Ray Dalio Linked in post:
https://www.linkedin.com/pulse/its-all-classic-main-questions-timing-what-next-downturn-ray-dalio/

In the “late-cycle” phase of the short-term debt/business cycle, when 
a) an economy’s demand is increasing at a rate that is faster than the capacity for it to produce is increasing and 
b) the capacity to produce is near its limits, prices of those items that are constrained (like workers and constrained capital goods) go up. 
At that time, profits also rise for those who own the capacities to produce those items that are in short supply. Then the acceleration of demand into capacity constraints and rise in prices and profits causes interest rates to rise and central banks to tighten monetary policy, which causes stock and other asset prices to fall because all assets are priced as the present value of their future cash flows and interest rates are the discount rate used to calculate present values. That is why it is not unusual to see strong economies accompanied by falling stock and other asset prices...

What we do know is that we are in the part of the cycle in which the central banks’ getting monetary policy right is difficult and that this time around the balancing act will be especially difficult (given all the stimulation into capacity constraints and given the long durations of assets and a number of other factors) so that the risks of a recession in the next 18-24 months are rising. While most market players are focusing on the strong 2018, we are focusing more on 2019 and 2020 (which is the next presidential election year). Frankly, it seems to be inappropriate oversight to not be talking about the chances of a recession and what that recession might look like prior to the next election.

the bond market is, after all, a fairly short-term instrument with an aggregate average maturity of 8 years and an effective duration of 5.7 years.

The historical data we have does not support many beliefs investors and advisors have relied on for many years. Careful analysis reveals some simple truths:

1)      Rates have risen since the election. It is a response to the expectation that new administration will reduce many regulations impeding economic expansion. Optimism has improved and capital has shifted out of fixed income and into equities and commodities. The Fed has had no impact on this shift.

2)      Long-term rates have risen more than short-term rates and already permitted banks and lending institutions to expand lending to businesses. The T-Bill/10yr Treasury rate spread which began to widen in July 2016 has become much wider since the election. When long-term rates rise faster than short-term rates, there is always an expansion in lending and equity prices rise. When short-term rates rise faster than long-term rates, lending slows. When the T-Bill/10yr Treasury rate spread shifts to 0.0%, economic activity and equity markets stop rising and enter correction-every time!

3)      Close examination of Fed actions on the Fed Funds rate reveal that the Fed acts after T-Bills have shifted. The Fed’s goal is to keep Fed Fund rates above T-Bill rates. They respond 1mo-3mos after there has been a market determined shift in T-Bill rates.

There are many market myths.  Value Investors do not invest with myths. They invest using facts! It is why they are called Value Investors. The current environment with lending beginning to expand is very positive for equity investors. The Fed will raise rates as they have done historically to keep up with market induced changes in T-Bill rates. What the Fed does with Fed Fund rates has no impact on economic growth.

Summary:

Investors should ignore Fed actions on Fed Fund rates. There is no impact on economic activity. Investors should focus on market induced changes to the T-Bill/10yr Treasury rate spread. A widening spread portends higher equity prices.

Yield spread suggests diminished odds of a recession in the next 12 months

All yield spreads calculated as 10 year less 3 month yield except Mexico (5 year less 3 month).

Historical time period begins: U.S. 1967, Eurozone 1970, Germany 1970, UK 1970, Sweden 1970, Mexico 2000.

VIX Term Structure

Why are Treasury Bonds the Ultimate Safe Haven?

The last 10 years have exposed a very important reality for any global asset allocator – US Treasury Bonds are the ultimate safe haven investment.  For decades we have heard stories about how gold, silver, real assets or other types of financial instruments would serve as the “safe haven” investment during times of crisis.  Many of these stories were based on mythical ideas about the coming collapse of fiat money or the bankruptcy of the US government.  There have also been endless discussions about the coming collapse of the T-Bond market due to a “bond bubble” or the end of QE. But every time the global economy encounters a hiccup it is T-Bonds that investors demand.

Tadas Viskanta wrote a very good piece about how T-Bonds tend to perform well during times of market uncertainty, but I wanted to take a more operational approach because I think this can be explained in a very simple way.  Importantly, running performance backtests doesn’t help us much here because the global economy is dynamic and the current state of T-Bonds as a safe haven is something that is not guaranteed to persist simply because it has been true in the past.  Byunderstanding the modern monetary system and taking a more operational perspective we can better understand why T-Bonds are so unique within the global economy.

The primary reason that T-Bonds are the world’s financial asset safe haven is a function of the US government’s tremendous revenue stream.  With the USA generating 22% of global output the US government has the ability to tax more output than any other safe haven entity.  In short, the US government has the largest high quality income stream in the global economy.  Interestingly, the US government is the only entity in the world that issues a liability that is attached to such a large and reliable income stream.  China, for instance, issues bonds, but we can’t trust their economic data let alone the financial instruments they issue. Europe would be the US equivalent except for the fact that they don’t issue a supra-national liability.  Instead, each country within the EMU issues its own liabilities and the safety of those individual liabilities has come under serious question in the last few years.

The main point is quite simple though.  When people want to protect their financial assets they can’t, in the aggregate, “get rid of them” so they necessarily deviate to the largest high quality income generating entity in the world.  For the investor who properly weighs their risks between maintaining purchasing power and permanent loss risk the T-Bond becomes the obvious choice since it provides you with safety characteristics similar to cash, but protects you against inflation better than cash.  But most importantly, it gives you access to the largest high quality income generating liability issuer in the global financial system.  This could change going forward and very likely will at some point, but for now, this remains an operational reality resulting from the USA’s unique position as the highest quality output producer with a federal government that can generate income from that underlying output.