The Turn is Coming

HFA Padded
Published on

“Davidson” submits:

The 10yr minus 3mo Treasury rate, called the Yield Curve, is moving higher at a rapid pace as investors adjust their inflation thinking to being more persistent in the 3%-4% range. At the moment, T-Bills priced at 5.25% remained roughly stable giving a Real rate of return of close to 2%. I expect this to hold for a while. The bigger story has been expectations for a significant rate decline on a weakening economy.

88% of portfolio managers in the Bank of America Fund Managers Survey last week believed lower rates were ahead. I saw strong evidence develop 2yrs ago of a hedged bet that managers may have shorted T-Bills and gone long on 5yr/10yr Treasuries to profit from expected rate declines. This appears to be reversing but it has a significant way to go. In my experience, we should see the 10yr Treasury rate move towards 7%+. With inflation at mid-3% range, portfolio managers have needed a Real rate of return closer to the long-run Real GDP closer to 3%. Often this included a premium. The calculation is simple:

3.5% inflation + 3% Real return + x% premium = 7% range

We began to head in that direction beginning July 2023 when the Yield Curve moved higher only to peak at -0.69% Oct 2023 when recession fears again arose and it slumped lower. In recent week we have fairly quickly risen to -0.77%. I believe we will rise above 0.00% in short order. Watching the response to core industrial’s earnings reports and guidance makes it clear that Eaton, EMCOR, Sterling Infrastructure, Transdigm, AZZ and other issues representing the industrial core of the US are strongly profitable and able to pass on inflation costs. Their prices are gaining from shifts in capital. Positive economic activity in the face of persistent inflation is the primary driver of the capital shift out of the 10yr Treasury rate and into industrials in my opinion.

I believe we are seeing a long awaited turn away from the single focus of high tech as the only option for investors.  I expect to see the “Mag 7” (as they have been titled the only investment option one should consider) to stall as capital commitments respond to the positive economics of core industrials.

Article by ToddSullivan, ValuePlays

HFA Padded

Todd Sullivan is a Massachusetts-based value investor and a General Partner in Rand Strategic Partners. He looks for investments he believes are selling for a discount to their intrinsic value given their current situation and future prospects. He holds them until that value is realized or the fundamentals change in a way that no longer support his thesis. His blog features his various ideas and commentary and he updates readers on their progress in a timely fashion. His commentary has been seen in the online versions of the Wall St. Journal, New York Times, CNN Money, Business Week, Crain’s NY, Kiplingers and other publications. He has also appeared on Fox Business News & Fox News and is a contributor. His commentary on Starbucks during 2008 was recently quoted by its Founder Howard Schultz in his recent book “Onward”. In 2011 he was asked to present an investment idea at Bill Ackman’s “Harbor Investment Conference”.