Making Hay Monday - October 23rd, 2023
Thanks to our Gavekal partners!
Blinded By The Flight
“It turns out that sending checks to voters is an effective macro stimulant and politically popular. Who could have guessed? That lesson won’t soon be forgotten.” -Gerard Minack, author of Down Under Daily
“It’s discouraging how hard it is for a President to slice away large chucks of a $305 billion budget.” -Former U.S. President Gerald Ford in the 1970s (today that budget would need to have a zero added to it and then nearly doubled)
Please accept my apologies for running two Guest Making Hay Mondays in a row, but the Haymaker is on a much-needed vacation. As usual, Mrs. Haymaker is with me and she’s the star of this holiday. We are one of those rare couples who share the same birthday. Ours is on Halloween-eve, otherwise known as October 30th. However, one of us is two years older than the other. In this case, the better part of marital valor is for me not to point out which of us is the eldest. But suffice to say that it’s a VERY big birthday for my significantly better half.
Pinch-hitting for me this week is Anatole Kaletsky, founder of our partner firm GaveKal. Like me, he’s been increasingly worried about dysfunction in the longer-term part of the U.S. Treasury (UST) market. Due to the extreme weakness in what is the world’s most important asset class, he’s wondering if it isn’t time to move to the buy-side. Also simpatico with me, he’s concluding not quite yet.
Unquestionably, long USTs are deeply oversold presently, creating the conditions for a muscular counter-trend rally (prices up, yields down). In fact, this is what happened earlier this month when they were similarly stretched to the downside as their yield erupted up to the psychologically significant level of 5%. This was followed by a quick mini-rally that pushed their yield back down near 4.57%, a meaningful decline in a short period of time. As is typical of bear market rallies, though, it didn’t last long. Within a couple of weeks, the yield on the 10-year T-note — arguably, the planet’s most crucial interest rate — was right back knocking on the 5% door. In fact, the 30-year UST decisively shattered resistance at 5%, making a 16-year high in the process.
As most Haymaker readers hopefully are aware, my 4F scenario — a Federal Fiscal Funding Fiasco — has been one of my two overarching risks of this year, along with a bursting of the global housing bubble. Frankly, the second one hasn’t been such a great call, as I’ve previously admitted. In hindsight, I should have forewarned about an implosion in the worldwide real estate bubble. That one is more clearly unfolding. According to credible property experts in the Seattle area, apartment buildings have fallen 20% to 25% even on the affluent Eastside. More disturbing, one of Seattle’s most iconic office buildings is close to being sold at a 70% markdown from its 2019 sales price. As you may have seen, there are numerous transactions of office properties selling, or being foreclosed upon, as much as 80% below their high-water marks of just a few years ago.
This feeds into one of my other dominant fears that the most recent banking crisis isn’t over. Small- and mid-sized banks are particularly vulnerable, as they hold roughly half of all commercial mortgages. Of course, they’ve also been absolutely smoked on their extensive holding of allegedly riskless government bonds.
Regardless, my repeated warnings about severe dislocations in the UST market have been resoundingly realized. Hopefully, a large number of readers took protective action against that outcome. At this point, it is reasonable to be pondering when it makes sense to flip to the other side. That could be right now but, as Anatole postulates, further downside is probable. This strikes me as particularly likely considering how exposed both retail and institutional investors are to long-duration U.S. government debt.
Should the yield surge accelerate from here, the spillover to the stock market is likely to be intense. Hopefully, conditions will stay orderly, but it’s not a bad idea to be on-guard for a much less benign scenario. A frenetic flight from the UST market would truly be a flashback to October 1987. That month’s collapse blinded millions of former stock bulls toward the plethora of bargains that nearly overnight free-fall created. Many stayed out of the market for years thereafter, similar to what happened in the wake of the 2008-2009 Global Financial Crisis. Don’t let what might be exploding volatility cause you to lose sight of what could be the best buying opportunity since the depths of the Covid crisis.
David “The Haymaker” Hay
P.S. For our Founding Members, we are still planning to run a mid-week premium content piece. However, our Presentation + Q/A webinar (which was tentatively scheduled for this week) will take place at some point next month; we’ll essentially be hosting one event for both October and November on account of the birthday trip this month and the Thanksgiving holiday next. (We will probably wrap-up the year with a final webinar a week or so before Christmas.)
To all standard-paid and non-paid readers, consider upgrading to Founding Member status for invitation-only access to these monthly webinars. It’s a great way to get direct market insights and enjoy some face-to-face dialogue with the Haymaker himself!
Give Me US Treasuries, But Not Yet
-Anatole Kaletsky
Now that all bond maturities across the US yield curve have traded with a 5% handle, has the time finally arrived for fixed-income investors to extend duration? Should unconstrained portfolios even consider buying some long-term bonds? Spoiler alert: at the end of this note my answer is “not yet”, but probably within the next month or two, when I think US 10-year yields will peak (temporarily) around the level of the Fed funds rate (5.25%-5.5%).
US inflation may not return to the Federal Reserve’s 2% target until at least 2025
My reasoning, which I have been presenting all (this) year in webinars and client meetings, can be summarized in the following four points: