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On My Radar: John Ray – I’m Calling the Bond Market Top (Low in Yields); It’s Got to Be Over

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February 28, 2020
By Steve Blumenthal

“I hope nobody took President Trump’s “buy the dip” investment advice…
The disruption to economic activity due to the coronavirus will be ongoing.”

– David Rosenberg,
Founder, Chief Economist, and Strategist, Rosenberg Research and Associates

This morning, I sat down and started writing about the coronavirus—something you may have expected, considering its impact on the markets. Then, around 7:30 am, my cellphone rang. I looked over and saw it was John Ray. When John calls, I stop what I’m doing and I pick up the phone. John is my long-time mentor. He got me the interview that led to my first job on a Merrill Lynch institutional options market trading desk. That was in early 1984. A year later, I moved to the retail side. John was my first client.

Once a month, he would take me to lunch at the Philadelphia Union League and he’d often call me over to his office. I’d walk down, pick up a check he’d want to deposit and he’d take me to school. My head would spin as I walked the few city blocks back to my office. He’s been my greatest teacher.

John nailed the secular cycle high in interest rates—and the story is a good one. Back then, he was a portfolio manager running a popular mutual fund at Delaware Funds, a large money management company. He was buying 14.25% Treasury bonds at a discount of 94 cents on the dollar. That meant the yield was even higher. He sought to put half the money he was managing in Treasury bonds, but his board of directors shut him down. I remember how frustrated he was. Inflation was out of control, and everyone thought rates would move even higher. That’s what it feels like at inflection points. I remember buying zero coupon bonds in his children’s investment accounts and had a hard time convincing the few other clients I had then to do the same. But John was spot-on. He nailed the top in yields and he took action.

It’s been months since we’ve spoken, but that never matters. What I love about John is he gets right to business. The first words out of his mouth this morning were, “Steve, listen to me. This is the bottom in yields,” he said. “It has to be. It’s crazy. We have upside down interest rates. It will reverse.”

I’ve been in the camp that we are going to 1% on the 10-year and John agreed that maybe we will. But think about it. The top was 35 years ago—I remember the talks we had to this day. Then, out of the blue, the call this morning. I think John Ray is right.

Here are a few more highlights – advice from John to me:

  • This is not Ebola. There is a 2% to 3% kill rate at best. This coronavirus will pass. If this isn’t the bottom in the fixed income markets, then put me in the grave. In the long-term secular swing, the high was in the mid-1980’s, this is the bottom in yields.
  • Go to cash in your bonds today. It’s over. And my advice to the U.S. government is this: Issue all the 50-year bonds you can right now. Solve the deficit problems. Rates will never be lower.
  • If I had a favorite stock, I’d be buying some. However, I think the stock market has to stop and turn first. That hasn’t shown yet.
  • For equities, it’s not time to buy. But it is nibble time.
  • I really believe that the bond market is driving this. It is insanity in the bond market. Who locks up their money for 10 years at 1%? Cash it out and wait for a higher yield down the road.
  • The Fed is promoting inflation appreciation with a target at 2%. Someone has to ring the alarm bell. Enough is enough. This is the low in interest rates.

I told John I’ve seen charts that show we are at 5,000-year interest rates lows. He told me he can’t argue. Who the hell is buying negative interest rate-yielding bonds in Europe? You can’t do it.

He continued,

  • Corporations have been destroying their balance sheets for 10 years. They tell you in business school that cash is trash. This is the one time in our lifetimes that cash is not trash.
  • He advised me to key off the bond market. It is in worst condition than equities. He asked me if I remembered when he had to walk over to my office and address a margin call during the ’87 crash. “Well,” he said, “this is like that for the bond market.”

I totally remember that moment. October 19, 1987. I was in Maui on an award trip and my phone rang at 3 am. It was my assistant. It was absolute chaos. My first call was to John. Then other clients.

More from John:

  • The closed-end fund market goes bonkers in times like this. You see insane discounts.
  • BIF has something like 40% invested in Berkshire Hathaway. Buffett at a discount. If you can lock down something paying 3, 4, or 5% dividend yields at a discount, that is a place to nibble.
  • Equities are always tricky at bottoms. When you think you are right, the next day always comes back to bite you. Bottoms are hard to call.
  • John’s advice: Get Barron’s this weekend and start scrolling through the closed-end fund section. Look for deep discounts and high dividend yields.
  • With strong emotion he asked, “Why would you buy a 1.22% yielding bond? Find higher yields at deeper discounts; then you don’t have to worry so much about timing.”

