I never, ever expected to encounter a chart like this one: Two-year Treasuries which historically sell at a discount to 10-year paper currently sell at a yield premium of 80 basis points over their 10-year counterparts.
30 Years of Yield Spreads:
2-Year vs 10-year Treasuries
Tracement covers over a 30 year activity span with the spread on 10-year paper so negative. What’s going on? No world war, deep recession or galloping inflation brewing. Nobody cares to explain this yield disparity. Is it good or bad for the western world or about to reverse itself?
Reviewing previous cycles where 10-year yields were much below 2-year bonds, I looked into the setting around 2000, 2005-’09 and 2015-’20 when 10-year bonds sold at a big premium, at 2.5%. All I saw was the economy was in an expansive mode, not in deep recession.
But, today our vital signs still grow at a trendline of 3 to 4%. Inflation bubbles near 5% with Fed Funds matching inflation. Long term, average yield premium on 10-year Treasuries approximates 1%, but recently made a low of minus 1%.
Trendline spreads between 2 and 10-year Treasuries normally run at least 100 basis points positive for the 10-year paper. Currently, the yield spread is negative by 80 basis points. I can’t rationalize this condition except to conclude serious money smells recession around the corner and wants to position in longer term maturities, now.
Elsewhere, I’m restive with market valuation at 20 times projected earnings. Pundits exude bullishness on earnings and don’t expect our FRB to bump up Fed Funds above 5%.
And yet, I remember Lehman Brothers bought at $4 bucks in 2010 only to blow up in my face. Evenhanded, I also bought, Bank of America’s $25 par preferred stock then at $5 and watched it fight back up to 25 over a couple of years. Luck of the Irish.
As a young security analyst, early sixties, at E.F. Hutton, I was mentored by a soft-spoken Virginian, Dick Fant. “Martin, never believe more than half of what you hear, read and see. Don’t ever take notes while interviewing headmen. You’ll miss nuances in their voice.”
Best advice I ever got. Act like a professional poker player. Wall Street, early sixties, was still a white button-down shirt enclave, double-breasted suits, fedoras prevailed. Carl Icahn hadn’t as yet learned how to green-mail corporations, but George Soros shorted the British pound with impunity while they swore to hold fast.
One day, Dick Fant entered my office with a box of multicolored confetti to toss out the window when Nixon toured by on Broadway, but I refused, Kennedy was my man. Jack sported a deep tan which hid his jaundiced face tone. Fant had taught me how to stand alone and so I did. Months later, I apologized profusely as my gentle Virginian lay expiring from stomach cancer.
While decades roll by, I’ve accumulated hundreds of charts and tables on the economy and financial market activity, particularly comparative valuations and interest rate variances, year-over-year, decade-to-decade. Markets invariably tap out when faced with surging rates onTreasuries. This is missing today, but could reassert itself soon enough.
Pushing close to 20 times earnings, there’s no room for disappointments or unforeseen events. The Fed wants to be our friend so long as the country stays competitive. There’s no sign of a widening deficit in trade.
But, the sharply inverted yield curve between 2- year and 10-year Treasuries is disturbing because it suggests serious money reckons recession is coming, entailing the collapse in Treasury bond yields all along the spectrum. Any sign of recession sends yields much lower.
Such a weak setting for low grade credits could touch off a Black Monday response, where nobody cares to inventory or bid on anything, especially low grade credits. (I’m a buyer.)
Traders at Solly and Goldie on Black Monday dared not pick up their phones, afraid to bid on 100,000 share blocks. I don’t recall last time I’ve been as low as 35% long in equities, but I am there now. Normally, I’m 150% invested.
I own energy through my MLP’s. Microsoft and Apple get my money, but no other high flyers. Too tough to model their earnings power. Occidental Petroleum’s a cheap energy play. I don’t inventory banks or basic industrials. Two-year Treasuries still suck in my reserves. I’m foolishly consistent but wrong here.
My inventory of contemporary art saves me from crying myself asleep. If you’re early and right, returns on art exceed venture capital. I’m talking 200 to 1, even better. Early on, I dismissed Warhol, Basquiat, even Jeff Koons, but then I changed my mind.
Don’t cry for me.
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