Sunday, October 29, 2017
October 29, 2017 Exit Redux
Risk/Reward Vol. 368
THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN
In Vol. 365 published at the beginning of this month I wrote the following:
"I do not see the stock market rally ending. As for interest rate sensitive securities (my favorites) caution is in the wind. The shine came off of these a bit again this week with the 10Year yield spiking, but not so much as to warrant any move. The monthly dividends that I receive far outweigh the slight hit to capital that I suffered these past two weeks. And with the futures now anticipating a December hike, all should be peaceful for the next 3 months. Should be, but may not be. That is because in the next few weeks The Donald is going to name a new Federal Reserve chair. Indeed, this week he interviewed Kevin Warsh for the job. As noted previously, Warsh has been critical of Bernanke/Yellen's easy money approach and is deemed a rate hawk. If he is the chosen one, it may cause rates to jump. Consequently, I may collect one more month's dividends and then sell while rates climb to a new "Warsh" normal."
How prophetic! This week those who support a hawkish approach to interest rates received a boost when The Donald took a straw poll of Republican Senators as to who the next Fed Chair should be and John Taylor won. He of the famous "Taylor Rule" is even more hawkish on rates than Kevin Warsh. The increased likelihood that Taylor would be named caused the yield on the US Ten Year Bond to spike above 2.45% on Wednesday, its highest yield in seven months. (Remember: the higher the yield the lower the price.) This sudden move was the signal I needed to exit my interest rate sensitive portfolio and to take a seat on the sidelines. Later in the week the yield fell a bit on rumors that Powell was still in the running. That move in turn was moderated by hawkish news that for the second quarter in a row gross domestic product exceeded 3% on an annualized basis. Given this volatility, I will let the dust settle and let rates stabilize (and hopefully overshoot) before re-entering. I may not be out too long given that the President now plans to announce his Fed Chair nominee next week. In retrospect I should have exited a few days earlier and indeed thought of so doing. But I was out of town and otherwise occupied. It cost me a few shekels, but the fun I had in the sun more than compensated for the small reduction in profits.
As for those of you who are index investors, the party continues. At dinner the other night I was asked whether the current rally is in anticipation of the passage of the President's tax plan and whether failure to pass it would result in a pull back. I have no doubt that the prospect of tax reform has played some role in the spurt, but even if it does not pass I do not see a sell off. Indeed, given recent positive corporate earnings reports, I foresee even market fundamentalists continuing to buy. Lastly, as I have written in the past, until there is an alternative investment that promises some meaningful return, stocks are the only game in town.
Sunday, October 15, 2017
October 15, 2017 Stock Index Wow
Risk/Reward Vol. 367
THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.
Wow. Both of the major indices are up 15% year to date with no end in sight. As I have written ad nauseam fundamentals do not justify these nose bleed valuations. Indeed, as of midday Friday, the Shiller CAPE price/earnings ratio was 31.2, higher than it was before the '29 Crash. Indeed, it has exceeded 30 only three times: 1929, 1999-2000 (dot com) and now. But what do fundamentals have to do with this market? I say nothing. The fact remains that for the vast majority of investors, There Is No Alternative (TINA) to the stock market. Traditional alternatives (bonds, cd's, money markets) produce no return at all and actually are much riskier given the uncertainty surrounding interest rates.
The earnings report issued this week by Blackrock, the world's largest money manager, underscores TINA. Blackrock now has over $6trillion under management. It and its major competitor, Vanguard, now manage over $11trillion. To put that into perspective, the gross domestic product of China (the world's second largest economy) is $11 trillion. As for their percentage of the market, the total amount of assets under management worldwide is somewhere between $70 and 80 trillion. But more significant than their market share is how they are growing. The lion's share of new funds being managed is going into passive, index funds. In other words, everyone is investing in the same thing---stock indices. Little wonder then that the two largest stock indices, the Dow Jones Industrial Average and the S&P 500 continue to increase in value every day. I hesitate to use the word Ponzi, but self fulfilling prophecy works.
