I Don’t Believe in the “Great Rotation” – Watch Out for a Drop in Stocks

Some market pundits are talking about the coming “great rotation” from bonds into stocks, based on the idea that bond prices are near 300 year highs. The idea is that people will move their money over to stocks because the yield in bonds is too low to justify the risk of holding the bonds if/when interest rates start to rise and bond prices start to fall. I think that is nonsense.

The fallacy here is the belief that bond and stock prices can move in opposite directions for extended periods of time. Sure, during a crash or a melt-up, both assets may move in the same direction for awhile, like they did during the 2008 crash, or like they did after Qualitative Easing announcements. However, the prices of stocks are ultimately (theoretically) based on what smart people believe future corporate profits to be. If interest rates go up, then cost of capital is higher, then growth and growing profits is more difficult. If smart people calculate that future profits and growth will be hurt by rising interest rates, they will lower their valuation of the stock market’s fair price, and sell those stocks.

Stock and bond prices have both moved up since the beginning of QE (quantitative easing) and I believe they will both move down as QE ends, or loses it’s effectiveness.

I would not be surprised to see a 20% or more drop in stocks from here if bond prices (and interest rates) do not stabilize.

Bonds are Crashing

The new jobs report today was considered positive. Stocks are up while real assets are down. However, bonds are crashing. The ETF for long-term US Treasuries is down -2.5% just today… more than a years return on 10 years US treasuries. Hopefully, nobody thinks of bonds as “low risk” anymore. The US dollar is up quite a bit versus other global currencies and gold. Of course, we are in a holiday weekend, so the markets may be overreacting due to the lower volume of trading.

Thinking ahead, if bond yields, and interest rates continue to rise, our national debt service costs will spike, thus putting the US in a much worse financial position than we already have. This cannot be good for our economy, or for the US dollar in the long run.

Moving Back In

Based on our models, we are moving back in to Emerging Markets and US Real Estate, which have been out of the portfolio for a couple of months (and been clobbered in the meantime). Also, we are re-opening positions in US stocks which were just closed in the last week or so. Finally, the commodities position is being re-opened. We are still betting against long term US treasuries.

In summary, it seems as if we have a temporary respite from the selling. Perhaps the world is beginning to believe the central bankers won’t stop printing money just yet!

Interesting Times

I won’t bore you with a long description of the bad news from around the world. We have enough bad news right here in the good old US of A. We now have around 48 million people on food stamps, around 20 million people who are unemployed or underemployed, and another 10 million people on permanent social security disability. That may sound a lot like a depression to you and me, but, according to Ben Bernanke, the economy is looking up, and he is hoping to cut back on the printing of $85,000,000,000 US dollars each month. The Fed says inflation is very low, but John Williams at ShadowStats.com says inflation is really 6.5%/year if we calculated inflation the same way the US Government did in the 1980’s (yes, our leaders have been changing the way thing are measured to make them look better than they are and hold down the costs of Social Security).

How does this affect our portfolios? Well, our models right now indicate 100% cash. As I’ve written before, we are holding on to the mining company stocks even though they are falling like, well, rocks! When you include the mining stocks in our portfolio models, the models calculate between 19% (conservative accounts) and 30% (aggressive accounts) for those stocks, with the rest in cash. That’s our strategy for now, until some asset classes start to come back.

I would not be surprised if the Fed blinks soon, and talks about INCREASING the money printing. Time will tell.

Where Does the US Dollar Go Next?

As investors and traders around the world have dumped all asset classes to raise cash, the US Dollar has rallied sharply for the last two days against other major currencies. But I don’t think this is going to last very long. Why?

Our very large national debt means very large interest payments which, until the last couple of months have been at record LOW interest rates. Now, what happens when a large debt with large payments at low rates suddenly becomes a large debt with humongous payments at ever-higher rates?

Nothing Good (for the US Dollar).

Our Methodology is Raising Cash Today – Things Could Get Ugly

Well, even though Helicopter Ben told us yesterday that the Fed would continue printing money at the rate of $85,000,000,000 / month, the markets are reacting as if he had taken away the punch bowl. Perhaps this reaction is because Bernanke said that if the economy kept trending up like it has recently, the Quantitative Easing would be wound down over the next 12-18 months. All asset classes are getting absolutely taken to the woodshed today.

As of the end of the day today, our methodology takes us out of all asset classes except cash. As I previously wrote everyone, I will hold the precious metals related ETF’s, because, though, yesterday they started trending down again, they have been falling for a year and a half. In fact, I increased our percentage in these assets another 1-2% this afternoon.

So, in summary, most people are 70% in cash or more, with 10-25% in precious metals related ETF’s.