Sage advice. I’m calling my mortgage broker this afternoon. I’ve been looking for a window to refinance and 30-year money is pretty cheap. For me, it’s time to act. I’ll also be reviewing all of our portfolios’ long-dated high quality exposure. It’s been an awesome run.

I’ve mentioned high and growing dividend ETFs several times recently. We’re putting the finishing touches on a whitepaper titled, “The Case for High and Growing Dividends,” and we will be adding a strategy to our institutional platform. The strategy will invest in five carefully selected dividend-paying ETFs, and we will use a stop-loss risk-management trigger that positions the strategy in cash. It’s somewhat similar to the equity signals I share with you each week in Trade Signals. If you’d like a copy of the paper, please send an email to blumenthal@cmgwealth.com and I’ll send it to you. (If you previously requested a copy, please accept my sincere apologies for the delay. My very big miss.)

There are a few great coaches that come into your life. John is my favorite. I’m not suggesting you act on his advice. I am suggesting you consider his perspective, and I recommend you have a conversation with your advisor. There is time. Make sure you have your game plan up to date and in place.

Brace for the Coronavirus

The coronavirus is serious. The outbreak is rising quickly outside China, and the odds of a pandemic have now doubled — from 20% to 40%, according Moody’s Analytics. “The economy was already fragile before the outbreak and vulnerable to anything that did not stick to script. COVID-19 is way off script,” Moody’s added.

Here are the stats:

  • The coronavirus affects a broader mix of people.
  • 0.01% of people who get the flu die from it. That’s 1 out of every 1,000.
  • Roughly 2% of the people who contract the coronavirus die from it. That’s 2 out of every 100.
  • The virus is three times more infectious than the normal flu.

When I wrote, This is EUPHORIA. Wait for PESSIMISM on February 21, I had no idea pessimism would show its face so quickly. Could COVID-19 be the snowflake that trips the avalanche? The answer is yes.

Last Sunday, I reached out to David Rosenberg and asked if he’d share his thoughts on the virus, the economy, and the markets. He agreed, and last Tuesday we recorded the conversation. You’ll find the podcast link below along with a few high-level bullet points.

David is the Chief Economist and Strategist of Rosenberg Research and Associates, an economic consulting firm he established in January 2020. Prior to Rosenberg Research, David was Chief Economist and Strategist at Gluskin Sheff and Associates. From 2002 to 2009, he was Chief North American Economist at Merrill Lynch in New York, during which he was consistently ranked among Institutional Investor’s All‐Star Analysts. David is brilliant. I’ve followed him for years and we broke bread over red wine at Mauldin’s Strategic Investment Conference last May.

The reality is we are learning more about the spread of the virus by the day. On Thursday, business partner and friend John Mauldin and I spoke with Ben Hunt. Ben is a good friend. He is the Chief Investment Officer at Second Foundation Partners, a consultant for large institutional investors, and the creator of Epsilon Theory, a newsletter and website that examines markets through the lenses of game theory, history, and nature. And it’s a great read—over 100,000 professional investors and allocators across 200 countries read Epsilon Theory for its fresh perspective and novel insights into market dynamics. In prior positions, Ben has managed a billion dollar hedge fund and served as Chief Strategist for a $13 billion dollar asset manager. He has a Ph.D. from Harvard University, was a tenured political science professor, and has co-founded three technology companies. Ben talked about the numbers coming out of China and how they don’t add up, especially when you compare them to past pandemics and the current data coming out of Italy, South Korea, and Iran.

You’ll also find the link to our conversation with Ben Hunt below, along with a few high-level bullet points. John and I mostly asked questions, but there was one moment when John jumped in and said, “The good news here is that this is not the super bug. It’s not good but it will be a real life test to get our health care system better prepared for such events.”

John also shared a conversation he had with Joseph Kim. Kim worked under Dr. Dario Altieri, President and CEO of the Wistar Institute. Wistar is located near the University of Pennsylvania campus in Philadelphia. The company is an international leader in biomedical research with special expertise in cancer, immunology, infectious diseases, and vaccines. The bad news: We should expect the virus to spike globally. The good news is Kim believes there will be a vaccine available next year. You’ll get your flu shot and your COVID-19 shot at the same time.

I learned a great deal more about the virus this week. My message to family, friends, and clients is this: brace for the virus. There is a high probability that it is coming. My message to my doctor’s office and other medical facilities is get prepared. Plan for the worst, but expect the best. We need to think about the coronavirus as we do the flu, though the death risk is higher. Death rates are highest for males, especially those aged sixty or older—and those at higher risk for health issues. Children and women appear to be least affected, though they may experience a week of downtime, much like the flu.

