was needed. That was the bottom and that was the end of the US credibility. It had begun to lose it during the GFC when the world looked at us giving houses to every Tom, Dick , and Harry, but this was truly it. The government is bailing out corporates. That was the end of American capitalism. It wasn’t just a Fed put but a Fed lifeboat. All told it cost damn near $10 trillion of Fed interference, monetization of debt, and two presidents that opened up the slot machine and poured quarters into the mouths of the undeserving public. That public had never even heard of inflation. Well, it has now and most people will choke on it.
Let’s say the market goes in recession, which is when you usually run large deficits like we are now. This NBER, newly born economic recession as I call it will need even more deficits than it has now. What is that going to do to bond issuance? It will sky rocket. If you thought we had trouble selling debt in October, try doubling it which is about what we would need. Remember tax receipts decline during a recession so we would need to sell even more bonds to offset that challenge as well. Do you think yields can decline when the supply of something is doubled? How does supply and demand work again? We have established that many people would rush to bonds as a safe haven proxy as they have in times of turbulence before which drives the bond price up and yields down. Is it going to double the demand? It would need to. I don’t think it can.
What I think is about to happen is a very strange set of events that would have the Fed paddling furiously trying to control inflation at the short end of the yield curve. They might cut 3 times as they have said or maybe 6 times like the market is figuring, but just like in March of 2020, the long end will not notice. It will detach itself and go where supply and demand take it. Janet Yellen thinks she has fooled the long end of the curve with her parlor tricks of moving around issuance. That isn’t a long-term solution. The only real long-term solution is to reduce debt. Raise taxes or cut spending. We are about to go into presidential election season and please show me the candidate that will do that and I will vote for them forthwith.
Remember poor Liz Truss, she set out her economic agenda and the Gilt market almost crashed and did crash her career. I think that is what is going to happen in the bond market. It will catch everyone by surprise because they believe it can’t happen because it hasn’t. Not because it can’t or shouldn’t. It can and it should. We mentioned on LBLF that the state of Texas was pushing back against the federal government regarding the border immigration situation. They said no mas. The Houthis are pushing back in the Middle East and saying no mas. I think the bond market is going to push back against Congress and presidential spending and say no mas.
I channeled my inner Squints last week and called the start of the recession, but I don’t know when this bond event will happen. I don’t know if it will happen in another part of the credit market and find its way into the bond market or if it will happen slow or fast. I only know that the US government has overstepped its place for a long time now and in many different capacities. The bond vigilantes will be back.
This is where it might get weird. Bonds have already crashed and even though very few people expect them to stay here at this elevated place or even go higher they might. They crashed 50% in the last couple of years. They are only one leg of the three-legged stool. Stocks and real estate are next. Higher for longer bond yields will be the cause of both crashes. This is an everything bubble, and we have seen the bond blowout, and that doesn’t mean it is done, but a large part could be. This is the peak of the AI bubble. It will pop next. That doesn’t mean that it won’t turn into desirable technology someday, but the stock market blow off top just peaked. It was the only thing that kept us going last summer, and now it is over. As people lose money in the market, they will raise cash by selling whatever they can and that will be the second house, the Airbnb, and the 4 plex that they bought during Covid after reading a real estate get-rich quick book. What happens when there is no bail out, what happens then. Taylor Swift will not break the internet, the cries of a petulant public will break the internet. They will pound their digital fists in dismay and ask why did this happen to them? Don’t be them. Be bold and hold on to your fortune.
Our Jedi Jerome Powell will try to arrest the sell-off, but I think the market will ignore him and demand to see Congress. They will demand a change in fiscal policy just like the Brits did with poor Liz Truss, and raise taxes? Americans good luck. Cut spending, Americans good luck and I don’t have any idea what Congress would do. I can try to analyze markets and yield curves but alas I am not a horse proctologist. I don’t analyze horse’s asses.
Sincerely Yours,
C Thomas Printer
On this date in history… 4 years ago to be exact, the UK left the European Union with their Brexit. Foreshadowing for Americans perhaps…
Also born on this date… author of the American West and world record fisherman Zane Grey.
Thank you for listening today and you can find all of our articles and more on our website cthomasprinter.com.