October 4, 2024
By Steve Blumenthal
“This beautiful deleveraging can only be done in countries that have most of their bad debts denominated in their own currencies and have most of the debtors and creditors as their own citizens, which is the case for China. Doing a deleveraging in this way not only reduces debts without triggering either unacceptable deflation or unacceptable inflation, but it also allows viable businesses to get back to business unencumbered by their old debts and it eliminates the “pushing on a string” problem of having scared people, companies, and other entities holding cash in safe banks and government debt assets. It does this by making cash a poorly performing asset class relative to the major alternative asset classes that are doing well because of the reflation. Doing these things starts to rekindle “bottom fishing” and “animal spirits.” We are clearly seeing that happen now..”
— Ray Dalio, A Beautiful Deleveraging with Chinese Characteristics
Ray Dalio posted an important piece on China this week. Ultimately, China may be the first to initiate what Ray calls “a beautiful deleveraging.” The macroeconomic crises across much of the developed world are debt-related, and attempts to restructure various countries’ debts are in the early innings. The end of the great debt accumulation cycle is the big economic elephant in the room. We need to keep our eyes on it. It won’t be an easy road. Before we discuss Ray’s thoughts on China’s liquidity move further, let’s first look at the risk of recession in the U.S. through the lens of the inverted yield curve as well as what causes lost decades (flat stock and bond market performance).
Inverted Yield Curve
An inverted yield curve is one of those things that sounds complicated, but it’s really just a red flag for the economy, signaling that investors are worried about the future. Usually, when you lend the government money for a longer period of time––say, ten years––you expect to get paid more interest than if you lend money for just a short period, like six months or two years. This makes sense: longer loans = more risk but also more reward.
But when the economic outlook gets worrisome to investors and the yield curve inverts, that more-risk-more-reward logic inverts, too. Short-term bonds become a better, more profitable investment than long-term bonds. When investors are worried about the near future, they’re willing to accept lower returns for long-term investments because they think something bad, like a recession, might be near. Like having a fever signals that you’re sick and your body’s fighting off illness, an inverted yield curve signals that the economy is not well and a recession is likely ahead.
But what defines ahead?
The following chart plots the yield-curve data going back to December 31, 1958. Ten inversion events, excluding the current inversion, have occurred since then. So far, a recession has followed nine of the ten (the exception being 1966-67). Will a recession follow the current inversion? We don’t yet know, but let’s look at the odds.
Focus on the shaded grey lines in the chart. They indicate prior recessions, as defined by the National Bureau of Economic Research (NBER). The small numbers placed before each gray recession bar on the top half of the chart indicate the number of months between the start of the inverted yield curve and the following recession. The shortest intervening period was seven months from the first inversion. The longest was 21 months. It took 11 months before the 2001 recession and 21 months before the 2008-09 recession. The median is 11 months.
It has been 27 months since the start of the most recent inversion, and it’s not over yet.
Inverted yield curves and recessions:
-
Inversion happens when the 6-month Treasury Bill yield exceeds the 10-year Treasury Note yield. Many follow the 2-year vs. 10-year Treasury (same idea – when short-term rates are higher than long-term rates, something is not well in the system).
-
Historically, inversions have resulted in a recession within 6 to 19 months. Source: Commonwealth Financial Network.
-
Among bear markets since 1946, the average stock market decline with a recession was 35.8% versus 27.9% on average without a recession. Source
-
Since recessions are only known in hindsight, assessing the probability of a recession in advance is essential.
I’m highlighting it this week, noting the depth and duration of the current inversion. Lights on!
One last and essential point, which is often misunderstood, is that a recession generally begins after the yield curve normalizes (when short-term rates are once again lower than long-term rates). Not before then, but after. That has already happened with the 2-year Treasury yield vs. the 10-year Treasury yield.
Grab a coffee and settle into your favorite chair. I often write about cycles with an eye on risk, of course. Along those lines, I read an excellent post by GMO’s Ben Inker this week examining the popular 60/40 allocation. Looking at the long-term data, it’s easy to conclude that we should all just put 60% in stock indices and 40% in bond indices––just like so many portfolio allocations today. However, Ben noted that six 10-year periods in the last 125 years have resulted in flat to negative annualized returns. The last was from 2000 to 2010. And if you look at those six lost decades, one of two things, or both, were evident before each of them: high equity market valuations or high bond market valuations (low yields). We’ve got both today. This is not a big problem for the 30-year-old, dollar-cost average investor, but it’s an enormous problem for the age 50, 60, 70, and older cohorts. You’ll find an excellent chart from GMO below and a quick summary review of Ray Dalio’s thoughts on China’s liquidity move.
