One if by Land, Two if by Sea – Studying Signals

For those of you who would prefer to listen:

I was in Boston this week for a CEO Summit for the investment industry. Firms from across the country were represented with discussions ranging from the current state and outlook for the Market, to the midterms, the Economy and the Financial Services industry at large.

The meeting topics drilled down on the future of work, with a substantial debate about the value of in-office versus virtual activity. No surprise, beliefs are strong and broad on the subject. We also discussed the role that cryptocurrencies and the metaverse might play for generations to come. We even had a professor lecture on neuroscience and applications in the business world. We studied signals to better understand our audience. It was quite an event.

Succession and future leadership are an issue everywhere. The younger generation definitely thinks differently. Millennials, today’s 20-40-year-olds, are called Digital Natives. They were raised with technology and incorporate it in pretty much everything they do. Social engagement takes place digitally as much as it does in person; Perhaps more. It’s hard for the younger generation to imagine life without devices. American society has changed so much in just the last few decades. Innovation and evolution have always been the American way. Collaboration and working as a team will never become obsolete. It’s how it all started.

The city of Boston has a unique existence in our nation’s history. Leadership was born there. The revolution began there. The spirit remains there.

Boston natives Samuel Adams and John Hancock led the movement by forming the Sons of Liberty. Locals named Revere, Warren, Wilson and Henry joined the group. Many others followed. Meetings were held in a public houses or taverns. Momentum surged. You may recall they threw a rather large tea party to send a clear message to the British. They rebelled against taxation without representation. The Sons of Liberty saw a future beyond British subjugation. They rallied the people to commit to a cause bigger than any one of them. Adams and Hancock studied signals and knew their audience. The American spirit took off.

Paul Revere is best known for his historic midnight ride from Boston to Lexington and Concord. The colonies were on a collision course toward the Revolutionary War. Colonial intelligence uncovered a British plan to arrest Adams and Hancock and destroy the colonial ammunition. Revere jumped on a horse and rode from Boston through the countryside to let people know the British were coming, the British were coming. The midnight ride foiled the British plan.

In anticipation of a British attack, the Liberty boys drew up a plan. The Old North Church was the location of a famous signal. It was the tallest building in Boston back then. 2 lanterns were brought to the top. One lantern lit meant the British soldiers were marching on foot. Two lanterns lit meant they were coming by boat. You’ve heard it: “One if by land, two if by sea.” The signal was meant to alert patriots about the route the British troops chose to advance to Concord.

Studying signals is essential for sound leadership. Signals are everywhere for those who pay attention. We investors never have all the answers. That’s why it is so essential to study success and pay attention to signals. Same goes for running a business. The Market has been sending some loud, and at times confusing, signals all year. The Bond Market and the Dollar have been the undisputed leaders in 2022.

Enter the Bond Market. The Bond Market has acted like the Sons of Liberty this year. The term “Bond Vigilantes” was coined by seasoned investor Ed Yardeni decades ago, describing how it tends to sniff out problems and force solutions. Like those colonial Bostonians who had enough of British tactics and forced a different outcome, the Bond Market has been forcing the Fed, investors and even governments to wake up and re-think its course of action. It’s showing its effectiveness. I often quote James Carville who said the Bond Market can intimidate anyone. He’s absolutely right. It sure has this year.

The Market kept increasing expectations for more inflation this week. By Thursday, it was pricing in a 4.5% Fed Funds rate by year-end and 5% by next Spring before rate cuts later in the year. That has the Market thinking recession hits before Summer of 2023, forcing the Fed to reverse course. The US is technically in recession, having already experienced back-to-back quarters of negative GDP growth already this year. Recession has never occurred with the unemployment rate at historic lows. The debate of whether it’s actually a recession lives on. That’s where things stand today.

Higher yields mean lower prices in Bond Land. The rising yields have been driven by this stubborn inflation and the Fed’s relentless campaign for higher-for-longer interest rates. Treasury prices have seen their longest decline since 1984. That was back when Paul Volcker was the leader of the Fed, wrapping up his monumental fight against inflation.

The 10-year Treasury yield punched through 4.3% in early trading on Friday. It was the highest level since 2008. But it quickly reversed lower. A Wall Street Journal article broke, suggesting the Fed might slow the process of its rate hiking campaign after its November meeting. A pause is coming? A Fed pause is one of the most plausible Bull cases for the Market right now. A lot of damage has been done. It takes time for interest rates to filter through the system. A Fed pause would certainly be welcome news for investors. The author of the piece is considered a Fed whisperer. Perhaps the message was Paul Reveresque, call it the “Midday Write…”

Three centuries later, the British are back atop the headlines with challenges that impact Markets over seas and land. The Prime Minister, Liz Truss abruptly resigned. She was on the job just 45 days, marking the shortest tenure in British history. Truss had said just 24 hours earlier that she was “a fighter not a quitter.” Then she quit.

Truss saw her leadership flounder after introducing a plan that called for big spending to help with the surge in the cost of living while at the same time proposing a number of big tax cuts. She planned to borrow big to pay for the plan. The Bond Market did not like that plan one bit and let her have it. Yields spiked as prices declined, reflecting serious stress in the financial system in London. Chaos followed with the effect on pension funds and the mortgage market forcing the Bank of England to step in and buy long-dated debt to stop the bleed. The 30-year Bond, known as the Gilt, saw its yield jump over 5%. The British Pound approached parity with the Dollar, touching $1.03 for the first time ever.

Economic troubles continue to pile up in Great Britain as inflation batters the cost of living. Its Consumer Price Index soared over 10% in September, five times the Bank of England’s 2% target, with food, energy, transport and household goods all the biggest driving factors. The government has since reversed nearly all its proposed tax cuts, providing some relief. But the British challenges remain.

Whoever succeeds Truss will have to learn an important fiscal lesson. Political leaders are no longer able to promise growth by borrowing money without a plan to repay it. Those days are over. Governments no longer have the support of quantitative easing, as central banks tighten policy to stave off inflation. The price of money has jumped. It’s no longer free. There’s no such thing as free.

The Bond Market and the Dollar are the undisputed leaders today. They have set the tone all year and are dictating asset prices. Stocks had big gains thanks to the two-day bounce to start the week, followed by the big rally into the weekend. The S&P 500 successfully tested its 200-week moving average and the 50% retracement levels from the Covid lows around 3,600-3,500.

The Sons of Liberty of Finance, otherwise known as the Bond Vigilantes, are riding again. They are making it clear to all that basic fundamentals still matter and the Market will force anyone’s hand that behaves irresponsibly. Studying signals and anticipating outcomes is so important. The Fed just might pause next year, which would provide much-needed relief. It sure feels good to see green. But until the system is completely cleared from the excesses built up in the system and the undisciplined attitudes change, we see rallies with a Bearish tune. And we’ll gladly take it. We are well on this journey to a better place.

Have a nice weekend. We’ll be back, dark and early on Monday.


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