Mike Larson is a senior analyst at Weiss Ratings and editor of the Safe Money Report.

Contact https://rthy.weissratings.com/high-yield-investing

Twitter @RealMikeLarson

INTERVIEW TRANSCRIPT (EDITED)

Albert Lu: I’m joined today, once again, by Mike Larson, senior analyst for Weiss Ratings and editor of the Safe Money Report. He joins me today from Palm Beach Gardens in Florida.

Mike, great to have you back on the Power & Market Report. How are you?

Mike Larson: I’m doing great, Albert. Glad to be here.

AL: Lots to talk about today. Some interesting things happening in the market regarding the S&P 500, technology, Apple, gold. Where do you want to start?

ML: Well, sure, I think one of the big themes you and I have talked about before was that the, what I call, boring stocks and the boring sectors of the market have really been the ones that have tended to do the best, and that’s not just a case when it comes to here today. Returns, for example, obviously, the year is not very old yet but, really, it’s been the trend that we’ve seen since the first quarter of 2018. By that I mean anything that’s more defensive — late economic cycle, has higher yields, has recession resistant business models, and so on. Those are the kinds of companies and kinds of sectors that have done very well.

The one exception would be technology — that’s done well also, but really when you dig behind that you see it’s things like your REIT stocks, utilities, consumer staples and so on that have been leading this market. Then, along with that, of course, has been what’s been happening in the precious metal sector, gold silver and precious metals miners. They’ve been coming on very strong of late. They’ve really been in renewed bull trend since 2018, and you add all that together and I think it signals that, again, this is a different kind of market that we have now versus what we had, really, from 2009 through 2018, early that year.  

AL: Since the last time we spoke, we’ve had a couple of shocks to the market. We have coronavirus, which is what everyone’s talking about now. But before that we had Iran and the conflict with the U.S., the counterstrike — the market has been able to shrug all of that off to a large extent. I can understand why if you, for instance, a utility stock, something like that, that would be able to shrug off what’s going on with China, supply chains and so forth, but to a large extent the rest of the market has been pretty robust.

Why do you think that’s the case and is this confidence misplaced?

ML: Sure. I think that investors have been trained over many years to expect that things will A) work out OK and B) if they don’t work out OK, we’ll get some kind of program from the central banks, whether it’s new rate cuts, QE, things like that, that will smooth things over. Once you’ve been trained to expect that and see that a number of times, it’s only logical that [when] you get some negative headline, the market sells off for a brief period and then people say why not buy because, fill in you know, central bank X is going to do this or another central bank is going to initiate a new type of asset purchase, and that works for a while. It has worked, but I think, again, we’ve noticed that the kinds of things people have bought after …

So in the post Q1 2018 timeframe, it’s been this, whether there is a renewed QE, whether it’s been renewed rate cuts. For example, the U.S. Fed, in the second half of last year, rather than dogpile into the aggressive type sectors — the transports, the financials, those kinds of things that do well early in an economic cycle, which are what investors were doing before 2018 — investors have been reacting to this stimulus by buying the more defensive stuff. It’s subtle. You have [to] look behind what the S&P 500 is doing to see these types of things. You can see that the same type of stimulus measures is, actually, having a different result when it comes to what type of stocks are outperforming and which ones are underperforming.

AL: Or you could say that, in terms of the environment, the Federal Reserve has certainly been propping up those high-flying stocks. We haven’t seen the big adjustment that some people are looking for. In terms of the market looking past the news, that’s what markets do, right? They just look beyond they price. In whatever is going on, they look beyond that.  

I’m a little bit surprised, with how much uncertainty there is, that the market is willing to move forward. I’ve heard estimates on the impact to China, GDP being reduced from 4-5% to much lower, 1% or 2%, for the next quarter. There’s so much uncertainty that I’m surprised the market is as confident as it is still. It seems that the bottom line is what you said, and Leon Cooperman was on CNBC earlier today. He said the same thing; really, it’s the Fed that really matters because if you look at all these assets by many measures, they are overpriced until you look at interest rates and then they’re underpriced.  

What do you think about that, the Fed on the one hand [as a driving force upward] versus everything else that’s telling us to be careful?

ML: Look at the history of some of these epidemics. And look, I’m certainly no virus expert, I don’t have that kind of medical background, but I think Wall Street in general has seen things like SARS. They’ve seen things like swine flu and avian flu over the years. They know that tends to have a short-term impact — travel gets cut, retail sales drop. In this case, obviously, you have tens of millions of people that are on virtual lockdown in China, and so on. The economic impact is significant, but people know that, in the past, it hasn’t been very long lasting. They’re willing to look over that valley, that downturn, on the expectation that, once the main threat passes things will rebound. You’ll recapture those sales. Apple, for example, that warned about its earnings in sales will reopen its stores. People will buy the iPhones they didn’t buy. During the time the stores were shut and so on, so there’s that again.