On My Radar:
- 60/40 – Lost Decades Are More Common Than You Think
- Ray Dalio on China’s Liquidity Move
- Random Tweets
- Personal Note: Puerto Rico, NYC, California, and Colorado
See Important Disclosures at the bottom of this page. Reminder: This is not a recommendation to buy or sell any security. My views may change at any time. The information is for discussion purposes only.
If you like what you are reading, you can subscribe for free.
60/40 – Lost Decades Are More Common Than You Think
By Ben Inker, Co-Head of GMO’s Asset Allocation
(Find the complete article HERE)
Asset Allocation Is Easy in Theory, Difficult in Practice
In theory, growing a pool of wealth over decades – whether for a family, an endowment, or a pensioner – is a straightforward endeavor. An advisor or allocator needs to do three things: understand the goals of their client, find different ways to receive compensation for taking risks, and then take the right amount of risk to meet those goals. Taking too much risk may expose the client to unacceptable drawdowns, while taking too little risk will likely lead to inadequate returns in the long run.
The de facto “passive” allocation of 60% equities/40% bonds has proven effective at compounding wealth over time by tapping into two key risk premia: the equity risk premium earned by underwriting the risk of an economic growth shock and an inflation risk premium received for bearing the risk of surprise inflation. Since 1979, when the Bloomberg U.S. Aggregate Index incepted, a 60/40 portfolio made up of U.S. equities and bonds has delivered returns of 10.2% annualized, outpacing inflation by 7.0% and exceeding the return requirements of most investors.
So, we’re done, right? We should all just run 60/40 allocations and call it a day? That approach has worked exceptionally well since 1979, and quite nicely over even longer time periods. While the classic disclaimer on investment ads says past performance is no indication of future results, we can take away some lessons from 120 years of results for a 60/40 portfolio. As Exhibit 1 indicates, a 60/40 portfolio (in this case U.S. stocks and U.S. bonds) has delivered real return of about 4.8% since 1900 – a couple of points less than the 1979-to-present period, but again sufficient for most investors’ needs.
But this enviable long track record hides the fact that there have been six periods, averaging 11 years each, in which an investor in a 60/40 portfolio would have either broken even relative to inflation or, even worse, lost money in real terms. Those chapters share something in common – they all followed exceptionally strong periods of return for the traditional portfolio and thus began when either or both stocks and bonds were trading at extremely high valuations.
Source: GMO
Not a recommendation to buy or sell any security. For discussion purposes only. Current viewpoints are subject to change.
Ray Dalio on China’s Liquidity Move
From Ray:
“In my 55 years as a global macro investor, I have seen, traded through, and studied many big debt crises (48 are covered in my book, “Principles for Navigating Big Debt Crises.”) It is that perspective that leads me to believe that China is at a fork in the road and can either: deal with its debt by beautiful engineering or deal with its debt crisis in a way that drags on. To me, this one in China looks like “another one of those” that can and should be treated in big, classic ways— but more is required. I go over this in my latest article.”
I’m going to start with Ray’s conclusion and then give you a few bullet points. But do read the full post (it’s short). He concludes:
“So, while last week we saw great actions and words that I am sure will be followed by highly stimulative policies that will help a lot and will support asset prices, I think that there are several important other things to keep an eye on to see how well China’s domestic debt-money-economy challenges will be handled.
Of course, these observations are about just one of the five big forces (the debt-money-economy force) in one of the big countries (China), and it’s important to remember that the other big forces (the internal political conflict force, the external geopolitics conflict force, the acts of nature force, and the technology force) are also affecting China, other nations, and the entire world. Last week was filled with comparably important developments pertaining to all of these things, and these developments seem, to me, to be broadly tracking the big cycle that will have big impacts on what the changing world order will look like. I will keep you posted with my thinking about them.
SB Here: Following are my summary notes:
Ray Dalio’s take on China’s recent moves highlights three big points.
- China’s leadership has boldly announced fiscal and monetary policies aimed at stimulating the economy and boosting the markets. They’ve also expressed support for free markets, signaling a significant step toward ending deflation and fostering innovation.
- Chinese assets are currently very cheap, which, combined with these new policies, has sent the markets soaring. This is a big moment that could end up being historic—similar to when the European Central Bank promised to “do whatever it takes” to save the euro.
