Heyer Capital, LLC

investment management and timely advice from a local CPA (Fox Valley, Wisc.)

Recession watch

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When dealing with economic systems built on the shifting sands of fiat money and bubble credit, recessions are necessary to wring out the excesses of the previous growth period. It’s always disconcerting to watch friends and neighbors lose their jobs as businesses re-shuffle, or have businesses suspend growth plans as credit contracts and lenders pull in their risk profile, and trading partners reassess plans themselves.

The trouble we currently face is that the greater and longer the boom, the harder the subsequent bust. Throw in the fact that governments always exacerbate the effects of the recession by a) not realizing we’re heading toward one, b) denying it when we’re in one, c) sweet-talking away the severity of it, and d) by the time the economy is actually out of recession and recovering they will start passing economic ‘aid’ packages creating further distortions.

Mike Shedlock (Mish) runs a great global econ blog, and his latest posts on recession indicators are worth the time to read (if you’re into econ.) The short answer is that there are about a dozen indicators the indicate we are currently in recession. Does it feel like one yet? How will we know for sure? When they lead the evening news with politicians denying it.

What does this mean for investors? Wait and see. The market will dictate our actions, not the history books.

I will tell you this. When we’re in the depths of the recession, junk bonds will crater in price as defaults rise and market shuns them. When things look their worst, the credit spread between junk bonds and the treasury will widen dramatically to where many junks bonds are yielding 10%(+) more than U.S. Treasuries. Friends, that what fear smells like in the market. At that point, I plan to start buying junk bond funds. (I’ll use funds to distribute risk against any individual issues.) The likely result: as the market returns to normal, the market price of the bond portfolio improves and I get a juicy yield to wait. Hold at least one year. Rinse. Repeat. (Hat tip to GPE for showing me the idea during the last recession.)

Right now that difference in yield (spread) between the junk credits and Treasuries is very narrow, recently reaching the lowest point in a decade. There is just a lot of money chasing yield right now, and it’s not (yet) scared away by default risk. Things always look great at the top. Unless you like riding through big declines in market price and suffering defaults, avoid junk debt until risk is adequately priced in.

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Written by heyercapital

March 31, 2007 at 11:59 am

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