Market Notes

Eagle, CO

Quarter one of 2019 is in the books. The markets got off to a great start this year, but most of the return came in the first 2 months. The S&P 500 tacked on 1.79% during the month to finish the quarter up 13.07%. Even bonds got in on the action with the Barclays Aggregate Bond Index up 2.94% for the quarter and the 10-year treasury yield dropping 10% (27 basis points) to finish the quarter at 2.414%.

Market indexes have held strong above major moving averages even in the face of the most heavily cited recession indicator (the inverted yield curve) flashing red.

If you have participated in markets long, you know that this is not surprising – this is standard behavior for this stage of the cycle. To be sure, a market top simply cannot arrive until everyone who is going to buy gets their money in. Only then will we see the top of this bull market – and history says we probably aren’t there yet.

As you can see in the chart, when the blue line (interest rate spread) touches the black line (0.00%), a recession has followed each time (over this time frame) – the key is that the recession is not immediate. But the clock is ticking. Anyone watching can see this. We all know it. Yet the market rises.

What it boils down to is that people are demanding to be compensated a higher interest rate for short-term loans than for long-term loans – the opposite of normal. If you were going to loan me $1,000 overnight, you might not even charge me interest – but if you were going to lend me the same amount for 1 year, you would expect to be paid some interest for your time without access to the funds.

This inverted situation means that the overall economic outlook in the short term is bad – compared to longer term measures. This also means that banks can’t earn very much money by lending to entrepreneurs or home buyers – and so they stop lending or take on unprofitable loans. None of which is good for the economy. Yet the market rises, and the politicians take us (our children) further into debts we (nor they) can ever hope to repay – because why not? The money is cheap.

Of course, this only lasts until it doesn’t.

For example – this document hangs on a wall in our office as a reminder of the difference between being early and being prudent. In case you can’t read it, the part circled in red says “October 6, 2006”.

This article is the earliest known document discussing the coming mortgage crisis. The article is cited in the movie The Big Short.

I wouldn’t describe being either (prudent or early) as “fun” but in many cases both are mandatory. Many people say being early is the same as being wrong – but I would argue that many trades are not possible if you wait for the optimal entry point. As an example, also from the movie The Big Short, the longer the characters waited to get into the trades (betting against the banks and housing market) the more creative they had to become to get them executed. On the other hand, Dr. Michael Burry was in “early” and taking heat from investors for losing too much before the eventual payday.

From my perspective, the guys who waited to get in until the trade was obvious took more risk of missing the trade completely – and they probably ended up paying a similar cost overall.

Lehman Brothers didn’t finally collapse until they filed for bankruptcy on September 15, 2008 – almost 2 years after this article was published – which explains clearly to anyone willing to read – that we were headed for a disaster. Yet only a few crazy people made the investment.

There is a fine line between crazy and brilliant – and I don’t really care to come anywhere close to it. We just follow rules that would work for anyone who can execute them. Our entry signals are getting us into great investments when the odds are in our favor and our trailing stops are getting us out when the odds turn against us.

The most recent additions to portfolios are Rockwell Automation (ROK) and Kraneshares China A-Share ETF (KBA) in the Appreciation Strategy, and Weyerhaeuser (WY) and China Mobile (CHL) in the Income Strategy. Please click here to review the one-pager for each investment.

Shane Fleury

Chief Investment Officer


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