- Dalio believes China is at a crucial crossroads. It can either manage its debt crisis effectively through a “beautiful deleveraging,” where debt is reduced in a way that doesn’t harm the economy, or it could mishandle it, leading to a prolonged slump, like the one Japan experienced. The key is whether China will restructure bad debts and keep interest rates lower than inflation and growth rates or even monetize debt, if necessary.
But there’s a catch. China must tackle several challenges to achieve this, including politically charged local government debts, inefficient tax systems, and demographic problems, such as early retirements and a shrinking workforce.
While Dalio sees China’s current actions as bullish for the markets, he warns that the road ahead will still be challenging and filled with complex reforms. He’ll be keeping an eye on how they handle their debt and economic challenges alongside other major global forces like political conflicts and technological changes.
Here is the link to the full article on LinkedIn. These views are Ray Dalio’s own and not necessarily Bridgewater’s.
SB here again: I believe China is an enemy, not a friend. Their actions in bonding with Russia, Iran, and North Korea are telling. By investing in China, we are supporting its capital markets structure and war capabilities. Since my friend, Dr. Jonathan Ward, wrote his book, China’s Vision of Victory, I believe the free world has woken up to the country’s plan. The Chinese government routinely disappears their former friends and colleagues. It’s a top-down, communist dictatorship with a far different view of the world than much of the free world. Please do what you feel is best for you and your family, but for my part, I won’t invest in China.
Not a recommendation to buy or sell any security. For discussion purposes only. Current viewpoints are subject to change.
Random Tweets
Tweet 1: “Inflation is a function of federal spending.” Click on the photo to listen to Milton Friedman.
Tweet 2: The FOMC member’s preference for low unemployment suggests that they prefer to cut interest rates too much too quickly to minimize the risk that the unemployment rate moves higher.
Source: Torsten Slok, Apollo Chief Economist
Tweet 3: Fear and Greed Index – Markets on the verge of “greed…”
Not a recommendation to buy or sell any security. For discussion purposes only. Current viewpoints are subject to cha
In Trade Signals, we combine a fundamental view with our arsenal of technical indicators to help with investment entry points and risk management.
If you are not a subscriber and would like a sample, reply to this email, and we’ll send you a sample.
Trade Signals is designed for traders and investors seeking a better understanding of macro trends. Click on the link below to subscribe or log in. The letter is free for CMG clients.
TRADE SIGNALS SUBSCRIPTION ACKNOWLEDGEMENT / IMPORTANT DISCLOSURES
The views expressed herein are solely those of Steve Blumenthal as of the date of this report and are subject to change without notice. Not a recommendation to buy or sell any security.
Personal Note: Puerto Rico, NYC, California, and Colorado
James, Andy, Steve, and Steve (Rockaway Hunt Club)
Steve
You can share this letter on X by clicking here.
You can share this letter on LinkedIn by clicking here.
Subscribe to OMR for free by clicking the photo.
Stephen B. Blumenthal
Executive Chairman & CIO
CMG Capital Management Group, Inc.
Private Wealth Client Website – www.cmgprivatewealth.com
TAMP Advisor Client Webiste – www.cmgwealth.com
Forbes Book – On My Radar, Navigating Stock Market Cycles. Stephen Blumenthal gives investors a game plan and the advice they need to develop a risk-minded and opportunity-based investment approach. It is about how to grow and defend your wealth. You can learn more here.
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.
Follow Steve on Twitter @SBlumenthalCMG and LinkedIn.
IMPORTANT DISCLOSURE INFORMATION
This document is prepared by CMG Capital Management Group, Inc. (“CMG”) and is circulated for informational and educational purposes only. There is no consideration given to the specific investment needs, objectives, or tolerances of any of the recipients. Additionally, CMG’s actual investment positions may, and often will, vary from its conclusions discussed herein based on any number of factors, such as client investment restrictions, portfolio rebalancing, and transaction costs, among others. Recipients should consult their own advisors, including tax advisors, before making any investment decision. This material is for informational and educational purposes only and is not an offer to sell or the solicitation of an offer to buy the securities or other instruments mentioned. This material does not constitute a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual investors which are necessary considerations before making any investment decision. Investors should consider whether any advice or recommendation in this research is suitable for their particular circumstances and, where appropriate, seek professional advice, including legal, tax, accounting, investment, or other advice. The views expressed herein are solely those of Steve Blumenthal as of the date of this report and are subject to change without notice.
Investing involves risk.
