The House Of Pain

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by: Mark J. Grant

I don't care which sector you are in. I don't care which asset class is your priority. With the bare exception, lately, of Treasuries, we are in the House of Pain.

In the last 60 days the DJIA is down 8.7%. The QQQ, the largest of the ETFs representing the FAANG stocks, is down 13.0% and VGT, the largest of the high-tech ETFs is down 13.8%. The NYSE Fang Index is down 16.2%, during the same time period.

No pain, no palm; no thorns, no throne; no gall, no glory; no cross, no crown.

- William Penn

Well, the equity markets are getting "crowned" all right, but it is the "Crown of Creation" being smashed on your bleeding heads. I would say that the "Trump Bump" has waxed and now waned and that the "Tax Cut Jump" has fallen back to the floor and fizzled out. In normal times this would leave us with earnings and profits to stabilize the equity markets, but we are hardly in normal times.

Part of the problem, a large part of the problem, in my humble view, is the Fed. They keep calling for a return to "Normalcy" when there has been no such thing, in a decade. With the President and the Congress doing what they can to improve the economy, the Fed has taken the exact opposite course. By raising and raising rates they are doing nothing but slowing the economy down to a grinding halt. I am not saying that the Governors are idiots, but I am saying the their continually raising rates policy, is sheer idiocy.

Just when I thought you couldn't possibly be any dumber, you go and do something like this and totally redeem yourself!

- Dumb and Dumber

I say to the Fed, "STOP! Just STOP will you because you are endangering the economy, driving us towards recession and having a disastrous effect on the markets. There is no reason for you to do this except some academic theory and the financial health, of both people and institutions, is not a theoretical proposition. Come out of your ivy-covered walls and see what you are doing to both equities and bonds."

If the facts do not conform to the theory, then they must be disposed of.

- Maier's Law

If equities weren't bad enough, let's consider the bond market. Moody's Investors Service warned Friday that an unprecedented number of corporate credit ratings could tumble right out of the Investment Grade category and into the "High Yield" debt pile. I do not take this comment lightly, and neither should investors.

Moody's said the amount of U.S. corporate bonds outstanding, rated at its lowest investment-grade level of Baa, rose to a record $2.83 trillion in the third quarter, topping the $2.62 trillion in single A corporate bonds and the $629 billion in outstanding bonds rated Aa or higher. Within the Baa group, the dollar amount of bonds rated Baa3, Moody's lowest investment grade rating, ballooned by 140% from the fourth quarter of 2007 to a record $705 billion, in 2018's third quarter.

Here again, the Fed is not helping, as they are driving up borrowing costs for all of these companies, across the board. There is also a danger here to many insurance companies as their credit rating could be downgraded, if more of the bonds that they own are reclassified as "Junk." Here is another "doom-loop" scenario that is playing itself out as yields rise and now gap out, in many credits, versus Treasuries.

Baa3 grade corporate debt outstanding has now reached an "unprecedented" 56.8% of speculative-grade, or "junk," high-yield corporate bonds outstanding. By comparison, the ratio of outstanding Baa3 rated bonds to high-yield bonds was 32.5% before the 2008-2009 financial crisis, 36.9% before the 2001 recession and 22.2% before the 1990-1991 downturn. Startling figures, no doubt.

Moody's stated:

Thus, from the perspective of dollar amounts outstanding, the U.S. investment-grade corporate-bond market is now riskier than it was before each recession since 1981 and possibly all prior downturns through the late 1940s. Greater uncertainty surround the sustainability of corporate earnings growth has adversely affected the performance of medium- and lower-grade bonds. Not since September 2016 has the long-term Baa industrial spread remained above 200 basis points on a recurring basis.

High Yield bonds are also taking a beating. Junk bonds were hit hard recently, amid concerns over a potential surge in supply, as shrinking corporate earnings lead to a jump in High Yield downgrades. The spread over Treasuries of a composite speculative-grade bond yield jumped to 415 basis points on Nov. 14 from 371 basis points a week earlier.

Even Moody's concludes that,

At a minimum, the FOMC should take every precaution with its ongoing firming of monetary policy so as to not risk a slowdown by domestic expenditures that is capable of shrinking profits by enough to significantly boost corporate debt repayment problems.

Equities or debt. Watch yourself.

"It ain't pretty."