”Fear is the most contagious disease you can imagine. It makes the virus look like a piker."— Warren Buffet
Today’s question: has there been enough “blood in the streets” yet to buy U.S. Treasuries?
We’ll give you an answer in a moment.
First some context. While we were conducting our live model portfolio, stock and bond, trading session for Essential Investor members, the House of Representatives managed to elect a new Speaker.
Representative Mike Johnson (R, LA) was ushered in by a 220-209 vote largely on party lines.
The 21-day gap the House was without a Speaker is the longest that Congress has been rudderless since 1962, when it took 55 days to elect a speaker.
So we’ve been there before. Just not at such a critical juncture in the nation’s spending history.
We don’t have an opinion of the new Speaker, or of the old one for that matter. In fact, we found ourselves in the camp suggesting maybe it’s a good thing Congress is paralyzed… they can’t do anymore damage.
Mike Johnson’s first order of business will be, by his own statement, to pass 8 outstanding spending bills, including those for aid to Israel and Ukraine.
The aid package to Ukraine is what stuck in the craw of a small faction of House Republicans who don’t support sending (borrowed) money to Eastern Europe when we have a host of more pressing issues here in North America, illegal immigration at the US southern border and an ongoing banking crisis among them.
Kevin McCarthy (R,CA), the former Speaker, kept his fingers crossed behind his back on the Ukraine issue, promising it wouldn’t be part of the stop gap measure passed on October 1 to keep the government open until November 17. Behind closed doors, and away from his own party’s deficit hawks prying eyes, he told enough Democrats they’d get their Ukraine money to pass the measure.
You’ll recall McCarthy’s gavel was promptly ripped from his hands. “You can’t trust Kevin McCarthy,” was a refrain in the ensuing days from both Democrats and Republicans.
McCarthy hardly has a monopoly on distrust.
A recent Pew Research survey revealed that, through the first half of 2023, 3 out of 4 Americans openly admit they don’t trust the government. That was even before the Freedom Caucus of the Republicans set about “burning the house” down in Congress.
In our view, without naming any names, the Freedom Caucus has a right to be worried about government spending.
According to the US Treasury’s own website, year-end data from the September 2023 Monthly Treasury Statement of Receipts and Outlays of the United States Government show that the deficit for FY 2023 was $1.7 trillion.
That’s one year. And $320 billion higher than the prior year’s deficit.
Adjusted for President Biden’s student loan forgiveness plan, the single year deficit ballooned to $2.02 trillion.
That’s an unsustainable trend in any economists’ book, especially given it’s a peacetime budget in a year when the economy has been stubbornly resistant to the Fed’s attempts to slow the jobs market and consumer borrowing.
As a percentage of GDP, the 2023 deficit was 6.3 percent, up a full percentage point from the year before.
What’s most alarming and will continue in the foreseeable future is the amount of money the government will have to carve out of its budget to service that mounting mound of moolah.
The interest on the debt alone has increased $184 billion as yields on the 10-year Treasury flirt with 5%. In fact, interest on the debt has increased at a faster pace than the Defense Budget, Social Security, Medicare and Bank Bailouts conducted by the FDIC.
Mistrust has been playing out in the bond market all year. Research done by Bank of America analysts show that the Bond Rout of 2023 will go down in history as the most aggressive sell-off in Treasury’s since they were first issued in 1787—the beginning of the nation itself.
You may recall a portfolio of supposedly reliable and risk-free Treasuries is what alerted many mainstream investors to the hoary underbelly of the banking system.
Famously, Silicon Valley Bank (SVB) collapsed back in March of 2023 because tech entrepreneurs, including those speculating in cryptocurrencies, were caught off guard by a sell off in the stock market. Many tech start-ups, who made up the bulk of SVBs depositors, started taking their money out of the bank. To cover the withdrawals, SVB was forced to sell their Treasuries at a loss, further diminishing the bank’s assets, which in turn spooked more depositors.
The bank collapsed in 48 hours. And fear of contagion took down Signature Bank within a few days.
Several weeks later First Republic had to be rescued and resuscitated.
The story of how the Fed restored trust in regional banks is in and of itself interesting. The Fed resorted to a rule first used by Alexander Hamilton to avert a banking collapse in 1792. It’s called Bagehot’s Law and effectively allows the Fed to buy bonds, both US and corporate, at face value, rather than the beaten down market price.
While the bank contagion quickly slipped out of the news cycle in May when the first debt ceiling debate captured the public’s attention. The crisis itself hasn’t gone away. The FDIC still lists 186 banks in danger of going under because of unrealized losses.
Bank of America itself carries an enormous portfolio of government debt and mortgage bonds—nearly $760 billion at the end of the second quarter, with unrealized losses of $110 billion.
“These losses have materialized,” our friend Porter Stansberry explained in a note, “because interest rates have risen, making the bonds it purchased in 2020 and 2021 when interest rates were vastly lower, less valuable.
Because Bank of America designates these investments “long term holdings” the losses don’t count against its required capital base. Pretending works fine… until depositors want their money… and those bonds have to be sold (and losses realized) to pay them back.
That’s going to happen because, with an average portfolio yield of only 2.44%, there’s no way that Bank of America can pay anything like short-term Treasury yields of 5%+
Thus… it is only a matter of time before depositors wake up and a run happens. It will destroy the bank in a matter of hours. That’s exactly what already happened to SVB Financial, where the unrealized losses don’t compare to those Wells Fargo and Bank of America are sitting on.
Of course, the Federal Reserve’s fight against inflation, using the billy club of raising the overnight Funds Rate, has caused a fair amount of the mismatched bond values on many of the nation’s banks books. But, so has a massive mistrust in the government’s ability to manage its own finances over the long run.
Two events this week signal the Bond Rout may be finding a bottom at 37 cents on the dollar. First, the yield on the 10-year T-bill went above 5% in intraday trading yesterday, but failed to stay there until the close. Second, big bond investors hedge fund billionaire Bill Ackman and former Pimco boss Bill Gross both began buying treasuries and set a floor in the market.
Ackman cited too much risk in the world geopolitically. “I’m covering my shorts,” Ackman tweeted to his followers, meaning he is taking profits now and may even become a net buyer of treasuries.
Perhaps a third event will strengthen the floor even more; The House electing a new speaker giving traders some hope the government won’t default when the funding deadline comes up again on November 17.
We’re skeptical, to say the least. Politicians can’t seem to avoid a few weeks of political theater every time the debt ceiling debates or funding measures come to vote.
So it goes,
The Wiggin Sessions
P.S. “Be fearful when others are greedy,” Warren Buffet has also famously said, “and be greedy when others are fearful.”
If Ackman and Gross are right, bond investors may still be fearful, even if the market has bottomed out. If you buy now, A 20-30% gain is certainly possible, Zach Schiedt told Essential Investor members in our briefing today. And you’ll get up to 5% return for giving the speculation a try.
Zach shared a specific, easy way to play the bottom of the bond market, if in fact the bottom is in.
P.P.S. If you haven’t already, please give Shell Game a listen, right here. When you’re done, share it with your friends and family.