(This is our daily morning note for Friday, November 4. A letter like this goes out 4 days a week)
The non-farm payrolls report sparked a spark in the markets with the Dow up more than 600 points. He has since relinquished all of those earnings. It looks like the markets have changed their conclusion on what the jobs report will bring from the Fed next month.
October’s nonfarm payrolls report left investors divided, fueling some concerns that the Fed will persist with its hike as the labor market added 261,000 jobs. Others interpreted the results as a sign that the labor market is starting to cool – albeit at a slow pace – as the unemployment rate rose to 3.7%.
In other news, rates are rising in the short term while the long term is fairly stable but again close to its 52-week high. Commodities are stronger with a weaker dollar. Terminal rate expectations are now at 5.13% as the stronger jobs report means the Fed will have to do more to inflict more pain to see the labor market turn around.
Yesterday, stock markets ended lower again, after Wednesday’s selloff amid disappointing comments from the Fed. The Fed raised rates by the expected 75 basis points, but reported rates could stay higher for longer to fight inflation. Growth stocks underperformed, which has become a trend this year with rising key rates. Treasury yields were also on the move, with the 2-year reaching a level not seen since 2007 and the 10-year trading around 4.2%.
The Fed did pivot, but not in the direction investors were expecting. At this point, it is quite evident that the Fed will go ABOVE the terminal rate implied by the markets of 5.13%. Thus, we will reiterate that now is not the time to stick your head out and be too risky or add more to your risk assets. If anything, I would reduce the risk.
Today’s surge in 2-year Treasury yields is due to the Fed Chairman’s press conference yesterday, where Powell explicitly stated that the FOMC was revising up its view of where federal funds would eventually peak. He did not offer advice on peak rates, however, so markets are on their own at least until policymakers act on that. The history above is a guide, and it indicates that 5.0-5.5% is a reasonable level to note. All that seems certain is that until 2-year yields stabilize, equities will remain under pressure…
Even owning short-term bond funds as a cash substitute means losses. MINT, for example, is down more than 2%. While that doesn’t seem like much in the face of around 40% losses on the Nasdaq, that’s not what one wants to see when it comes to their “cash”.
The question is, where are you “hiding?” If you are losing money in cash proxies like MINT, NEAR, GSY, JSPT and others as 2yrs rise towards that likely terminal rate of 5.5%, then why invest in them here?
Because of this, money has been drained from ultra-short duration funds, taking cash with it. In fact, nearly $2.5 billion came out of the $21 billion iShares Short Treasury Bond ETF (VHS) on Tuesday alone. It is the largest one-day exodus since the fund launched in 2007.
This could be the result of the latest rally in stocks as investors pull money out of ‘cash’ and shift to longer duration risk assets that have driven the S&P up 8% in recent weeks. .
The other thought is that investors are buying long-term debt like 10-year Treasury bills. The idea is that the Fed will rise more than originally thought and that a recession is more likely than ever.
Investors have a choice. Lock in those juicy yields today for several years and if rates rise, settle for unrealized losses at market price knowing that ultimately you are recouping par. Or you can go short, very short, in something like SHV above or a target iBond ETF that is 2024 or earlier.
We will discuss this in more depth in the coming weeks. For now, we continue to adopt a risk aversion strategy. Mike Wilson just said he sees the S&P 2,950 in the next few months. That’s another 20% downside from here.
Below is a new number that is hitting the market that looks interesting.
Wells Fargo & Co. (WFC) Rating spread over 5 years
Coupon increase schedule:
6.00% From 09/11/2022 to 13/11/2025
6.25% From 11/14/2025 to 11/13/2026
8.05% From 11/14/2026 to 11/14/2027
Maturity: 14/11/2027 – Year Maturity
Call info: 5/24 @ 100 – No call 6 months
Transaction date: 09/11/2022
Or you can venture into some of those high-quality favorites that are way below par right now. The chance of being called is basically nil right now. But either way, you could see strong appreciation if rates go down.
For example, you should check:
- RiverNorth/DoubleLine Strategic Opp (OPP-B), yield 6.74%
- RiverNorth Opp (RIV-A), yield 6.82%
- Schwab Series D (SCHW-D), yield 6.43%
- JP Morgan Series K (JPM-K), yield 6.35%
- Wells Fargo Z Series (WFC-Z), Yield 6.70%
- Capital One Series J (COP-J), Yield 7.05%
These issues could be a good replacement for those who don’t want to own individual bond issues (like the one I posted below). The big difference being that these don’t have an expiry date which gives them that pull-to-par (price converges with par as the expiry date approaches) which is a huge advantage in this market.
Or investors can combine their current bond holdings by adding some of these positions to their portfolio to diversify and lock in some returns without the possibility of a call anytime soon.
Finally, check out JCE, a fund we called a ridiculously high price a few days ago.
Have a good week!