The Markets are in Free Fall

I clipped the following charts early this morning. Data is through Thursday, February 27 close. The market is off another 4% at the time of this writing.

Here’s what’s going on:

  • It was the worst week for US stocks since 2008. A correction is defined as a 10% or greater decline. As of Thursday’s close, US indices entered correction territory.

  • If the 10% correction seemed to happen in a blink, it did.
  • Since 1980, the six-day sell-off is the fastest to -10% on record.

Source: Deutsche Bank Research, @YahooFinance; Read full article

  • A bear market is defined by a 20% or greater decline. There have been eleven sell-offs of 10% or more over the last 20 years.
  • Two have been greater than -20%.
  • It is the -40% to -60% corrections that we all must protect against.

  • Some short-term good news is that volatility, as measured by the VIX index, suggests we may be nearing the lows in stocks.
  • Bottom line: Expect a bounce (at least in the near-term).

My advice to our clients and friends: Don’t panic and adhere to your stop-loss downside risk protection rules. “Buy the dip” has worked well in the last ten years. The Fed has quickly come to the rescue when there was a whiff of trouble. The pandemic risks from the coronavirus are different. We may be moving into a different regime where “buy the dip” doesn’t work. Thus, the fun humor in Rosey’s quote I shared in the intro to this week’s OMR. I recommend using rallies to raise cash (and/or hedge equity exposures). If you are managing your own assets and don’t have a process in place that risk protects your downside, up your game plan.

I had a more detailed conversation with ETF.com’s Cinthia Murphy yesterday. A few highlights from the interview follow. Click on the photo to get to the full article.

Source: ETF.com

ETF.com: What’s your current macro view? Could coronavirus push this long bull market into a big correction?

Steve Blumenthal: We’re way late in the cycle, and now, you have a shock to the system like this. It’s meaningful. This could be something that accelerates the timing of the next recession.

I look at a number of recession launch indicators regularly. The weight of evidence right now says no recession for the next six months. Could coronavirus accelerate that? Yes, it could.

The problem is, it’s in recession that all the bad stuff happens. That’s when you get the 40-60% declines. We sit late cycle. We sit extremely overpriced. And we’ll have another recession. That’s what investors need to be prepared for, and make sure they defend against significant loss.

ETF.com: Mohamed El-Erian recently told CNBC that “shock events” such as a virus outbreak could be more disruptive to economic growth than a “traditional fundamental downturn.” Do you agree with that?

Blumenthal: El-Erian is a valiant and brilliant thinker. I’m going to absolutely agree with him.

Grab that coffee and find your favorite chair. And later today, put your sneakers on, plug in and listen to the podcast recordings while you go for a nice walk. I do hope you enjoy them and find them helpful. I learned a great deal.

If a friend forwarded this email to you and you’d like to be on the weekly list, you can sign up to receive my free On My Radar letter here.

Included in this week’s On My Radar:

David Rosenberg Podcast – Coronavirus, Economy, and Market Impact

I like David’s style: fast-paced, direct, and loaded with data. You’ll find our discussion on the virus, the economy, and his thoughts on the timing of recession. Click on the orange arrow button below to play the podcast.

David offers a free trial to his daily research.  I’m a happy subscriber and please know I am not compensated by Rosenberg Research.  You can learn more here.

Ben Hunt Podcast – Coronavirus, Economy, and Market Impact

Ben is fun, witty, and very likable. There were a number of times while listening when I thought to myself, “Oh my God, this is brilliant thinking.” You’ll find our discussion on the virus, the economy, and his thoughts on the timing of recession. Click on the orange arrow button below to play the podcast.

You can learn more about Epsilon Theory here.

What We Are Seeing in the Ned Davis Research CMG US Large Cap Long/Flat Model

I traded emails with my friend David Schassler from Van Eck yesterday. A lot of investors are calling in and asking what we are seeing in terms of signal timing for the Ned Davis Research CMG US Large Cap Long/Flat model (shared in the Trade Signals section – you’ll need to click on the link provided below).

Here is what we are seeing in the model:

  • The breadth score is reacting to the correction. The score moved from 85 at the market peak on 02/19/2020 to 77 as of yesterday’s close. The growth industries remain bullish while the value industries are either bearish or are close to turning bearish.
  • The chart below shows that growth stocks, as measured by the S&P 500 Growth Index, did not start to decline until 02/19. By comparison, the S&P 500 Value Index peaked in mid-January and has been struggling since. Correlations have spiked across the industries and the growth stocks are falling more than value stocks.

