Given that everyone is focused on the increasing geo-political tensions, I want to take a moment to talk about something else.
The Economist magazine recently ran a cover story about the mysteriously under performing US economy.
They outlined the usual host of reasons why growth has been so anemic this recovery. I am not going to bother going through them – you have already heard them all.
But I do want to take a moment to point out that these sorts of articles don’t happen when trends are just starting. These sorts of cover story articles happen at the end of trends. Just because the Economist is a quality magazine does not make their cover story hit rate any better than other more popular magazines. No one will ever forget their “Drowning in Oil” cover story right at the bottom of the oil market.
There is no doubt that the recent American recovery has been sub-par when compared to other recoveries. There are many reasons for this, but I believe that one of the biggest factors has been a lack of confidence amongst the American public. The 2008 credit crisis really spooked a lot of Americans. The pain has been too vivid in their minds to easily forget. This is one of the main factors that has caused the rebounding growth to be tepid.
But as sure as day follows night, this pain is gradually being forgotten. The American economy is poised to take off – especially when you compare it to other large global economies.
This sort of pessimistic cover article is exactly the sort of story you would expect to see right before the trend changes.
My prediction: the US economy will lead the world economy in outperformance versus expectations in the next couple of years. I will take the other side of the Economist cover story bet.
Now don’t confuse an outperforming economy with a rising stock or bond market. I think that US financial assets are priced at ridiculously optimistic levels that are destined to disappoint.
But in terms of the actual economy – everyone (including the Economist) is selling the Americans short. I am willing to fade that consensus.
High yield stampede
The stampede out of high yield seems to be accelerating. We have spoken about the crazily stupid tight spread levels in the past, but it seems to be that investors are finally getting the message. The selling this week has picked up to a pace last seen during the “taper tantrum.”
I am not sure how long this selling will continue, but don’t be a hero and try to buy the dip. Even with the backup in spreads, high yield debt is still priced at absurdly low yield levels.
As corporate America continues their arbitrage of leveraging up company balance sheets by issuing cheap debt and buying back their stock, the supply of high yield paper will continue to expand. This trend is not going to reverse just because spreads have widened by 100 basis points. And as the supply from new issuance weighs on the market, the existing high yield long investors are going to get more nervous. Once the geo-political problems settle down, the focus will return to the Fed’s move off ZIRP. If I am correct about the US economy picking up steam, then fixed income of all flavours will be on offer in the coming months.
The prospects for high yield debt are not appealing. Although I am bearish on equities, I am probably even more bearish on high yield debt. There is so little upside, with the potential that the recent selling cascades into a real rout. Don’t try to catch this falling knife!