One Step Closer to Recession

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And so our year commences with a quick dive.

Stocks tanked on Monday on fears (yet again, though still misplaced) that China’s tumbling stock market portends an ill wind for the world. By the way, that’s wrong, but that’s a topic for another day.

I was looking elsewhere on Monday — namely at beautiful snow drifting down upon farmlands in western Virginia as I was driving back to Louisiana from a short stay in New York. I caught wind of the rout on Wall Street. I heard it was because of China. Seemed plausible; investors regularly wet themselves when they perceive bad news from China. The more likely villain was a recognition that, whoops, maybe Yellen and her henchmen were a tad premature in raising interest rates…

A key gauge of manufacturing in America — the so-called Institute of Supply Management (ISM) Index — fell for the sixth consecutive month in December. That inspires no confidence in where we’re headed. But it gets worse. For the last two months, the index has recorded a sub-50 showing, an indication of contraction and almost always the precursor to recession in America.

Which is what I’ve been saying: America’s economy was never healthy enough to support an interest-rate increase.

Which is why I say again now: The Fed’s next move will likely be to cut interest rates, not raise them.

Which means you might want to consider putting some interest-rate sensitive assets in your portfolio — something like the Nuveen Municipal Value Fund (NYSE: NUV).

I am still trying to figure out why the Federal Reserve raised rates.

Fed governors are not stupid people, so I have to assume they felt some kind of pressure to act. Pressure from Wall Street pros too antsy to wait any longer for the first rate hike after all these years and — no matter how ill-advised — irrationally pushed the Fed to act. Or pressure from the economy that the Fed knew was weakening, so the governors wanted at least one arrow in the quiver — the ability to cut rates — when the recession is official.

Probably, it’s a combination of both.

Signs Point to Recession

Whatever the real answer, the very same Wall Street that demanded a rate hike is now mulling the idea that maybe the Fed acted rashly. Wall Street is a very fickle place, and just like politicians, it never admits its role in subsequent failures. Always someone else is to blame.

Clear, though, are a few facts that determine our next stage in the American economy:

  • U.S. manufacturing is in a deep recession. Deep recessions in manufacturing almost invariably lead to a recession in the broader economy.
  • The U.S. dollar has continued to climb. The dollar index sat just below 97.60 on December 14, the day before the Fed began its two-day rate-hike meeting, and today it has topped 99.30. That’s a 1.7% move — seemingly small. But when you are an American exporter already suffering the slings and arrows of a strong dollar that has eroded your sales and profits overseas, every additional penny of dollar strength is just another painful body blow.
  • Dollar strength, in turn, is hurting China’s economy (its currency is largely pegged to the buck) and every country in the world dependent on commodity prices. As the dollar rises, most commodities fall — and that’s exactly what has happened. Which means the global economy is ever weaker as the U.S. dollar gets ever stronger.
  • At some point, all of these conspire to send America and the world into a global recession.

When the recession begins is the only question at this point.

Beat the Rush

News of the recession’s arrival will prompt the Fed to reverse course. The token interest-rate cut that allowed the impatient to exhale will have been for naught. The Fed will have to replace that hike with a cut, and we will be back to the beginning, bouncing around the zero bound.

When that happens — and it’s quite likely by the middle of the year — interest-rate-sensitive assets such as the Nuveen Municipal Value Fund (NYSE: NUV) will see their share prices rise as demand picks up. In this case, this is a closed-end fund holding municipal bonds and kicking off monthly income that equates to an annualized yield of more than 3.8% — not a bad take in the current environment.

As a closed-end fund, the share price moves independent of the value of the underlying assets. At the moment, that means the fund trades at a slight 1.4% discount to those assets — so the fund is on sale.

How long that will last, who can say?

But the economic data foreshadow bad tidings for the U.S. The Fed, despite Wall Street’s oxygen-deprived expectations of three or four more rate hikes this year, is just as likely to have to cut rates soon. And when that happens, bond prices will rise, bond yields will fall … and the Nuveen fund will see its yield decline and its share price rise.

Get in now while you can still lock in a solid yield, and ride the shares higher when news of a recession has Wall Street realizing an interest-rate cut is next in line.

Until next time, stay Sovereign…

Jeff D. Opdyke
Editor, Profit Seeker

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