There’s an inclination to look through things even if they don’t, as you mentioned … look at what’s happened in the past on multiple occasions in the last decade. Regardless of what the underlying threat is, whether it’s been things like a U.S. debt default, whether it’s been a slowdown here or a slowdown abroad, central banks have reacted by throwing money at the market. So while that hasn’t done much really at all — in terms of hitting their underlying inflation targets or getting growth [beyond] this muddle through 1-2% — it certainly has supported asset prices. It’s supported stocks, risky bonds and, we’ve talked before, you can see it in the commercial real estate market [and in] housing to some extent and so on. Assets have been propped up. People are willing to buy A) on the assumption it’s going to pass so to speak and B) on the assumption that if it doesn’t and it takes a little while, we’ll have that liquidity support for the asset markets in the meantime.

AL: Mike, I heard a gentleman on Bloomberg last week make an interesting point, and sort of the counterpoint to the point you just made, in that we have coronavirus now but China has experience with these things if you look back — SARS, for instance — and the economy has experience with these types of supply chain disruptions. However, his point was the last time China had a shock like this, it really wasn’t the manufacturing force that it is today, and if you want to look at a more reasonable comparison, you look at what happened in Japan with Fukushima and the supply chain disruption that that caused, especially when it came to semiconductors, memory and whatnot.

What do you think, if you look at it in this light? Do you think we could be underestimating the effect?

And the other point I’ll make, before you answer that question is, Apple came in and revised, or warned, but a lot of other S&P companies have reported and have really said almost nothing about this, which says to me that they don’t know and they’re not comfortable making a projection. If that’s the case, then why would we trust Apple’s forecasts on this?

ML: A couple of thoughts. When it comes to Apple, obviously they’re kind of throwing their best guess out there. It’s a company with operations all over the world, all over China. From both the supply chain perspective and a demand perspective, they’re getting pressured on both sides there. The factories are shut down, their employees are not able to work on their phones, and at the same time their retail stores and so on are shut, and nobody is shopping anyway because they’re kind of holed up. So Apple is one of these companies. It has a lot of exposure, but when you really look at the tech sector in general there’s a lot of other companies — whether it’s [a] supply chain sourcing situation or demand for their products, things like semiconductors and computer hardware and so on  — that are going to be impacted by this as well. There’s so much up in the air. You have to figure a lot of these executives are looking at the same news stories we are and trying to figure out, hey, is this going to be a thing for another week, month, quarter, who knows? That’s one side of this.  

­­­The other thing that I find important, though, you mentioned that other companies haven’t provided guidance, [is] you’re starting to see some companies — for example Walmart just recently or Target — that are domestically oriented, that get most of their demand or from the U.S. consumer seeing some weakness. Walmart had the worst sales growth since mid-2018, and if you look at some of the Fed’s data, on lending activity, for example, you’re seeing credit card delinquencies rise. You’re seeing auto loan delinquencies rise. You’re seeing demand for consumer financing and commercial financing start to slack, and it’s been going on for a few quarters now. It doesn’t look as bad, obviously, as things did in the depths of the last recession but, to me, it does look pre-recessionary.

In other words, what you’re seeing [with] coronavirus, and before that the trade and tariff headlines about China and so on, [is] the mainstream narrative is that that’s the only issue facing the economy, and previously if we could just solve the trade issue and now if we can just get past coronavirus, everything will be fine.

I’d argue that you’re seeing more evidence behind the scenes of a real cycle — turn in the credit markets, a turn in the economy that dates back to well before coronavirus. We’ve talked about the interest rate markets. For example, the yield curve had been flattening and inverting for basically 18 months through last year, long before anybody heard of this virus; and even [during] the rebound in the equity markets in the fall of 2019, the interest rates went up, but they got nowhere near their highs they had back in 2018 before some of these concerns surfaced.

So long story short I think there’s other things going on here other than the virus, and I think that people are going to start to appreciate that as time goes on.  

AL: Mike, that’s the point that Peter Schiff has made, that there are other reasons to sell and that the virus gave people that excuse. I believe that to some extent, however, we’re back to the Federal Reserve, right? I heard someone last week asked the same question, or similar question, and said, well, if the Fed said that they were going to increase interest rates, you know, 6% or so we’d be in a very different situation with regard to stocks.

I would counter that with, if the Fed said that they were going to raise by a quarter point at the end of this year, we’d be in a very different place when it comes to stocks.

