Risk/Reward Vol. 321
THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.
As discussed last week, with interest rates world wide at zero or below the only game in town has been stocks. This remains true even though the performance of the underlying businesses does not warrant current valuations. The resultant bubble in stock prices has not gone unnoticed by market commentators who have increased their criticism of the Federal Reserve's refusal to raise rates. Mindful of this criticism and of the inflation of stock prices, heretofore rate dove Eric Rosengren of the Fed spoke on Friday of a possible rate increase as early as September. Mr. Market was unprepared for such a switch and began to sell. The rate of selling increased Friday afternoon when the Fed announced that uber rate dove Lael Brainerd will speak on Monday fueling rumors that she, too, will become more hawkish. By the close, both major indices had fallen over 2% experiencing their worst day in months. Not surprisingly, the bond market also tanked with the rate on the bellwether US Ten Year spiking above 1.6% (Remember, the higher the rate the lower the value.)
So what do I make of this? As I wrote last week, in my humble opinion, these hawkish teases are nothing but head fakes to address criticism of the Fed and to keep stock prices from hitting ridiculous new highs. Indeed, despite Friday's action, the futures market is still assessing only a 24% probability of a rate increase in September. Do I think that the Fed would do the unexpected in September and raise rates, a move that would cause a massive sell-off in the bond and stock markets as presaged on Friday? No way. This would seriously wound the candidate who advocates a hands-off approach to the Fed (Clinton) and play into the hands of the candidate who wants to audit the entire operation (Trump). That said, I remain comfortably on the sidelines and will await the Fed's next meeting scheduled for September 21 before deciding to buy---or not.
And speaking of central banks, earlier in the week the European Central Bank announced that it would stand pat in its asset buying program. It purchases 80billion Euro worth of sovereign and corporate bonds per month and will continue the program through March, 2017. The ECB may have trouble doing so, however, because it is running out of bonds to buy. It now owns 1/7th of the government debt of all of the Eurozone countries and is quickly absorbing all available corporate debt. Indeed, for the FIRST TIME IN THE HISTORY of corporate finance two companies, Sanofi and Henkel, issued negative interest rate bonds last week. That's right, you read that correctly. Sanofi borrowed 1billion Euros last week via a 3 1/2 year bond. During the life of the bond, Sanofi will pay no interest and 3 1/2 years from now will return less principal to the bondholder than it borrowed. In effect and in fact, Sanofi is being paid to borrow money. Does anyone think this is sustainable?
I don't, but I haven't a clue as to when it will end. I am reminded of 2005 when I sat on the board of a company where over 50% of its revenue came from real estate related sales. We were mindful of the real estate bubble even then and instituted a "canary in the mine shaft" early warning system to help us predict when the bubble would burst. We had about a 90 day window which helped us reduce exposure when the bubble began to deflate. But, there was no way we or anyone else could predict how disastrous that burst became. I have deja vu---all over again. That said, I cannot afford to sit in cash forever. I am sure that I will make several more forays into the stock market before it crashes. But these forays will be strategic and short lived. Indeed, I see one forming now. Unnoticed in Friday's furor was the fact that oil prices rose 5%. Nevertheless, oil stocks fell with the market in general. I am not buying now, but these type of events present profitable opportunities.
By nature, I am not a pessimist. But I am a realist. I do not know how anyone can be sanguine about the world's financial situation. Ceding so much power to central banks, as we did in the wake of the 2008 financial crisis, is proving a mistake. The value of every financial asset worldwide is now dictated by a handful of unelected central bankers. This policy has worked to the decided disadvantage of those without substantial assets thereby exacerbating the wealth gap and dampening the demand for goods and services. Add to this the aging demographic time bomb that exists in every developed economy and one must conclude that we are in for a rough ride. What can one do? I, for one, have become a trader. My buy/sell signals come from correlating the yield on the US Ten Year to other assets. I take profits often and mitigate against loss by selling losers early and maintaining a large cash position at all times. What can you do? How about showing this email to your financial advisor and asking if he/she agrees with its central premise (to wit, the value all financial assets is now largely dependent on the whims of a few central bankers). If he/she does agree, then ask what his/her plans are for your portfolio if and when central bankers begin to raise rates in earnest. If he/she does not agree, well.... Either way, please share the answers with me
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