Time & Patience

Time & Patience

By Julien B. Booth, Davis Dawson

June 22, 2018

“The two most powerful warriors are patience and time.” – Leo Tolstoy

Post the election of Donald J. Trump we have been actively navigating the surge in growth expectations and a generally more business-friendly climate = extending a record-long economic growth cycle.

The Federal Reserve has (Fed policy, here we go again) entered the arena and aggressively begun raising short-term interest rates. Income/Bond managers are generally hated during these interest rate hiking cycles per the last 18+ months (see chart 1.0), as longer duration securities adjust to a new rate regime.

When you start at the 0% interest rate bound it is especially acute! Real-Time Example: The investment-grade bond index is down -4.90% year to date for 2018. Fortunately, a focus on shorter duration and floating securities has protected our performance thus far in 2018.

The benefit of age is the ability to be more patient in waiting for a longer duration thesis to be realized. We are approaching an underlying shift to our forward-looking (6+ months) economic expectations.

Per the attached presentation, we have attempted to decompose the underlying performance of the market signals that drive our forward-looking portfolio management process (growth, inflation, Fed policy).

As the economic stimulus of the new Tax Policy is fully digested we are beginning to see indicators of FUTURE trends that indicate a slower pace of growth and a more rewarding environment for traditional bond strategies.

Being in the weeds of trading makes patience and understanding of the time for this to develop a painful, yet truly educational experience.

The US economy is showing textbook signs of being in the late expansionary stage of the economic cycle – the final precursor to the recessionary stage. As an economy decelerates, it shows 4 characteristics, 3 of which are largely present in the current US economy:

(1) Rising inflation, (2) Central bank tightening, (3)Flattening/Inverted yield curve, and (4) Out-performance of equities & commodities.

Rising Inflation

Inflation has been on the rise for quite some time now & picked up speed in recent months. Currently at 2.8%, the US inflation rate is the highest it’s been since February of 2012 – a six-year high.

Central Bank Tightening

The Federal Reserve has been less than subtle with its shift towards contractionary monetary policy, effectively increasing interest rates and decreasing the money supply. The past 3 months have shown a substantial decline in money supply triggered by increased buying operations in government bonds by the Federal Reserve.

Flattening/Inverting Yield Curve

The spread (difference) between the 10 & 2 Year Treasury Bonds has been on the decline and readily approaches zero (& sub-zero) levels. This is a strong indicator that growth US economy is slowing and readily meets the criteria for an economy in the late expansionary stage.

As usual, thank you for investing with Forest Capital! For additional information on portfolio positioning, please contact Forest Capital directly at jbooth@forestcapital.net.