So isn’t [the key factor] really going to be the Fed, and then if the Fed continues to be accommodative, then the calls for recession, or the fears of recession, are misplaced. Would you agree with me on that?

ML: Two thoughts here. First of all, when it comes to the overall markets, I haven’t been one of those who’s been saying for months and months you should short the stock market. I’ve been saying, if you have money in equities, and really, I’ve been saying this since the first quarter of 2018, it’s not sell everything, it’s raise cash number one, and number two get into those more defensive yield-oriented and pre-recession sectors — utilities, REITS or consumer staples. Buy that kind of stuff [and] sell financials. Sell transport [and] things that do better early in an economic cycle.  I think we’re still in that transition market.

I would also say as part of this, you want to be adding exposure to other things to do well at the end of an economic cycle — that’s things like gold, silver and precious metals miners. It’s no accident that they’re doing very well and have been for the last few quarters, because that’s what should be happening if the economy is slowing. I would also add can you talk about the S&P — it’s done fairly well.

If you go back two years and start the clock and, say, [look at] the two-year total returns to the S&P 500 for some of these different sector ETFs and then also for things like gold, Treasuries, extended duration Treasuries — there is an ETF called the EDV which just owns super long-term Treasury strips that’s outpacing the S&P 500 by about 8 percentage points in the last two years. So, essentially, if you own the most boring Treasury and longest-term Treasury bonds, you’ve made eight percentage points more than you’ve made in the S&P 500. If you’ve owned utilities, the average of the utility ETF XLU is up more than 50% in two years, beating the S&P by about 20 percentage points.

So this is the same kind of stuff you’ve seen in other transition markets. You saw it in 2000-2001, for example, and I think it’s telling you, as an investor, you’ve got to pay attention to this. You’ve got to adjust because of it.

AL: Mike, that is one of the things we saw and learned in 2019 — if you did pick wisely, you could almost match the 30% S&P return by buying more conservative stocks and other holdings such as the REITs you mentioned.

The question is, is that strategy going to work for 2020?

ML: Here’s my general thought, as long as the Fed is backed into a corner and is either going to keep rates the same or cut further later this year as the economy slows further, which is actually my base case — I would not be surprised in the least if the Fed cuts two or three more times this year to be honest — and I think that in that situation, where the economic news is going to get worse, where the Fed is going to likely have to cut further, and where foreign central banks are cutting — we see that other central banks are already cutting along with ours — it will cause investors to chase duration. They’re going to try and buy long-term bonds. They’re going [to] try and buy anything with yield that has lower risk — that’s a lot of these dividend-paying higher-grade, higher-rated stocks. I don’t think that trend changes absent some unexpected, significant pick up in the economy.

If that happens, then the Fed is going to have to go back to a hiking path. [If] that happens, long-term interest rates are going to go up, and many of these sectors are going to get hurt. But I just don’t see that happening because we have a very long economic expansion — longest bull market in history — and I think we’re just tired. We’re at the point where now the economy is slowing and that’s going to be a persistent trend, at least for the rest of this year and likely end of next year as well.

AL:  Mike, we have a fairly reactionary Fed. Something pretty bad would have to happen to justify going in and doing two, or even three, cuts this year.

Are you predicting that something bad is going to happen?

ML: I think there’s a high likelihood of a recession beginning this year here in the U.S., and I’ve been saying this since mid-2019. If you look at the traditional period, or lag time, from when the yield curve inverts to when you see recession start, it tends to be about a year. It does change. It’s different in every cycle, but it’s at least several months to anywhere as long as a year [or] year and a half. If you start the clock when the three-month, 10-year yield curve measure inverted, that was back in April for the first time, and then May consistently of 2019, that means the clock has been running for about eight months now. I think that it would not be shocking in the least to see the economic data continue to weaken. I think we’re seeing some evidence of it already, particularly on the business side. I mean you look at things like business investment, business spending, that’s down. The job market is not in bad shape by any stretch yet, but you are seeing job growth begin to slow. You’re seeing some sectors of the economy impacted there.

So you add it all up and I think that the ‘94-‘95 scenario, where the Fed cuts a few times, they engineer a soft landing, I don’t think that scenario is in play. It’s certainly not, in my view, and when you think about it, you look back at the Fed’s history, that was the one time the Fed really got it right. The other three times when the Fed started cutting it was because the economy was rolling over. That was in the late ‘80s, early ‘90s, again at the turn of the century and then again in the mid-2000s, when the housing market began to meltdown.

AL: Mike, we’re out of time so we’re going to have to leave it there. I’ve been speaking with Mike Larson, senior analyst for Weiss Ratings. Mike, thank you very much for coming on. Let’s do it again soon.

ML: Thank you. 

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