10-3 Inversion and Recessions

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In their latest episode of the VALUE: After Hours Podcast, Brewster, Taylor, and Carlisle discuss 10-3 Inversion and Recessions. Here’s an excerpt from the episode:

Tobias: I like to check the 10:3 inversion every-

Jake: Four minutes. [laughs]

Tobias: -15 minutes or so.

Jake: Yeah.

Tobias: The 10:3, the most it’s ever been inverted is negative 0.77, which was the 2000 crash. It was at 0.73 on Friday, 0.72 today, something like that. So, it’s close to being as inverted, as steep as it’s ever been. I don’t know if that means anything. I don’t know if that’s relevant or it counts. It’s just [unintelligible 00:46:45] me out.

Jake: It’s just poor market– [crosstalk]

Tobias: What the last few years I think have shown us is how many times things that have never happened before have happened, how much unprecedented stuff has gone on. So, I don’t think 10:3 inversion is great. There’s a little bit more research that came out. Cam Harvey has said it’s 90 days of inversion. Another one came out and said– When I look at it, it just eyeballing it, it looks to me every single time that we’ve inverted, it’s preceded a recession by about six months. But this research came out, I’ve actually gone and looked at it. They said all you need is 10 consecutive days. So, we’ve well and truly had 10 consecutive days. I think it started October 25. So, it’s more than a month now.

Jake: Do you think we’ll get to Cam Harvey’s 90 days?

Tobias: I don’t know. I’ve got no idea. On this little bit of research that I saw, these guys have said that 10 consecutive days is all we need and it leads it by 10 months on average.

Jake: Okay. So, [crosstalk]

Tobias: That’s predicted eight of the last eight recessions over the 50 years.

Bill: I think we’re going into a recession.

Tobias: It seems inevitable, right?

Bill: Yes. Let’s assign probabilities to it. But I would say anywhere between 60% to 70%.

Tobias: Yeah, fair enough. But I would say higher than that. It would be the first time that this indicator has been wrong, if it’s wrong.

Bill: Yeah, I just know I don’t know anything greater than 70%.

Tobias: 40%. 40% is my prediction.

Jake: Yeah, that the– [crosstalk]

Bill: Yeah. There you go.

Jake: Classic.

Bill: No, the question is, what does it mean? I can’t see it being a good thing in the next 18 months.

Tobias: That’s right. I don’t know either.

Jake: What are we going to spend less money on? That’s I think the question we figure out.

Tobias: It just makes the E go down, which makes the P go higher, where there’s no market running out. So, the market gets more expensive and then the value does seem to predict–

Jake: Or it doesn’t.

Tobias: Yeah.

Bill: You know something I was thinking about today is, I think enterprise values might be a little misleading right now, because the bonds are not trading at par. So, enterprise value is probably screening a little higher than market would say it is. It’s kind of interesting.

Tobias: Because they can buy the bonds at a discount too.

Bill: Yeah.

Tobias: So, you think heavily indebted companies have less debt, because they could buy them back at discount.

Bill: Yeah. On the other hand, if that debt comes due, you don’t get to buy it back for pennies on the dollar. It’s a hundred cents that the debtors want or the creditors want. Yeah, I don’t know. It’s just something I was thinking about. It’d be nice to have mark to market enterprise values.

Tobias: That is interesting. Yeah. I saw this little tweet. This was– [crosstalk]

Jake: You think there’s real information in that though? Do you think the bond market has that kind of stuff right and you would want to change your EV calculation? Or you want the face value?

Bill: Uh, I don’t know.

Tobias: It is.

Bill: I think it probably depends.

Jake: We use market cap. So, that moves around all over the place. Why does the debt sit still?

Bill: Yeah. Well, I think because it’s a contract, but I get your point. I guess it probably makes sense to market to market until it doesn’t make sense in which case you’re totally screwed. So, it’s probably better to just be conservative all the time.

Tobias: Bram de Haas has a good line on– I think this is the inversion. “Maybe it doesn’t predict but cause it.” I did wonder about that a little bit too, whether there was something in the curve– [crosstalk]

Jake: Growth’s going a different way?

Tobias: Yeah, it wasn’t so much a prediction, but it shows there’s some malfunction in the underlying market.

Bill: Well, you get a lot less incentive to take long-term debt risk.

Tobias: Debt paid on the short term.

Bill: You combine that with credit standards that are starting to tighten. This is not a positive for velocity of money.

Tobias: Somebody sent me an interesting note that said that the inversion was the ordinary case. It’s only a reasonably recent phenomenon that there haven’t been an inversion, that when we were on the gold standard for hundreds and hundreds of years when there was essentially no inflation whatsoever and wealthy aristocrats used to put their money into gilts, they all traded in an inversion. I guess it was because they tended to put their money out on the short-term market and that doesn’t really make sense either, does it? [crosstalk]

Jake: No, that would be the opposite, right?

Tobias: Yeah, this doesn’t make sense.

Jake: There’s more demand for shorter-term, right?

Tobias: Yeah. I don’t know. The Twitter account sent me a paper. That’s apparently that’s pretty well known, the inversion zone. The inversion is the ordinary case. Before then, it was rare that it was the other way around– [crosstalk]

Jake: Well, I guess just you have natural deflation, which is what the 1800s saw.

Tobias: Maybe it’s predicting in deflation. Maybe that’s what it’s doing.

Jake: Yeah, so like further 10 years from now-

Tobias: That’s interesting.

Jake: -you would have a negative– [crosstalk]

Tobias: It’s predicting inflation– It’s predicting inflation or deflation depending on how the shape of the curve goes and that might be worth a paper.

Bill: I’ve been thinking about Peter Zeihan’s book. If anybody can introduce me, that’d be awesome, because I don’t want to just tweet it at them and continue to ask them on the pod. That’s a little bit loser-y.

Jake: [laughs]

Bill: But the amount of- [crosstalk]

Tobias: Whatever gets it done.

Jake: Yeah.

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