This letter may contain forward-looking statements relating to the objectives, opportunities, and future performance of the various investment markets, indices, and investments. Forward-looking statements may be identified by the use of such words as; “believe,” anticipate,” “planned,” “potential,” and other similar terms. Examples of forward-looking statements include, but are not limited to, estimates with respect to financial condition, results of operations, and success or lack of success of any particular market, index, investment, or investment strategy. All are subject to various factors, including, but not limited to, general and local economic conditions, changing levels of competition within certain industries and markets, changes in legislation or regulation, Federal Reserve policy, and other economic, competitive, governmental, regulatory, and technological factors affecting markets, indices, investments, investment strategy and portfolio positioning that could cause actual results to differ materially from projected results. Such statements are forward-looking in nature and involve a number of known and unknown risks, uncertainties, and other factors, and accordingly, actual results may differ materially from those reflected or contemplated in such forward-looking statements. Investors are cautioned not to place undue reliance on any forward-looking statements or examples. All statements made herein speak only as of the date that they were made. Investing is inherently risky and all investing involves the potential risk of loss.
Past performance does not guarantee or indicate future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by CMG), or any non-investment related content, made reference to directly or indirectly in this commentary will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this commentary serves as the receipt of, or as a substitute for, personalized investment advice from CMG. Please remember to contact CMG, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services. Unless, and until, you notify us, in writing, to the contrary, we shall continue to provide services as we do currently. CMG is neither a law firm, nor a certified public accounting firm, and no portion of the commentary content should be construed as legal or accounting advice.
No portion of the content should be construed as an offer or solicitation for the purchase or sale of any security. References to specific securities, investment programs or funds are for illustrative purposes only and are not intended to be, and should not be interpreted as recommendations to purchase or sell such securities.
This presentation does not discuss, directly or indirectly, the amount of the profits or losses realized or unrealized, by any CMG client from any specific funds or securities. Please note: In the event that CMG references performance results for an actual CMG portfolio, the results are reported net of advisory fees and inclusive of dividends. The performance referenced is that as determined and/or provided directly by the referenced funds and/or publishers, has not been independently verified, and does not reflect the performance of any specific CMG client. CMG clients may have experienced materially different performance based upon various factors during the corresponding time periods. See in links provided citing limitations of hypothetical back-tested information. Past performance cannot predict or guarantee future performance. Not a recommendation to buy or sell. Please talk to your advisor.
Information herein has been obtained from sources believed to be reliable, but we do not warrant its accuracy. This document is general communication and is provided for informational and/or educational purposes only. None of the content should be viewed as a suggestion that you take or refrain from taking any action nor as a recommendation for any specific investment product, strategy, or other such purposes.
In a rising interest rate environment, the value of fixed-income securities generally declines, and conversely, in a falling interest rate environment, the value of fixed-income securities generally increases. High-yield securities may be subject to heightened market, interest rate, or credit risk and should not be purchased solely because of the stated yield. Ratings are measured on a scale that ranges from AAA or Aaa (highest) to D or C (lowest). Investment-grade investments are those rated from highest down to BBB- or Baa3.
NOT FDIC INSURED. MAY LOSE VALUE. NO BANK GUARANTEE.
Certain information contained herein has been obtained from third-party sources believed to be reliable, but we cannot guarantee its accuracy or completeness.
In the event that there has been a change in an individual’s investment objective or financial situation, he/she is encouraged to consult with his/her investment professional.
Written Disclosure Statement. CMG is an SEC-registered investment adviser located in Malvern, Pennsylvania. Stephen B. Blumenthal is CMG’s founder and CEO. Please note: The above views are those of CMG and its CEO, Stephen Blumenthal, and do not reflect those of any sub-advisor that CMG may engage to manage any CMG strategy, or exclusively determines any internal strategy employed by CMG. A copy of CMG’s current written disclosure statement discussing advisory services and fees is available upon request or via CMG’s internet web site at www.cmgwealth.com/disclosures. CMG is committed to protecting your personal information. Click here to review CMG’s privacy policies.Please take note of the following text:
“The blue line in the lower section shows how much the orange line is above or below the long-term trend line. It is currently in the “Overvalued” zone. Lastly, the data boxes at the bottom of the chart display the annualized gains based on each zone (Overvalued, Fairly Valued – blue line in the middle zone, or Undervalued).”Please take note of the following text:
“The blue line in the lower section shows how much the orange line is above or below the long-term trend line. It is currently in the “Overvalued” zone. Lastly, the data boxes at the bottom of the chart display the annualized gains based on each zone (Overvalued, Fairly Valued – blue line in the middle zone, or Undervalued).”