October 1, 2021
By Steve Blumenthal

“Bonds continue to sell off as investors reprice for a less-friendly
central bank policy setting and a gnawing realization that cost
pressures from the squeeze on supply chains are going to linger for longer.”

― David Rosenberg,
President and Chief Economist and Strategist, Rosenberg Research

The typically challenging September—October period is, so far, true to form. The Dow Jones Industrial Average dropped 500 points on September’s final day, down 4.3% for the month. The S&P 500 was down 4.8% for the month, its worst monthly decline since the March 2020 pandemic sell-off. It’s 5% below its record high for the first time this year. The Nasdaq fell 5.3% for its worst month since March 2020.

Inflation pressures remain, causing more than a few episodes of heartburn for Fed officials. The personal consumption expenditures price gauge, which the Federal Reserve uses for its inflation target, rose 0.4% from a month earlier and 4.3% from a year earlier. The annual increase was the largest since 1991.

I noted the spike in interest rates in Trade Signals this week (below). Inflation and rising interest rates are the kryptonite to the confidence market participants have placed in the Fed. However, we’re still in the early innings.

On September 2, I had a chance to listen in on an outstanding interview. Grant Williams quarterbacked a conversation with Dr. Lacy Hunt and Felix Zulauf. You likely know all three, and if not, you’re about to… Hunt, Zulauf, and Williams are some of the best minds in the investment business. I’m excited to share a link to that interview with you today.

Both Lacy and Felix believe inflation will ease next year, and the secular downtrend in growth will accelerate. Recession is possible mid-2022.

To set the stage, Lacy stated the following, and Felix concurred:

The US global economy has a lot of serious problems. The most important of which is that we’re excessively over indebted. And we’ve taken on a great amount of new additional debt in the past year to try to ameliorate the consequences of a pandemic. And while this debt can be deemed as politically popular and socially irresponsible, it’s going to have a very deleterious effect on economic growth for a long time to come. In addition to that, because we’ve been on this high debt path for so long, the trend rate of economic growth has fallen dramatically below what we were achieving up until the late 1990s (when we became so over-indebted). And each year that goes by we, we move further below the curve.

Felix added,

The 2020 recession was the shortest on record, but it was not a normal recession, it was government-induced late in an aging business cycle. And due to government interference, the recovery out of that decline setting happened very quickly, and therefore we cannot treat it as a normal recession. A recession normally clears the system from excesses that have been built up previously in an expansion that has not materialized. This time, the excesses are still there, and they are bigger than before.

It is for this reason that I believe the next default cycle (whenever it comes) will create one of the best investment opportunities in my professional investment career. A “clearing of the system,” as Zulauf puts it. Something my partner John Mauldin calls “The Great Reset.” There is a simple process you can follow that will help you better navigate from here to the opportunity that, if we are correct, will present. Interestingly, much of what we need to know is found by analyzing the price movement in the high-yield junk bond market.

We have experienced three major clearings in my career. The 1991–92 recession (Drexel Burnham and Michael Milken troubles), the 2000–02 recession, and the Great Financial Crisis of 2008–09. For the last several years, I’ve been saying that the coming decline will be “epic” – the biggest in my career. Well, I was wrong. The pandemic decline was only -20.5%, as pictured in this next chart. The prior three declines each exceeded -30%.

“Epic” remains ahead. Why? The excesses are bigger than before. Notably, there is very little covenant protection in outstanding bonds. The quality of junk has never been junkier. Picture high-yield bonds yielding more than 20%. That’s where yields were in 2009. I know it sounds crazy but that’s the opportunity that likely presents. It will occur when liquidity dries up.

I’m watching the high-yield market like a hawk. In full disclosure, the CMG-managed strategy traded out of high-yield bonds a week ago. I look at the trend in price and use short-term and medium-term moving averages as a signal. While the following is not our indicator, it does do a pretty good job at signaling the predominant trend. You look for the price line (black and red) to rise above (buy signal) or below (sell signal) the 63-day smoothed moving average price trend line. While it is hard to see, if you look at the upper right-hand side of the chart, the current price is sitting exactly on top of the 63-day MA (green) trend line.

I’m not suggesting this is the tipping point. I really have no idea. I’m willing to risk a few whipsaws to avoid what I believe will be a major reset in price. I suspect that when the next crisis hits, the Fed will come in with guns a-blazing (liquidity creation, buying HY ETFs, etc.). Therefore, we may be two bear market declines away from the “epic” default cycle I foresee.

Think of the high-yield junk bond market it as a canary in a coal mine. My process is currently in a sell signal. Lights on.

The Hunt-Zulauf-Williams discussion link is up next. Put your sneakers on, plug in, and enjoy a walk as you listen. If you’d like to learn more or have additional questions, please send me a note, or contact Jennifer Mendel at info@felixzulauf.com.

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Dr. Lacy Hunt, Felix Zulauf, and Grant Williams

Zulauf Consulting hosted Dr. Lacy Hunt for a webinar on September 2, 2021, which featured a lively conversation moderated by Grant Williams, publisher of Things That Make You Go Hmmm… and the Grant Williams Podcast. The discussion covered macro themes, including deflation, interest rates, and various other topics.

Please click on the image below to access the webinar. The replay will start automatically once you submit your information.

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Trade Signals – 10-Year Treasury Note Yielding 1.54%

September 29, 2021

Posted each Wednesday, Trade Signals looks at several of my favorite equity market, investor sentiment, fixed income, economic, recession, and gold market indicators.

For new readers – Trade Signals is organized into three sections:

• Market Commentary
• Trade Signals — Dashboard of Indicators
• Charts with Explanations

Market Commentary

Notable this week:

Click HERE to read to the balance of Wednesday’s Trade Signals post.

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.

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Personal Note – Penn State

Susan, Matthew, and I are heading to Penn State early tomorrow. The number-four ranked Nittany Lions host Indiana University in Happy Valley at 7:30 pm. The red wine is packed, and the IPAs are on ice. The tailgate begins around noon and I’ll be with a dozen or so of my fraternity brothers and another 100,000 cheering fans.

One of my dear friends, former U.S. Representative Charlie “Chuckles” Dent, and I shared a room in our house on Locust Lane. Back in college, we hosted an annual charity event called the Phi Psi 500: a 1.1-mile beer-drinking race. Run to bar number one, put down a quarter and chug a beer. Run to bar number 2, another quarter, another beer. Two thousand racers took their marks, most of whom were dressed in crazy funny costumes. Six bar stops, six quarters, six beers. The streets were lined with thousands of spectators cheering on the teetering racers as they staggered on towards the finish line. Young and dumb we were, but the event raised more than $25,000 each year for local charities. The memories we made will last a lifetime, and I’m sure we’ll reshare many of those stories this weekend.

I have a few questions for Brother Chuckles too. I’m particularly interested in his insider perspective on what’s happening in Washington. Debt ceiling, infrastructure bill, taxes… You know, all those nasty little (big) things they sneak into a bill. For example, 80,000 more IRS agents and mandatory reporting by your bank to the IRS on all of your transactions of $600 or more. Yep, that’s in the current proposed bill. On second thought, maybe I table that conversation for another day. 😠

But ever forward is the only choice. And to that end, a beautiful fall day with great friends is immediately ahead. To give you a feel for what the party looks like. Check out this video from the “White Out” game a few weeks ago.  I can’t wait.

Wishing you a fun weekend… Go LIONS!

All the best,

Steve

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

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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.

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