  • The diagram below shows the risk scores of each industry in the S&P 500 Index. As a reminder, risk scores above 50 are bullish and scores of 50 or below are bearish.
  • As you can see, many of the value industries have already turned bearish. These include energy, materials, automobiles and components, banks, and telecommunications.
  • The growth industries are still bullish because of the positive momentum leading up to the correction. It will take a significant amount of continued weakness to turn these industries bearish in the near-term.

  • Separate from the model, below is an interesting analysis that NDR just released. It shows that the market typically performs well following sharp declines from market highs.

You can find the full post of the most recent Trade Signals here.

I continue to favor diversifying to several different risk-managed processes.

Trade Signals – Weakening Trend Data, Daily Sentiment Reflecting Fear

February 26, 2020

S&P 500 Index — 3,116

Notable this week:

Clearly, coronavirus is a risk. It will spread globally and may just be the pin that pricks the asset bubble. I’m sticking to the drill and following the price indicators. Fundamentally, valuations are crazy high, we sit late cycle and, yes, perhaps my “On My Radar: This is EUPHORIA. Wait for PESSIMISM” post last week called the top. That would be just plain luck. I do believe we are in a “sell the rallies” environment vs. “buy the dips.” The trend indicators are weakening. I continue to favor diversifying to more than one process. For example, I use the Ned Davis Research CMG U.S. Large Cap Long/Flat signal for my large-cap exposure and a combination of short-term, medium-term and long-term exposure on the CMG Beta Rotation Strategy and high and growing dividend ETF strategies. None are perfect but the odds are good. The overriding idea is to make sure to protect against the major bear market declines of 40% to 60%. It takes a 100% return to overcome a 50% loss and a 300% return to overcome a 75% loss. Those are real risks.

No signals yet on the major equity trend indicators (dashboard and charts below). One notable data point this week is the NDR Daily Trading Sentiment has turned Extremely Bearish, which is a short-term bullish signal for equities. Also, HY moved back to a sell signal. I’m continuing to focus on the combination of the trend in HY and credit lending conditions. No guarantees, but I believe they are keys to identifying the next bear market turn. We’ll have most of the month-end recession watch charts updated next week. The coronavirus is a shock to global supply chains, investor behavior and ultimately economies. Markets that are richly priced. The move in gold has been outstanding.

Not a recommendation for you to buy or sell any security.  For information purposes only.  Please talk with your advisor about needs, goals, time horizon and risk tolerances. 

Click here for this week’s Trade Signals.

Personal Note – Park City, Snowbird, NYC, and San Antonio

“Live as if you were to die tomorrow. Learn as if you were to live forever.”

– Mahatma Gandhi

The coronavirus has me seriously thinking about my travel schedule. However, as of now, I have no plans to slow down. I fly out Sunday evening to Salt Lake City to attend an annual investment conference in Park City. ETF strategists, option trading specialists, portfolio managers, industry consultants, market makers, and advisors will be attending. It is a carefully selected group with one common thread. We are there to learn from each other and expand our knowledge. One of my favorite annual events. Oh, and the skiing is awesome.

On Monday, twelve of us will be backcountry skiing with guides and proper equipment. One of our friends owns a lot of land next to the Park City ski resort and a snowcat is lined up to take us up and down the mountain. The conference begins on Tuesday. The conference sessions are held in the mornings and we ski in the afternoons. Then, back to the rooms, rest, review the markets, answer emails, return calls and then off to dinner.

Next Friday, I’ll be driving out one canyon and up into another. Warning: I expect a short update (and maybe that’s a good thing). My sons, Matt and Kyle, daughter Brianna and good friend Andy are joining me for a long weekend in Snowbird. This will be year 41 at “The Bird.” Ugh, that sounds like a long time. This year Brianna will attend the investment conference. That makes for a happy dad.

NYC follows on March 11 and 13 for meetings and San Antonio is on the agenda March 28 where I’m speaking at an agriculture conference. I’m a consultant and investor in a biotech agriculture company doing some exciting things.

Excellent photoshop from a funny client!

Stay safe, stay healthy and wash your hands frequently.

Subscribe to OMR

Warm regards,

Steve

Stephen B. Blumenthal
Executive Chairman & CIO
CMG Capital Management Group, Inc.

Stephen Blumenthal founded CMG Capital Management Group in 1992 and serves today as its Executive Chairman and CIO.  Steve authors a free weekly e-letter entitled, “On My Radar.”  Steve shares his views on macroeconomic research, valuations, portfolio construction, asset allocation and risk management.

Click here to receive his free weekly e-letter.

Follow Steve on Twitter @SBlumenthalCMG and LinkedIn.  

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