So, when, if ever, will it end? Simple: when there are alternatives. But alternatives won't arise unless and until central bankers stop suppressing rates--- which they continue to do despite hints to the contrary. Don't forget, the German 6 year bond still pays a negative interest rate and the 10 year yields only 0.41%. Similar yields prevail in France and Japan. Why? Because central banks, under the guise of "quantitative easing", continue to bid up sovereign bond prices (thereby depressing the yields) so that no one else can or will buy the bonds. This negatively affects the yield on all other debt because all debt is priced in relation to government bonds (the "spread"). The natural consequence is for investors to buy equities in lieu of low yielding debt. Yield suppression has been tolerated in the decade since the Great Recession in order to spur employment which in turn is supposed to spur inflation and economic growth. But the connection between low unemployment and inflation (the Phillips Curve) is slowly being debunked as is the perceived infallibility of central bankers, most of whom view the Philips Curve as the Holy Grail. In the meantime, central banks have run out of tools should we face another true, economic crisis. That is why some conservative monetarists are clamoring for speedier rate hikes. Notably among them are John Taylor and Kevin Warsh, two of the leading candidates for Federal Reserve chair. Should either be nominated, look for Mr. Market to take a pause. But even if one of these two is elevated, the entrenched bureaucracy of the Fed will be hard to turn. So I do not expect any significant jump in debt yields and thus no great stock reversal any time soon.
THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.
Wow. Both of the major indices are up 15% year to date with no end in sight. As I have written ad nauseam fundamentals do not justify these nose bleed valuations. Indeed, as of midday Friday, the Shiller CAPE price/earnings ratio was 31.2, higher than it was before the '29 Crash. Indeed, it has exceeded 30 only three times: 1929, 1999-2000 (dot com) and now. But what do fundamentals have to do with this market? I say nothing. The fact remains that for the vast majority of investors, There Is No Alternative (TINA) to the stock market. Traditional alternatives (bonds, cd's, money markets) produce no return at all and actually are much riskier given the uncertainty surrounding interest rates.
The earnings report issued this week by Blackrock, the world's largest money manager, underscores TINA. Blackrock now has over $6trillion under management. It and its major competitor, Vanguard, now manage over $11trillion. To put that into perspective, the gross domestic product of China (the world's second largest economy) is $11 trillion. As for their percentage of the market, the total amount of assets under management worldwide is somewhere between $70 and 80 trillion. But more significant than their market share is how they are growing. The lion's share of new funds being managed is going into passive, index funds. In other words, everyone is investing in the same thing---stock indices. Little wonder then that the two largest stock indices, the Dow Jones Industrial Average and the S&P 500 continue to increase in value every day. I hesitate to use the word Ponzi, but self fulfilling prophecy works.
So, when, if ever, will it end? Simple: when there are alternatives. But alternatives won't arise unless and until central bankers stop suppressing rates--- which they continue to do despite hints to the contrary. Don't forget, the German 6 year bond still pays a negative interest rate and the 10 year yields only 0.41%. Similar yields prevail in France and Japan. Why? Because central banks, under the guise of "quantitative easing", continue to bid up sovereign bond prices (thereby depressing the yields) so that no one else can or will buy the bonds. This negatively affects the yield on all other debt because all debt is priced in relation to government bonds (the "spread"). The natural consequence is for investors to buy equities in lieu of low yielding debt. Yield suppression has been tolerated in the decade since the Great Recession in order to spur employment which in turn is supposed to spur inflation and economic growth. But the connection between low unemployment and inflation (the Phillips Curve) is slowly being debunked as is the perceived infallibility of central bankers, most of whom view the Philips Curve as the Holy Grail. In the meantime, central banks have run out of tools should we face another true, economic crisis. That is why some conservative monetarists are clamoring for speedier rate hikes. Notably among them are John Taylor and Kevin Warsh, two of the leading candidates for Federal Reserve chair. Should either be nominated, look for Mr. Market to take a pause. But even if one of these two is elevated, the entrenched bureaucracy of the Fed will be hard to turn. So I do not expect any significant jump in debt yields and thus no great stock reversal any time soon.
Friday, October 13, 2017
October 8, 2017 Cassis
Risk/Reward Vol. 366
THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.
Greetings from Cassis. I have been instructed by my bride to stop describing how beautiful it is here. So if you are inclined to come, don't. She does not want any one else to "discover it."
Week after week after week of record highs. This while bond yields inch higher. I see few if any clouds on the horizon that could stop the upward march of equities and certainly nothing that would cause a collapse. Enjoy.
THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.
Greetings from Cassis. I have been instructed by my bride to stop describing how beautiful it is here. So if you are inclined to come, don't. She does not want any one else to "discover it."
Week after week after week of record highs. This while bond yields inch higher. I see few if any clouds on the horizon that could stop the upward march of equities and certainly nothing that would cause a collapse. Enjoy.
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