December 20, 2018

We Are All Interest Rate Traders Now

I haven’t pitched my podcast in a while. Go here to listen to my friend Jimmy Yahnis who talks about the beer distributor business, and go here to listen to my friend Brendan Ahern talk about what it is like to run an ETF issuer.

You can also check out the music from my latest party here.

Let’s Begin

I have said this before: the 30-year fixed rate mortgage is the greatest financial innovation of the 20th century. Perhaps of all time.

Problem is, the 1/1 adjustable rate mortgage is probably going to be the financial innovation of 2019.

For the last five years (or more), you would have been called stupid if you even thought about getting an adjustable rate mortgage. No surprise—we were in a rising rate environment.

What about now?

You may have heard some of the chatter about monetary policy this week. Stan Druckenmiller and Kevin Warsh weighed in, saying that the Fed should decline to hike rates any further.

The Wall Street Journal editorial page also sounded off about rates. And of course, Donald Trump said that the Fed should ignore the reams of economic data it is given to analyze and instead, “feel the market.” Which, in spite of being a violation of Fed independence, is not a terrible idea. The market does feel awful.

If we are not yet done hiking interest rates, we probably will be done soon. We’re reaching the end of the rate hiking cycle. The markets seem to be discounting a period of economic weakness. Nobody is really talking about it yet, but we may find ourselves in a rate cutting cycle.

I have been a vocal bond bull, mostly in The Daily Dirtnap. 10 year interest rates are down almost 50 basis points from the highs. I expect them to fall further.

People have spent the last few years trying to protect themselves from rising interest rates. Now, people should be thinking about how to get exposure to lower interest rates. Read on.

A Falling Interest Rate Environment

First off, falling interest rates are no fun for savers. At times, I have been an income investor. This makes things harder.

But it sure is fun on the way down. And yes, it is possible to have a great deal of fun with an adjustable rate mortgage. These aren’t exactly in fashion right now, but finance and fashion both rhyme.

At this particular point in time, I’d actually recommend a 1/1 ARM instead of a 5/1 ARM. Not super interested in hybrid ARMs right now. Think big. If this really turns into a big recession, the Fed might cut rates to zero, ten year yields might go below the all-time lows of about 1.4%, and mortgage rates might go well below 3%.

Even if you don’t think rates are going lower, you must agree that they aren’t going any higher. Not in this environment.

That sounds too good to be true, but it is very real—even though there isn’t a fixed income forecaster alive that is predicting ten year yields below 2%.

Also, I’ve been harping on about this for months, but three months ago would have been a terrific time to take your allocation to stocks from 100% down to something closer to 30%. Shoulda coulda woulda. We’re deep into correction territory and most people are still loaded up on stocks. If you were two-thirds bonds, you would be hanging tough and feeling pretty smug.

You’re probably seen that periodic table of asset class returns—bonds have not been inspiring for quite a while now. But if we get our recession—and if the Fed starts cutting rates—bonds will be the place to be. Of course, everyone was max bearish and limit short six months ago, but that is usually how it works.

Give It Time

Give it time. Before long, people will be talking about deflation again. They will have forgotten all about this inflation scare. Hard to feign concern about inflation when oil is trading in the 4 handle.

Interest rates are no different than anything else in the markets. When everyone believes the same thing, it usually turns out to be completely wrong. Take a look at this chart:

Above 3%, everyone believed that there would be inflation—and they were wrong.

Below 2%, everyone believed that there would be deflation—and they were wrong.

It’s like anything else: you want to trade extremes in sentiment.

Lots of people have been made to look very foolish with their interest rate forecasts.

Keep in mind that interest rates are negative in Europe and Japan. If they go into a recession with rates already negative, how do they ease monetary policy?

The mind boggles.

Shoulda Coulda Woulda?

Today, the Mauldin Economics Alpha Society reopens its doors for a short time, and given this exciting environment we find ourselves in, I think it’s something you should considering joining.

This reopening is a big deal if you love discussing investments, the economy, and big picture ideas.

When you join the Alpha Society, you get all subscription services published by Mauldin Economics now and in the future… for the lifetime of the service.

As fantastic as that is, it’s not even really the main reason you should join. It’s the interactive stuff that’s the most fun, and super useful.

For example, there are Alpha Society-only Quarterly Conference Calls, which give you more direct access to all of the editors. Last quarter, I sat down with Gavekal Research’s Louis Gave for a great conversation (you can still listen to it, once you join).

And today, the final Quarterly Conference Call of 2018 takes place. Alpha Society members will get to hear Ed D’Agostino host Mauldin Economics’ Patrick Cox and Dr. Michael Roizen, chief wellness officer of the Cleveland Clinic.

There are a bunch of other terrific reasons you should think about joining the Alpha Society today. You can see what they are right here.

Jared Dillian
Editor, The 10th Man

Share Your Thoughts on This Article

Was this email forwarded to you?
Click here to get your own free subscription to The 10th Man.

Use of this content, the Mauldin Economics website, and related sites and applications is provided under the Mauldin Economics Terms & Conditions of Use.

Unauthorized Disclosure Prohibited

The information provided in this publication is private, privileged, and confidential information, licensed for your sole individual use as a subscriber. Mauldin Economics reserves all rights to the content of this publication and related materials. Forwarding, copying, disseminating, or distributing this report in whole or in part, including substantial quotation of any portion the publication or any release of specific investment recommendations, is strictly prohibited.
Participation in such activity is grounds for immediate termination of all subscriptions of registered subscribers deemed to be involved at Mauldin Economics’ sole discretion, may violate the copyright laws of the United States, and may subject the violator to legal prosecution. Mauldin Economics reserves the right to monitor the use of this publication without disclosure by any electronic means it deems necessary and may change those means without notice at any time. If you have received this publication and are not the intended subscriber, please contact [email protected].

Disclaimers

The Mauldin Economics website, Thoughts from the Frontline, The Weekly Profit, The 10th Man, Connecting the Dots, Transformational Technology Digest, Over My Shoulder, Yield Shark, Transformational Technology Alert, Rational Bear, Street Freak, ETF 20/20, In the Money, and Mauldin Economics VIP are published by Mauldin Economics, LLC Information contained in such publications is obtained from sources believed to be reliable, but its accuracy cannot be guaranteed. The information contained in such publications is not intended to constitute individual investment advice and is not designed to meet your personal financial situation. The opinions expressed in such publications are those of the publisher and are subject to change without notice. The information in such publications may become outdated and there is no obligation to update any such information. You are advised to discuss with your financial advisers your investment options and whether any investment is suitable for your specific needs prior to making any investments.
John Mauldin, Mauldin Economics, LLC and other entities in which he has an interest, employees, officers, family, and associates may from time to time have positions in the securities or commodities covered in these publications or web site. Corporate policies are in effect that attempt to avoid potential conflicts of interest and resolve conflicts of interest that do arise in a timely fashion.
Mauldin Economics, LLC reserves the right to cancel any subscription at any time, and if it does so it will promptly refund to the subscriber the amount of the subscription payment previously received relating to the remaining subscription period. Cancellation of a subscription may result from any unauthorized use or reproduction or rebroadcast of any Mauldin Economics publication or website, any infringement or misappropriation of Mauldin Economics, LLC’s proprietary rights, or any other reason determined in the sole discretion of Mauldin Economics, LLC.

Affiliate Notice

© Copyright 2018 Mauldin Economics