Risk/Reward Vol.
THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.
Wow. Were you watching the futures market election night? Talk about volatility. Late Tuesday night, the race was so close, a Year 2000 fiasco (remember the "hanging chad") became a possibility. Understandably the Dow Jones Industrial Average futures plummeted 800 points. Much of that was recovered by the end of the night when a winner was declared. Then, once the markets digested the news, all time highs were achieved in the DJIA. So why didn't Wall Street support Trump during the election? That's easy. No one thought he could win. Mr. Market does not support losers especially when Elizabeth Warren is on the other side. But once victory was assured, the prospect of de-regulation, infrastructure spending and tax reform caused the green lights to shine. Will the averages continue to appreciate and if so why?
They just might, and the reason can be found in the bond market. Allow me to explain. Although financial news reports invariably focus on the equity markets, the real action starts and ends in the bond market. Why? As explained by Warren Buffet (and as discussed in Vol. 207 http://www.riskrewardblog.blogspot.com), the rates of return that investors need from an investment are directly tied to the risk free rate of return. There is no "risk free" security in the real world, but the 10Year US Treasury Bond is the closest. Simply put, if one can achieve, say, a 6% return from the 10Year, why would one accept a lesser return from a riskier investment? Conversely, if one is only achieving a 1.7% return from the 10Year, but one perceives that a significantly higher one will be achieved from a solid, albeit "riskier" investment such a blue chip stock, a rational investor will sell the bond and buy the stock. And that is what is happening. The increased likelihood of infrastructure spending and other fiscal stimuli promised by Trump is very good news for heavy industrials which dominate the Dow. So Mr. Market has sold bonds and bought blue chips. As a consequence, behemoths like GM and Caterpillar are up more than 10% just since the election. Add to this Mr. Trump's desire that the Federal Reserve stop depressing yields on bonds and one has both fiscal and monetary policies aimed at raising rates: a perfect storm for reflation. Think not? Look at the yield on the 10Year. It has gone from 1.77 to 2.12 in one week---that's a 20% increase! Bond King Jeffrey Gundlach sees the yield rising another 40 basis points near term. Who am I to disagree?
So what does this mean to you and me? For the buy and hold equity index crowd it means an above average year at least for the Dow. For me it presents a great buying opportunity. For those who obsess on interest rates (such as yours truly) there is no time better to be in cash than when rates are escalating. And I am in cash. Moreover, I am expecting a road map of rate increases to be announced at the Fed's December meeting. After that, I will repurchase a host of my longtime favorite income producing securities, many of which are currently in the tank due to Mr. Market's overreaction to the reflation discussed above. I see a win/win: increased yields purchased at bargain prices. (Remember the higher the yield, the lower the price.) I just need to be patient.
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