February 9, 2022 | Treasury Bonds Outperform During Falling Growth and Inflation

U.S. consumer credit expanded $18.9 billion in January while retail sales slid 1.9%.
As in December, consumers are borrowing to cover basic needs and make ends meet as their interest costs are rising.  No wonder U.S. consumer sentiment is at a decade low.

As stocks continue through a much-deserved bear market, corporate bonds are, as usual, dropping along for the ride.  As bond prices fall, yields on the riskiest CCC issues have risen 33% since July (from 6.6 to 8.8%), while BB issue yields are up 51% (3.1 to 4.7%).  We expect yields to widen further as default and liquidity risk are priced back into corporate security prices.

At the start of tightening cycles, it is typical for liquidity to drain out of all asset classes.  But as the economic slowdown picks up steam and available cash contracts, default risk becomes the dominant concern.  That is when government bonds become the most attractive asset class on offer, and safety-seeking inflows drive up their prices as everything else drops.

I explain this stuff all the time.  Sometimes, it’s nice to see others take a stab.  Lance makes a solid effort in the clip below.  Here is a direct video link.

PIMCO co-founder, Bill Gross, explained these dynamics well in his January 28, 2008 market letter as follows:

“…early is a portfolio manager’s best maxim. In this case it has nothing to do with birds getting the worm or being the first runner out of the starting blocks, but more about being positioned when markets move into crisis mode. Risk assets in a highly levered, finance­ based global economy can move so quickly to the downside that by the time you hear the birds chirping or see the starter’s gun smoking the race may be already half over. Admittedly, there’s a price to be paid for sitting out the frenetic last thrust of any bull market. In stocks, it comes in the form of being labelled old ­fashioned or out of touch…In bonds, it shows up as lost carry when yield spreads compress, and high-quality government bonds are shunned for derivative structures offering double-digit levered rewards. But when risk markets perceive a change in the wind—a turn in profits, a potential recession, and most importantly as was the case in mid­ 2007, an implosion in the pyramid scheme, chain letter driven structure of modern finance—then you’d better be already positioned. Exit doors lock automatically as illiquidity and the psychological frailty of the human mind prevents quick action in order to preserve capital.”

Danielle Park February 9th, 2022

Posted In: Juggling Dynamite

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