Four Indicators That A Recession Isn’t On The Horizion
I recently spoke with Terri Spath, CIO at Sierra Investment Management, to discuss today’s economy and her approach to investing.
Wallace Forbes: What’s your main approach to investing?
Terri Spath: At Sierra Investment Management we are a rules-based manager of money. We have strict rules for determining whether it’s time to buy or time to sell various securities. They’re based on three key bullets: The first is trend-following. We look for trends that are rising or falling. And, particularly on the rising side, once we identify a trend—for example, right now we’re seeing some strength in the high-yield corporate bond market and in commodities—that leads us to the second thing we do, which is to look within that asset class to select securities.
We’re big believers that active managers are providing alpha in many asset classes. It’s hard to find alpha for large-cap stock managers, but in areas such as emerging debt, small-cap stocks and high-yield corporate bonds to name a few, there are managers that consistently outperform the passive benchmarks. And so, we dig into the securities selection and then we’ll put those into our portfolios.
The third thing that is key to our strategy, and I think it’s what makes us unique, is we have a sell discipline that essentially ensures that we’re never wrong for long.
Forbes: Can you expand on that, please.
Spath: We don’t like to lose money at all. We love to make money, but we really hate losing money. So, we set stop losses underneath every single holding across the firm to ensure that when a trend does shift from rising to falling, we’re never wrong for long. And so, you essentially make money by not losing money. In a nutshell, that’s our investment philosophy.
Forbes: So where does that put you at the moment?
Spath: On the fixed-income side we’ve got rising risk and we have rising rates, so you better have a process in place. On the rising rate side, we’ve had the Fed increasing rates—that’s going to continue. Inflation and employment are their two mandates, and they’re close to their target. I don’t see any reason why we won’t see a few more increases in interest rates as we have since the start of this year, and seven since they started raising.
Forbes: So, you’re negative on fixed income?
Spath: I just think you need to have a process. Because in addition to rising rates, which impacts everything on the fixed-income side differently, you have rising risk. And in particular the Barclay’s Aggregate Index, which is essentially the S&P 500 of the bond market, currently is sitting at its highest duration in at least three decades.
So, for those who are looking at fixed-income, if they think putting money into just a standard intermediate-term bond solution is going to protect them on the fixed-income side, they’re flat wrong. You need to have a more tactical approach right now, because that duration essentially means for every little uptick in interest rates you’re going to get hurt by your traditional bonds.
High-yield corporate bonds, floating rate loan funds—that’s where we’ve been adding on the fixed-income side because those have been trending up. They’re not as influenced by interest rates. They’re more influenced by the strength of the economy. Certainly, for high-yield corporate bonds. For floating rate loans, you get that adjustment feature. In an environment of rising interest rates and rising risk in traditional fixed income, you really need to broaden your horizon and have a process.
Forbes: What are your selections influenced by?
Spath: They are influenced by the trends. When we’re looking at the high-yield side, we’re absolutely seeing a positive trend. And in floating rate loan funds, we’ve been making money in those two areas on the fixed-income side.
Forbes: How about on the equity side?
Spath: We’re conservative on stocks. We’ve been watching what we call the four horsemen of the apocalypse—what would be the apocalypse for this market and for the U.S. economy. There’s so much economic data out there, I’ve collapsed it down into four areas and I think if you just looked at these couple of factors you’ll get a good insight into what could happen next.
The first horseman is leading economic indicators. They turn negative year over year in front of every single recession and that’s not happening right now. The second is that housing starts peak and start to fall ahead of a recession. We’re not seeing that either. We’re still seeing close to peaks at its current levels.
The third horseman is consumer confidence, which takes a nosedive ahead of a recession. It’s absolutely at high levels, and it continues to post those, so zero for three. And then probably the most important one, which has gotten a lot of press, is this flattening of the yield curve and in fact, an inversion of the yield curve. Very consistently ahead of any recession goes negative and flashes a red light, but we are not inverted–the curve is still positive.
So, all four of those horsemen are nowhere to be seen, at least at this juncture. Everything’s fine on the economic front and we don’t see a recession on the horizon. That means the volatility of this year’s markets, which is much more typical of historical levels, is not a warning sign to get out of risk-on assets. We got very spoiled last year with the complacency in the market. This year we’ve had a lot more volatility, and it’s uncomfortable, but it doesn’t suggest that there are problems going on in the economy or in the stock market.
We’ve been comfortable in some of our risk areas. And specifically, in equity, it’s more on the commodities side than an equity play. The higher-octane part of the spectrum–no pun intended–is where we’ve been putting money to work as in some of the commodities areas.
Specifically, we are buyers of the United States Oil Fund (USO), which is the exchange-traded fund that tracks the price of oil. And similarly, the First Trust North American Energy Infrastructure Fund (EMLP), which is an actively managed ETF that primarily invests in master limited partnerships. These have a little bit more volatility to them, but both funds are on the higher risk side of the spectrum, are in areas that we’re comfortable putting money to work there for our clients and our clients are conservative. We still think they’re showing strong trends and there’s volatility, but there’s no sign of a problem on the horizon.
Forbes: Well, that’s very encouraging, Terri. I appreciate your taking the time to share your thoughts with our readers.