Carty Capital Management
Carty Capital Management



Quite a Shift

Good Morning,


In a matter of days, fears have erupted and become totally focused on inflation. 


Mind you, we have lived in a world of highly deflationary pressures for years.  The fact that rates have "suddenly" begun to rise have been used as an excuse to claim that the inflation monster is back. 


It isn't - and this worry too shall pass. 


Let's review for a second.  I did a video a couple weeks ago and sent it out for your review.  It covered the bond market - from a 1-year, 5-year and 30-year perspective.  I have provided that link again here for your review in case you missed it. 


Remember - the password is:  BondReview0118


A Few Other Items May Help


Sometimes, when all around you seems to have gone on tilt - and the news is trying desperately to catch up with events, often after the fact, it is helpful to step back and view the big picture.


Some of Scott's charts can help us do that now:



The first chart above shows the nominal and real yields on 5-yr Treasuries - and most important, the difference between the two.  The difference denotes the market's expected annual rate of inflation over the next 5 years.


Inflation expectations are well-anchored at just slightly above 2%. It's tough to conclude from this that the market is concerned about either too much or too little inflation. Current inflation expectations are very much in line with what we have seen in recent decades - at least going back to the late 90's.


The second chart does the same thing for you - just on a 10-year basis.  Again, the same can be seen - with current expectations very much in line with past experience.  Indeed, on a 10-year basis the green line shows that since 1996, we are at best - sitting at about mid-range.  Not too hot - not too cold (deflationary).


Yet Another Perspective?


This third chart provides you another piece of insight - from a different angle.   


Here the data compares the real yield on 5-yr TIPS with the inflation-adjusted Fed Funds rate. The blue line is the overnight real short-term interest rate, while the red line is the market's expectation for what the blue line will average over the next 5 years.


Remember - the Fed follows the bond market - not the other way around.  As such, this further tells us that the market currently expects only a modest amount of "tightening" from the Fed in coming years.


Once again - key note:  The slope of the real yield curve today is positive; if it were negative, that would be a sign that the market thinks the Fed has tightened too much and will need to lower rates in the future. 


Someday that may happen again - but that is not anywhere close to where we are now.


Best for Last?


So what is everyone really worried about deep in their hearts - other than the repeat of 2008-2009? 


Yes, recession.


There are clear clues we can follow to see if we are close to those risks. 


This chart above is that clue:  it shows the classic way to see whether the economy is at risk of recession.


Recessions have always been preceded by a substantial increase in real short-term interest rates (blue line) - along with a flat or negatively-sloped yield curve (red line).


As you can see - today, we are not even close to the conditions that would suggest a near-term risk of recession.


Said another way?  While the talking heads will chatter til their faces turn blue, this data suggests the Fed is not even remotely too tight, nor is it expected to be any time in the foreseeable future.  Be assured the bonds will tell you first.


Long forgotten, it is important to remember that excess bank reserves are still abundant (about $2 trillion) - and cash on hand for consumer is neat $11 Trillion.


Past recessions were triggered by very tight Fed policy, when the Fed drained bank reserves and squeezed liquidity in order to boost short-term interest rates. Today, the Fed can tighten by either draining reserves (but it might take a long time to create a scarcity), and/or directly raising short-term interest rates.


Here is the key:  to date they have done neither in a way that might be considered a threat to financial stability. They have merely nudged rates higher in response to a healthier economy - and the fact that the bubble in fear - at least for a moment, let a little air out.


Closing with Good News...


Many will call this a negative - but the ISM Services Employment Index has hit record highs.  This should provide some confidence in that it shows the all-important service sector is expecting to increase hiring significantly in coming months. This is consistent with surveys of consumer and small business confidence, all of which are showing a big improvement over the past year.


In Closing


As noted for you, with the latest bout of panic hitting markets, the one-year forward P/E ratio is now only 15.2, only slightly above its long-term average.


Trailing 12-month earnings are up almost 14% as of the latest reports - and forward is on a 20% clip thanks to the sharply lower corporate tax rates.  It can be stated that stocks are no longer cheap, but neither are they egregiously overvalued.


So, in the end - one is left with a simple set of thoughts that we must focus on logically as we have seen it all before.  Same song - new verse:


Do I go with the earnings evidence, the fundamental readings, the packed jobs markets, the record incomes, the $11 Trillion still in the bank? ....or


Do I go with the dumb-ass morons who have once again created something that really does nothing in the end but cause strife, fear, stress, short-term disconnects from reality and more fees - having nothing at all to do with investment values?


Something worthy of pondering I suspect.  


The prayed for correction is here.


This will sound completely nutty - but be grateful for it.


Demogronomics keeps you on the leading edge of change but there is a cost:  it requires a much larger, more patient and disciplined view of the elements at work.


It's the long-term currents we need to invest upon - not the short-term waves which will assuredly always roll ashore to block the horizon - just as they are now, causing doubt in the minds of millions once again. 


Those waves are the noise too many will likely continue to be lost in...and the reason the long-term game is so hard to win based on fearful activities.  


Play it Again Sam....


In the end, like it or not, long-term investors have learned this: 


Demographics Rule The Long-Term Game


Until we see you again - may your journey be grand and your legacy significant.


InvestingMike Williams