In Leiu of Yield, Risk.

In Leiu of Yield, Risk.

By Julien B. Booth

July 8, 2020

Good Wednesday:

I hope this note finds you well, and safe.

Communicating the currents running in the financial markets today remains challenging.  They can change daily.
There is a large element of inconvenient truth regarding our financial system that most investors do not want to consider, its inherent fragility.

The financial system has become quite brittle – and now solely dependent on the U.S. Federal Reserve.

When adding modern investor behavior (highly variable day-day), political+social strife, and re-surging Covid; we get some fantastic comments and inquiries!

Patience+understanding = wisdom.  Yet it is a virtue so few exercise (myself included).

On that note, there is a tendency to confuse liquidity (per the “new” $6,000,000,000,000+ that has been “created”) with solvency (i.e. company survival). $6 TRILLION is alot.
We are swimming in a sea of debt-based liquidity, but adding more debt rarely cures the underlying problem (of too much debt).

It’s somewhat akin to adding more booze to the punchbowl, after midnight, rarely does it end well.

Net, net, we have gone over the waterfall:

Below is a quick snapshot of 10 Year Government Bond Yields.
This is your ANNUAL yield for taking 10 years of time risk.

All income securities trade on a spread to these yields.  The spreads for US investment grade bonds is about +1.40% = 2.08% (gross return).

After fees/taxes/inflation (friction) you have a low probability of a positive return.  We do not like trades that are all risk, no return.

Given scant returns in fixed income, a deteriorating profile in credit, and stocks at Bubble levels, opportunities do not abound.  To us, capital preservation is the most prudent course.

Where does this financial reality leave investors?

A:  Settle for negative real returns in “safety”
B.  Scramble for remaining yield in lower rated junk bonds
C.  Buy riskier assets (stocks) @ historically high valuations going into a recession
D.  Do nothing (null option)

We have a simple 4-legged strategy:

1. Hold more cash;
2. Cling to structurally superior securities of corporate entities that can withstand this recession;
2. Own (debt free company with asymmetric profitability to Gold prices); and
3. Own several income securities from restructuring firms, Oaktree Capital, Brookfield et al.

These securities are not immune from price volatility, only cash fits that need at this point, but the durability of their cash flows is where we focus.

Longer duration, we have serious underlying concerns for the monetary system.  Quite simply, we are losing dollar purchasing power = stagflation.

Please note the performance of Gold vs. US Dollar (see attached charts).

For the time being the U.S. remains the cleanest, dirty shirt.

We remain focused on capital preservation and generating a real (after inflation) return.

Thank you for your interest in Forest Capital-BRC Wealth Management.