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  • Martin Sosnoff

Escalating Interest Rates... A Fly On The Wall



Nobody ever promised me a rose garden, but until 30-Year Treasuries pierce 3%, the market can flow on its course like Ol' Man River.

Current holders of long maturity Treasuries do need medical intervention, but BB bonds yielding near 5% look OK. An economy showing early foot puts away residual fears of default risk. Actually, play in high risk paper like US Steel and American Airlines which still bleeds profusely is rewarding. Months ago, American Airlines issued a 6 ½% convertible now trading at 140. I was there, Charlie, but not in spades.

Everyone who invests in financial assets by now should have implanted in his brain the history of interest rates during the postwar decades, dating back to the late 1940s. You'll be surprised by the volatility of yields and how price-earnings ratios for equities got crushed. I've seen all the financial panics dating back to President Kennedy's face-off with Roger Blough, headman of US Steel, over Blough's steel price bump . Believe me, anyone who managed money during the Cuban missile crisis had to make up his mind whether the Russians would arm their missiles in Cuba, aimed at our mainland. Castro pressed for a missile launch but Khrushchev said "Nyet".

A fake crisis like Black Monday in 1987 and the financial meltdown of 2008-09 were much easier to deal with. The press by Volcker in 1982, putting interest rates up to 15% to rid the country of its inflationary expectations was more harrowing, because the Federal reserve Board was your profound enemy that would destroy you along with Jimmy Hoffa. The Big Three automakers then raised prices on their cars 7% per annum, thus making the country uncompetitive with Volkswagen and Toyota. Chrysler later needed a Treasury bailout and in succeeding cycles, General Motors, too. I remember buying Chrysler's preferred stock at $5. Then in 2009, Bank of America's preferred likewise traded at 5 bucks until Warren Buffett loaned them billions. I wouldn't dream of buying a preferred stock at its par price of $25. Nearly all preferreds are from banks and sundry financials, callable at par so there's no possible price appreciation. What happens to stock prices in market panics seems a repeatable pattern. The S&P 500 Index retreats to book value sells at 10 times earnings and yields 5%. Then, you're supposed to step in and buy Mr. Market. As a frame of reference today, the market sells at 20 times earnings, about 2 times book value and yields around 2% at most. If a fully invested player who never sells, you are risking being schmeissed in half in equities and at least 20% in long term Treasuries which sell in a yield to maturity construct.

Inspecting long term charts on interest rates can be upsetting and scary because there's no regularity of price stability. Players in bonds panic just as readily as stock speculators, nearly an overnight phenomenon. The yield history in 10-Year Treasuries shows a range near 1% currently to as high as 15% under Volcker in 1982. My 50-year trendline would be at 5%. As for stocks, I'd draw the trendline at a price-earnings ratio of 15, but presently it's 20. The market's discount function is always working.

Everyone expects normalized earnings six months ahead. The volatile play in commodity cyclicals like Freeport-McMoRan has surprised even yours truly. Bought this baby in single digits, now it's trading in the thirties 9 months later. The most potent investment concept remains reflation. Bank stocks still playable if you see higher interest rates ahead. The overperformance of tech houses and internet plays these past 5 years may be history. Can somebody please tell me what US Steel, Alcoa, Freeport and Halliburton can earn next 24 months?

I keep repeating to myself: Reflation, reflation and more reflation. Play it!


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