Where's the Lemonade?
Your hard-earned capital is stored labor. It represents the virtues of hard work, thrift, and delayed gratification. It thus deserves to be honored today. Happy Labor Day! Unfortunately, your stored labor is being repressed and forced to work over-time.
The Lemon Economy
Washington’s policy response following COVID is not so radically new. It’s better described as a radical acceleration of the old policy – that is, the policy in place since the 2008 financial crisis. The Federal Reserve has pressed interest rates even lower. No longer content to keep just short-term rates low, it now aims to keep longer-term rates repressed as well. This is being done by expanding its purchases of US government and agency bonds (itself a radical departure in 2008) to now include municipal bonds, corporate bonds, and even fallen angels (a polite term for junk bonds). Last year, you could earn 1.70% on a one-year treasury bond. Today, you earn just 0.13% on that same bond. You won’t earn much more on higher-risk corporate bonds. For this, you can thank the Fed’s recent buying spree. It is a stealth tax on capital. As with 2008’s radical intervention, today’s is meant to be temporary. Long after the financial crisis, the Fed kept rates near zero. We suspect that today’s emergency COVID policies will ultimately be longer-lived than anyone in Washington will admit publicly. If that proves to be the case, we must prepare for an economy wherein downside risk is socialized (paid for by taxpayers and Fed printing), while upside profits remain privatized. In the 1974 Mark J. Green coined the phrase “lemon socialism” to describe this state of affairs. Our views of this lemon policy – whether it proves effective, or is fair, etc. – is a moot point. (No one from Washington called Fielder’s offices to solicit our feedback. Can you believe it?) We, like investors everywhere, simply need to adapt. These are the new rules of the game. We need to accept them and figure out how to navigate best that we can. The Fed’s intervention has repressed interest rates on most bonds and fixed income to the point that it no longer makes sense to buy them. Treasuries used to provide a risk-free return. Today we see long-term treasuries as offering return-free risk (as Jim Grant once quipped). That is, they expose us to far greater risk (namely inflation) than we are being paid in interest to compensate for that risk. The same holds true for most of the assets the Fed is now buying (repressing).
Where’s the Lemonade?
To find fixed income with attractive returns relative to risk, we must look in areas where the Fed is not actively propping up prices and repressing yields. To find "true" yields we have to identify securities where prices are still determined naturally by buyers and sellers (markets) rather than by technocrats. This means areas outside of government, municipal, and most corporate bonds. It also includes where banks cannot or will not loan money. For example, alternative lenders, such as investment funds and business development companies (BDCs), invest in or structure secured loans to private companies. There are also some high-dividend equities that we believe are compelling alternatives to bonds today. All of these alternatives involve more risk than treasuries, to be sure, but they pay us substantially higher yields -- yields that, in many cases, we judge attractive compensation for the risk. Any one of these alternatives may or may not be appropriate for you or any specific client. They are something that should be considered on a case-by-case basis, and only as one small component part to a broader portfolio allocation. For that reason, we plan to select and size these alternatives within the appropriate risk parameters for your specific portfolio. Our goal moving forward is to invest where the government is not actively distorting prices and repressing yields. Fielder will continue to identify and research these types of alternatives. We will be discussing with clients shortly how these alternatives can be implemented in their portfolios. Please, as always, let us know if you have any questions or would like to discuss your portfolio.
Happy Labor Day!
Frank Byrd, CFA, CFP® Steve Korn, CFA
PS: In case you've not yet seen it, we encourage you to watch the 6-minute video we shared two weeks ago. It provides more context on this subject. HERE is the link:
Fielder is an independent, fee-only adviser that provides asset management and family office services.
Disclaimer: While the information presented herein is believed to be accurate, Fielder Capital Group LLC (Fielder) makes no express warranty as to the completeness or accuracy, nor can it accept responsibility for errors appearing in the document. Fielder is under no obligation to notify you of any errors discovered later or of any subsequent changes in opinions. Nothing herein should be construed as a recommendation to buy or sell any of these securities. It should not be assumed that any of the securities, transactions, or holdings discussed will prove to be profitable in the future or that investment recommendations or decisions Fielder makes in the future will be profitable or will equal the investment performance of the securities discussed herein. Fielder or its employees may have an economic interest in securities mentioned herein.