Watching Yields, Soft Landing And Extending Bond Durations

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Rob Isbitts and Matthew Tuttle return to discuss monitoring yields and why Fitch downgrading U.S. debt from AAA to AA+ is not that big of a deal (1:00). AI rally, rate hikes and what other shoes might drop (3:00). Extending bond duration, taking on more credit risk at this point in the cycle (5:30). This is an abridged conversation from Seeking Alpha’s recent Investing Experts podcast.


Rob Isbitts: I’m Rob Isbitts, a Seeking Alpha contributor, under the profile Sungarden Investment Publishing, formerly Modern Income Investor.

I am joined again by my friend and industry colleague and veteran, Matthew Tuttle of Tuttle Capital Management. He is a fellow Seeking Alpha contributor, a highly experienced trader, and very much an ETF innovator.

We’re recording this on Wednesday about 12:30 P.M. It is August 2nd. So, last night, Fitch, one of the rating agencies, downgrading the U.S. debt from AAA to AA+. It may not seem like much, it may not be much. Wanted to get your initial impression, and then I really want to kind of hammer on this for a minute.

Matthew Tuttle: My initial impression is, it’s not much. I mean, as we sit here, the market is selling off a bit, but I think we’re at a spot after this recent run where it doesn’t take much for people to start taking profits.

The thing I’m monitoring is, I am monitoring yields. So, the 10-year is back over 4%. That has not typically been a good spot for stocks, but the past couple of times we’ve gotten at that level, we’ve come down real quick.

So, that’s what I’m watching more than anything, if this does bring yields over 4% and keep them over 4%, then I may change my mind. But for now, I think, we’ll go above 4%, we’ll look around for a while, and then we’ll come back down, and this will be much ado about nothing.

RI: The narrative is that the Fed is going to get this right, we’re not going to have a recession or if it is, we’re barely going to notice it, et cetera, et cetera. What do you think?

MT: Yeah. So you look at all the data, it’s all pointing to a soft landing. The Fed heads are all talking about a soft landing and the market is hoping for a soft landing. I’m not a huge fan of the Fed either. I think that they were the ones who caused this mess. They didn’t see it when they called the transitory. And I think they’re making up the solution as they go along.

I think if we do have a soft landing, it’s not, wow, look at how Jerome Powell handled this and he created a soft landing. I think they could lock their way into it. I don’t think that’s going to happen. I think whenever you raise rates from 0% to 5% in a very short period of time, you’re going to have dislocations and those dislocations are going to come out of that field like a bunch of regional banks going under all of the sudden.

Yeah, I think you’re going to have some other stuff. And certainly, if the 10-year stays above four and maybe keeps going up from here, you’re going to have some issues. You’re going to have some issues in the economy when this filters into mortgage rates, it filters into small business lending. There are a whole bunch of other shoes to drop that we haven’t seen yet.

But certainly, you see this rally, a lot of it obviously is AI and happened after NVIDIA (NVDA) earnings, but a lot of this last latest leg has been people kind of assuming, all right soft landing and the Fed is going to bring rates down very, very quickly. And if that happens great; if it doesn’t, watch out.

RI: That is, as one of my industry colleagues like to say, a real tour de force on what is going on right now. And you’re right. It is an issue right now where we don’t know what other shoes are going to drop because that’s the way these things work, right? Historically, you raise rates a few times. It could take a year, year-and-a-half before you really see it roll through the economy. And now you’re talking about 11, 12 rate hikes.

So, I heard a prominent industry voice, won’t say who, who seemed to be goosing what I would call a financial advisor audience about, oh, you should be extending bond duration. You should be taking on more credit risk.

Does that, like at this point, and I mean even before the announcement yesterday by Fitch and anything that may or may not turn into, because ultimately, this stuff all ends up coming down to yes, there’s a fundamental underpinning but then it’s the emotions that take over.

So, to me, when you have, let’s say, somebody preaching the idea of extending bond duration, taking on more credit risk at this point in the cycle with all the risks that we see, does that not say product sale to you? Or does it make sense?

MT: Yeah. So it says two things. It says product sale and it says, I don’t know what the heck I’m talking about and maybe a combination of both. If I can buy T-bills and get 5%, no, I’m not going to extend my duration. I’m not going to add credit risk. I’m going to have T-bills and then I’m going to trade equities around those T-bills.

To me, that makes a whole heck of a lot more sense. Towards the end of last year coming into this year, we were buying preferreds because I thought you had a better risk reward on preferreds than you did on commons, but, haven’t been doing that in a long time because commons have been doing well here.

And yeah, I mean, with T-bills where they are, if you’re talking about extending duration, if you’re talking about the two year, okay, I’d do that. But I’m not going to buy like 30-year treasuries for anything other than a trade. And I am buying them this morning because I think there might pop off some of these lows, but that’s a trade that’s not, I’m going to hold on to these for a while.

RI: Guess what the credit card interest rate has now risen to?

MT: I don’t know, tell me.

RI: 22%

MT: Coincidence, maybe not.

RI: Yes, right. Can you believe that, okay? So, there’s a lot of comeuppance here and we haven’t even talked about corporate bonds, but boy, I mean there are a lot of corporate bonds going to mature next year. And I was looking at this. At the end of 2020, the average BBB rating was 2% and the average BB rating was 3.3%.

Well, about three years later, that BBB average rate has gone from 2% to 5.8% and the BB, which is in the junk category, BBB barely considered investment grade. That BBB, which was 3.3%, it’s more than double to 6.8%.

Translation, interest costs have more than doubled, inflation is eroding profit margins. Tell me how this ends well, but for all but the most stable businesses/stocks and I’m not even talking about what you pay for them in terms of valuation.

I’m trying to find a bullish case beyond ‘it’s going up because it’s going up in the stock market’, which is why the bond market, as we’ll discuss in a few minutes, actually looks more interesting to me even from a tactical standpoint.

MT: So yeah, and I can’t explain how it ends well, which is why I don’t think we’re going to get a soft landing. But again, I’m not a permabear, I’m not a permabull. I trade based on what I see. And if the market is ramping things up under the idea that we’re going to have a soft landing, Fed’s going to start cutting rates soon.

So, all of that stuff you mentioned is going to come back down, and AI is going to change everything. Then we’ll participate with my head on the swivel and be looking for whatever opportunities I can to add that to the short side if needed. So far, hasn’t been needed lately.

RI: We are speaking from a very similar book. I can tell you that. And by the way, would that be the exact same swivel model that you were using, earlier this year or late last year when you were buying those preferreds because you probably were buying with your left hand, but your right hand was on the sell.

MT: Yes. I mean, we were looking to get equity exposure through preferreds, figuring that that was a better way to do it while tactically doing a lot of shorting, shorting regional banks, shorting commercial REITs. We had a lot of fun with that and I keep watching for more opportunities. I did short a regional bank today. We’ll see how that goes. It is fun to try to dip back into that trade a little bit, but we’ll see.

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