Friday, March 6, 2020

What Is Freaking Me out Right Now

Other than the collapse of the energy markets? Which is killing my energy portfolio -- but I have to think long term. But interest rates have a bad omen about them.

A year ago, the 10-year Treasury yield was 2.6%. Today, it's continued its plunge -- falling off a cliff -- to .73%, as I write this. That is after a low this morning of .67%.

Of course the Fed didn't help, by cutting the Fed rate by .5% last week. Stupid idea. There is nothing wrong with the economy -- recent market activity is all psychological, not fundamental -- and they are not keeping their powder dry in case of a real weakness in the economy.

This has all the hallmarks of a bubble or "buying panic." Either we are going permanently lower in rates -- joining the "zombie" financial systems of Japan and Europe -- or we unwind a la the "taper tantrums" of the past and rates shoot higher, which could also now destabilize the financial system because everyone is positioned the other way.

Either zero/negative rates, which would destroy the banking system, savers, and older Americans whose medical inflation is way outpacing their income gains; or, rates rip higher. In that case, a repeat of the 1994 bond market blowup that ultimately bankrupted Orange County, Calif., comes to mind. Keep in mind, inflation from supply shortages is possible this year, and wages were still growing 3% as of this morning's jobs report. That could easily become a catalyst for a bond market selloff.

Cities are already struggling to balance their books, despite the decade-long expansion. One of their biggest obligations is paying the pensions of past and present workers. Let's say a town has $50 million owed in 2030. Well, it needs a lot more money today to hit that future target because there's no return left in "safe" fixed income products. What is the town supposed to do, invest in stocks? That's not actuarily sound, obviously. So they need to put more money aside today for pensions out of a fixed budget. That means less going to the rest of the services they need to provide: schools, roads, policing, trash pickup, etc. They can either cut back those services or raise the cost of them. Or, they can raise taxes generally to bring in more income. Not good for you and me either way.

The same principle, applied to companies that still have big pensions, means more of their earnings have to go to pensions and less is available to reinvest in the business, pay current salaries, etc. AT&T, GM, Ford, and General Electric were highlighted by Barron's last year for owing in pensions almost as much as their combined market cap. Airlines including Delta and American already had less than 70% of their pensions funded. I cannot imagine what will happen now that rates have absolutely cratered. Although it will certainly favor newer tech companies with 401(k) plans instead of pensions, as if they needed it.

And the housing market really doesn't need lower rates. Now you have the risk of, yes, sparking another housing bubble. Because lower rates mean higher prices, and people love to chase higher prices, and they'll all want to jump into real estate because you can't get a return anywhere else. We just told my younger sister to tell us where to buy in her local market, Denver. Who knows if we'd actually pull the trigger, but does the Fed really want to encourage us to compete against local homebuyers?

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