Kass: My 'Fast Money' Recap
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This column originally appeared on Real Money Pro at 9:04 a.m EDT on March 23.
- The flight to safety in bonds will be reversed -- remember, over history the yield on the 10-year has approximated the sum total of nominal growth in GDP in the U.S. (i.e., real GDP plus inflation). We are currently growing domestically at slightly under 2%, inflation is about 2.3%, so you get a theoretical 10-year yield of between 4% and 4.3% vs. the actual yield of 2.25% for the 10-year now.
- This morning's Intrade odds that Obama regains the presidency are at 60%, odds that the Republicans regain the Senate are at 59%, and odds that the Republicans retain the House are at 70%. Based on these probabilities, gridlock is on the agenda in Washington, D.C. There will be little addressing of our fiscal problems, so it's only a matter of time before the bond vigilantes demand higher returns on U.S. paper.
- I don't see demand-pull inflation as the economy recovers slowly, but I do see the potential for cost-push inflation, particularly from higher oil prices and from the continued need to ease quantitatively around the world (which will likely push up commodity prices).
- Most vulnerable are companies and industries with large debt-to-equity ratios, particularly those that have a large amount of variable-rate debt and low returns on assets. The most vulnerable industry sectors would include telecom -- I found a lot of long-distance and broadband providers on the Bloomberg screen that I conducted -- as well as names in retail, real estate, media and materials. Some exposed and possible short candidates with large debt loads include Pitney Bowes (PBI), which is in the mail and shipping business; Pepco Holdings (POM), which is engaged in the transmission of electricity and natural gas in the Mid-Atlantic area; CenturyLink (CTL), which provides local, long-distance and network access; PPL Corporation (PPL), an electrical and utility holding company; Avon Products (AVP) cosmetics; Cablevision (CVC), cable; and CMS Energy (CMS), a Michigan-based utility.
- High-yielders are up next. Every strategist that lives has encouraged buying high-yielders over the past few years. Now, not only are these yields less competitive as rates rise but proposals by the Obama administration to nearly triple the tax rate on dividends will make dividends less valuable. Utilities would likely be losers, a sector that has had terrific share price performance. Some other qualifiers include Frontier Communications (FTR), another local and long distance provider; Windstream (WIN), another broadband and voice provider; Supervalu (SVU), retail food distributor; and Gannett (GCI), a newspaper chain.
- Finally, we have sectors that have prospered from an unprecedented drop in interest rates and that have contracting margins or reduced demand for products as interest rates rise. Homebuilders would be prominent in this list.
- Banks are obvious winners, but they have run up a lot and, as I discussed on "Fast Money" two weeks ago, it's my view that a fragile muddle-through recovery will result in sluggish loan growth and probably the end of the great credit-quality cycle that we have seen since the recession ended. (There has been a huge reduction in loan-loss provisioning.) My view is that these factors could trump net interest margin gains. Less obvious beneficiaries in the financials would be the life insurers. Industry valuations have been hurt because the marginal investment opportunities were lower yielding than their current portfolio returns, but this would change. Prudential (PRU), MetLife (MET) and Lincoln National (LNC) are good names.
- Also less obvious are the discount brokers. Companies such as E*Trade (ETFC) and Schwab (SCHW) are obvious beneficiaries from a rotation out of bonds and into stocks. More important, with large free-money balances, their net interest margins will expand relative to expectations. Property and casualty names, such as Chubb (CB), Travelers (TRV), Loews (L), and reinsurance companies, such as Berkshire Hathaway (BRK.A)/ (BRK.B)and XL Group (XL), benefit from large floats earning higher levels of interest.
- For a rotation out of bonds and into stocks, there is purity in asset managers such as T. Rowe Price (TROW), Legg Mason (LM), Waddell & Reed (WDR) and Franklin Resources (BEN), which should be viewed as possible longs.
Pair TradeFinally, given rising rates and higher marginal tax rates on dividends - a possible interesting pair trade is long municipals via iShares S&P National AMT - Free Municipal Bond Fund (HUB) and short U.S. taxable bonds via a short of iShares Barclays 20+ Year Treasury Bond Fund (TLT) or through a long in ProShares UltraShort 20+ Year Treasury (TBT). Let's go to the tape!
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