November 25, 2018 Red Zone

Risk/Reward Vol. 399

THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.

Last weekend I was in deer camp. Undisturbed by ruminants, I ruminated.

Both the S&P 500 and the Dow Jones Industrial Index are negative for the year, and the NASDAQ is barely green. Last week saw a 4% drop across the board. Once again the reportage as to the cause(s) was unrevealing. The two most frequently cited tropes: the Fed raising rates too quickly and the threat of a trade war, just don't fit. They have been in the wind for most of the year. While it is true that many companies are projecting slower growth in 2019, that too has long been expected. I put the cause on politics. In anticipation of a series of debilitating investigations run by a Democrat controlled House of Representative, I see Mr. Market taking profits accumulated since The Donald's election and rotating out of equities.

Why politics? Because like all of us, Mr. Market is not immune to them. If The Donald's election can boost a market, his downfall can diminish it. And let there be no doubt, the underlying purpose of the upcoming investigations is to destroy Donald Trump and his presidency. Moreover, given his predilection to overreact, the President will likely be his own worst enemy. Add to this the hard left turn of the Democrats as they select a candidate, and I foresee more turmoil (yes, that is possible) and increased uncertainty. And Mr. Market abhors uncertainty.

Has a rotation begun? Sadly, I think so. Take a look at bond yields. Given the Fed raising rates at the shorter end of the yield curve (Fed Funds or overnight rates) and given the supply of bonds increasing because of 1) the Fed selling its portfolio of longer term duration bonds as part of its balance sheet reduction and 2) the Treasury issuing more bonds to cover a larger than expected deficit, one would expect yields to increase. Remember an increase in the supply of bonds should lower their price which in turn should increase their yield. And yet bonds are selling like hot cakes, and yields/rates have plummeted. It is this drop which saddens me. The Ten Year which was consistently yielding 3.25% just two weeks ago is now trading at 3.05%. The Two Year was at 2.95% and now has fallen to 2.81%. This counterintuitive downward march in rates indicates that many investors are not just "raising cash" in order to re-enter the equity market when valuations are cheaper. Rather they are abandoning equities and buying bonds. Given the huge runup in stocks over the past several years and given the increase in interest rates to an almost rational level (3%), they have determined to take a profit and rest comfortably in bonds . Once out, I don't see many (especially Baby Boomers) coming back.