Good Afternoon,


I admit, it’s an ugly wake-up call.  Like that alarm clock you know is coming at 5:20 a.m. but you would much rather just sleep.  It was so much more fun hearing the financial pundits speak of another record high – even if they did so under the light of explaining how it should be impossible “given all the problems we have…”


Today’s action takes us back to price levels of almost a month ago – the morning of July 12th to be exact – all in one day.  Last week I hinted that we should remember “the string of records was not moving by a lot overall…”  I also hinted that it would only take a day or two of red ink to wash away any semblance of “record-setting excitement” in the crowd.


Sadly, we can be confident today did just that – but the crowd was already scared.


The latest AAII sentiment data from last evening show once again, that the bulls were culled.  Bullish sentiment fell again!  This on the back of all those new record highs last week – and before today’s red ink across the board:  read ’em and…smile if you are a long-term investor:

More Breadcrumbs….


Bullish readings are just 1/3 of the crowd?  You have seen the notes before on all of this sentiment stuff and it has remained the same – for 137 weeks now.  This has been a standing contrary signal that what is most feared is a setback – and not the missing of opportunity.


On a supporting front…


In case you may still be wondering if we are operating in a new world as it relates to the often referenced “economic uncertainty” and the various “perceptions of safety”, check this latest set of data points from the bond world:


Argentina, a serial defaulter, issued a 100-year bond in June that was four times oversubscribed.


Greece, whose government as recently as 2012 defaulted on €206B of its bonds, was able to access the bond market in July at an interest rate of 4.5%.


The government of heavily indebted Italy can borrow money in the market for 10 years at only 2%.


How does one logically choose any one of the above or, should I say, choose to stand in line for any one of the above?  I mean as a comparable against, say, an old-fashioned, boring group of household name stocks, around for decades and paying increasing dividends each year?


Well, let’s not mince words here:  You can’t – logically.


You can (only) if you start from a standing perspective of near-stark-raving-mad fear about the future economic uncertainty.


No matter how you slice it, fear remains paramount – showing up on any day of red ink.


Today is Perfect…


Let’s review a couple headlines streaming right now on major financial sites:


“As Fears over North Korea Mount, Stocks Crumble”


“Record Close Run Shattered as Stocks Tank”


“Tech Stocks Collapse as Fears Increase”


“Stocks Spiral Lower, gold climbs, as North Korea Tensions Weigh on Market”


And I would cap it off with this gem (I could go on for pages):

Now, for me anyway, I wonder aloud if they could have found a picture of Ray that looked more strained?


My, my, my – what damage a well-timed chart or photograph and headline can do to the psyche – and ultimately to the success – of any investor.  Were we all lucky enough to have the patience of the great ones, the world would be a wealthier place.  But heck, even then I suppose we would come up with new stuff to worry about.


Speaking of Worrying….


Bonds aren’t.  Here are a few charts first – and then supporting notes below:

Credit spreads are the extra amount of yield that investors demand to hold debt which is more risky than Treasuries.  The fact that they are uniformly low suggests that liquidity in the bond world is abundant (which explains people standing in line to overbid on bond offerings).  This further suggests that systemic risk is low.


It also hints that the outlook for corporate profits and the economy is healthy.


In the first chart above, Scott shows us the 2-yr swap spreads, arguably the bedrock and most important of all credit spreads are solid.  Just for your file, “Normal” spreads on two-year contracts are usually 20-40 bps. As can be seen above, today’s 25 bps shows that two-year swap spreads are perfectly normal.


This helps to tell you that Fed tightening has not created a shortage of money, as it usually does in advance of recessions.  Swap spreads have been effective predictors of conditions in the broader economy.  As such, they tend to rise in advance of recessions and decline in advance of recoveries.


In the second chart above, we see the corporate credit spreads as derived from the universe of bonds issued by US corporations: $6.3 trillion of investment grade bonds and $1.3 trillion of high-yield (junk) bonds.  Both channels show that spreads are relatively low, as one would expect them to be in a healthy, growing economy.  Of course, they are not at record lows, but still low enough to be impressive – and supportive for confidence.


Last but not least, the third chart compares two-year swap spreads to high-yield corporate spreads. With a little review, one sees as Scott puts it, “further evidence of how swap spreads tend to be good predictors of the health of the economy (HY spreads are particularly sensitive to the underlying health of the economy).”


Closing Thoughts…


Maybe “it” is here.  My email was surely active today with queries about “was this the start?”  Maybe North Korea was the “final straw” as so many constantly ponder when the next shoe will drop.  My hunch?


Well, as you might expect, it’s a little more positive than the headlines might suggest tonight.  The waves of fear reporting will roll through the audience as they hear repeatedly, “Market Tanks By Over 200 Points” (gasp).


Our take is kinda simple:


Fear makes things cheaper for long-term investors.


Fear makes the masses move out of growth markets and into “safe bonds” at 50 times earnings.


Fear can twist the mind such that poor perception appears wise.


North Korea, as Ken wisely puts it, is a China created event – it will pass even as tensions build.


In the meantime, bring on the fear, the swoon – and cheaper prices.


Relax friends.  This is early…in a very long game.


The “Barbell” dynamics moving through our economy are setting the stage for powerful decades of opportunity to come.  Not weeks or months.


North Korea won’t stop that….


That all noted and filed away, simple things count by a wide margin:  Patience always positions itself as the tougher requirement.


Even more so, as history shows, during the worst of the summer churn and haze.


Enjoy the beach and travel plans ahead.  Time with loved ones and friends is sacred – enjoy, be well and please travel safe!


Until we see you again, may your journey be grand and your legacy significant.