I Can’t See the Logic

After the Fed’s announcement that they will continue buying $85,000,000 of treasuries and mortgage-backed securities, with no real hints as to when they will “taper”, the market reacted exactly opposite what I would have expected. Everything went down, except the US dollar. Stocks, gold, silver, bonds, you name it. This makes no sense to me at all. I had determined, earlier this week, not to make any changes at all for a couple of days after the Fed announcement, and, so far, am sticking to that decision.

But this makes no sense.  We’ll see what happens next.

Guess What the “New” Dividend Stocks Are?

I had to chuckle this morning, when I was checking the CNBC.com web site for quotes on GDX and SIL, our gold and silver mining ETF’s. They have both fallen so far in the last couple of years that their dividend yield is around 1.58%/year! That’s more than 5 year US Treasuries at 1.06%/year! Where would you rather put your money for the next five years?

Things Are Getting Crazier – Overweighting Precious Metals

I’m going to set aside 10% of most portfolios for precious metals-related stocks and ETF’s and keep them in the portfolio’s separate from and in addition to my standard methodology allocations beginning yesterday, Friday, June 7. This is an increase from the approximately 5% I had been setting aside before.
When almost all investors are betting on the same thing (currently against gold and foreign currencies), there are no more people to join that trend, and a reversal is near. Here is the quote in yesterday’s daily analysis.
It appears that there is an opportunity developing that comes along only once every 10-20 years. Gold and precious metals have been falling since August of 2011, and have been bouncing in an 8% range for the last 8 weeks. Mining stocks are historically very volatile and have done even worse, falling about 60% from their highs in 2011. They also have begun to “bounce along” a possible bottom. At the same time, our Federal Reserve has created many more US dollars, and our deficits continue to reach historic highs daily with no end in sight. So the mining stocks are at the prices of the 2008 crash lows, but there are many more dollars in existence than there were then. While sentiment continues to worsen, the precious metals prices have stopped falling.
Ironically, the big news today causing this sentiment concerns the Federal Reserve possibly beginning to “taper” the $85,000,000,000 monthly purchases of US Treasuries and Mortgage-backed Securities with freshly created US dollars. No one seems to notice that the “taper”, if it does occur, simply slows down the pace at which the Fed is printing money. There is no talk of an end to the money-printing at all. Simultaneously, our recent “sequester” did not reduce our national debt, it simply slowed the pace of annual increases in our debt!
Russia, China, India, Iran, Australia and other countries have been entering into agreements that allow them to bypass the US dollar as the worlds reserve currency, and some are now buying gold and natural resources with the US dollars they have in their reserves. On Thursday this week, the US dollar index dropped -1.2% … in one day!
 
I don’t know when, but this trend of US dollar strength cannot go on for long with our financial balance sheet worsening, and our economy moving in slow motion. So, I am making this move both as a long-term investment and as a hedge to protect the purchasing power of your life savings against some sudden dislocation in the US dollar. We may be early, but a sudden move by the markets or our government to devalue the dollar could leave me without the opportunity to protect you.
 
Now, let me talk about what could “go wrong” with this idea. I could be early. The US could roll over into recession, causing a crash in stocks and bonds. In that event gold and our mining stocks could fall too. My plan, if that occurs, is just to ride it out with this 10% and follow the methodology with the other 90% of your portfolios. Precious metals and the other related assets could begin a new down-trend. I plan to ride that out also. These investments fluctuate as much as 5% in a day, so your total portfolio values will have much more day-to-day fluctuation than you have seen in the past. However, after much thought and prayer, I strongly believe the hidden risk of not doing this now is much greater than the obvious risks inherent in watching your account values drop for a few weeks or months if I am too early.

 

Go Away May, Go Away

May 2013 was a lousy month that turned really ugly during the last week or so. US Stocks were up slightly for the month, but anything sensitive to interest rates and/or a strong dollar got clobbered, especially at the end of May. The fear that Bernanke was nearing the end of QE3 caused all manner of bonds, international stocks, precious metals, REITS and commodities to drop drastically. At the end of May, even US stocks began to stumble.

So what happens in June? My answer is that, for our clients, it doesn’t matter (unless you need all your money this month, and then it should not be in the markets at all). While client account values were significantly affected, depending on how aggressive your allocations, the risk management components of our methodology reduced or eliminated exposure to bonds and many stocks, and began increasing exposure to real assets, which seem to be at or near an 18 month bear market. So, even with a tremendous dislocation in several markets (Bill Gross of PIMCO “officially” called the end of the 30 year bull market in bonds), we emerged from May with losses that can easily be made back up in a month or two of more normal market activity. More importantly, if May’s dislocation turns into a market rout, we enter the second week of June with much less portfolio risk.

Again the key lesson here is that we never, ever allow losses to run away with us while telling everyone to just “hang on, things will bounce back”. By managing risk in this way, we will do much better over the long run.

If anyone has questions or knows a friend who is unhappy with recent behavior in their investments, please let me know

Thanks.