@theMarket: Interest Rates and Stock Market
After years and years of historically low-interest rates both here and abroad, stock investors are suddenly paying attention to the day-to-day movements of the world's bond markets. They may be getting a little too obsessive for their own good.
This week, the 10-year Treasury note and the equity averages moved hand in hand. As the yield on the U.S. Treasury moved higher, stocks moved lower. As the yield fell, stocks gained ground. This change in behavior is causing a great deal of needless volatility but I believe it is all part of the "normalization" process.
That is a term coined by investors to explain what happens when our central banks begin to back off the last ten years' worth of monetary stimulus and let the markets begin to dictate the level of interest rates. Now, historically, bond and stock holders have had a symbiotic relationship.
As interest rates rise, stock holders would take account of the rising yield on bonds and compare it to what they can get in the stock market. If they deem that bonds are a better deal than stocks, they sell equities and buy bonds. Usually, investors take into account the longevity of these investments -- one, five, seven, ten, twenty or thirty years, while what happens to yields on a day-to-day basis does not tend to move stocks. But these are not normal times.
The controversial but largely successful actions of the world's central banks to stave off a second global depression brought on by the U.S. financial crisis is now being unwound. Since there were no precedents for the Fed's massive market "save" over the past decade, there is no surety that reversing the process will work without tipping us into some unforeseen calamity.
Remember too, that we now have an entire generation of financial sector players from retail brokers to institutional proprietary traders that have never experienced a rising interest rate environment. It has been almost 45 years since interest rates topped out during the Jimmy Carter years. Since then, rates have fallen lower and lower until quite recently.
At the same time, the wide spread use of algorithms, computer-driven trading and the like has largely replaced human thought and behavior in over 70 percent of daily trading volume. These computers are driven by software programs created by extremely young and unseasoned "quants" that simply look at numbers. They instruct their machines to sell if "X" price falls or rises by a certain amount.
They have neither context nor history to adjust their programs for a rising interest rate environment, so they treat bonds just like they were stocks. These technicians are running around building "models" to trade these short-term blips in bond movements, while trying to figure out their impact on individual stocks and indexes. There is no doubt in my mind that they will succeed. The problem is that bonds are not stocks.
Unlike the majority of stocks today, bonds are meant to be held, sometimes, until they mature (which can be as much as 30 years). Daily price movements are simply "noise" in the grand scheme of things in the bond world. But, today, young Turks act and trade like a 4-5 basis point move in bond yields will mean that the trillions of dollars invested in these instruments will be sold or bought in the next minute or so.
For you and me, what this development will provide is another reason why daily and weekly moves in the equity markets will have little to do with reality. The day's stock market results will simply be a reflection of a schoolyard full of little boys and girls playing with their toys. Some will make money doing it, while others will lose.
As for the markets, this week I expected them to pull back some. They did. During the last four days, stocks traded up and down in huge intra-day moves. On Tuesday alone, the Dow gained over three hundred points, dropped almost the same amount, before gaining half of it back. This kind of volatility tells me this consolidation period may not be over. We could still see a little more damage in the very short term, but overall, I am still convinced we are going higher and fairly soon.
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The Independent Investor: Is America Back in the Space Business?
If you were watching television this Thursday, you may have caught the launching of a low-orbit Spanish government-commissioned satellite launched from Vandenberg Air Force Base in California. The difference between today and 25 years ago is that it was a private company called Space X, rather than NASA, that made it happen.
For old guys like me, space exploration was a big deal while growing up. Americans my age cheered and cried as the U.S. raced for space from the tragic death of the crew of Apollo One in 1967, to the first moon walk in 1969 (and no, I don't mean Michael Jackson). The work day would be put on pause as everyone watched the latest rocket launch from Cape Canaveral. If the launch was on the weekend, the family would gather around the television to applaud our latest leap into space.
But America's interest and commitment to space waned as the years went by. The space shuttle program was expensive and the government had other wars to fight. Building new space craft required lots of new technology with no guarantee of success. And there was a limited pool of people that had the expertise in space flight operations and even less who were capable of space flight operations.
Yet, there were some among us, call them entrepreneurs, visionaries or just good businessmen, that still believed in space. But in addition, they believed that there were economic possibilities in pursuing space. People like Elon Musk (the electric car guy) who was willing to go where others feared to tread. A flood of new private money began to flow into private space projects. Rather than construct the behemoth rockets and huge space ports of yesteryear, today companies such as the Musk-owned Space X make do with a few trailers and super-thin rockets topped by large payload capacities.
In a new approach to cost savings, rocket parts are designed to be reusable (like the old space shuttles). Space X, for example, tries to save the first stage of its rockets. New technologies also allow for many of these modern rockets to land once their mission is over, which saves even more money.
Thursday's successful launch, for example, is the second time Falcon 9 is being used for space duty. It is the same rocket that was launched in 2016 on a cargo resupply mission for NASA. Its payload this time is a satellite for the Spanish government.
Space X is reported to be charging $60 million for the service, plus launching costs. There have been other cargos that commanded even more (upwards of $160 million), depending upon the amount of cargo involved. The cost to make the Falcon 9 was roughly $60 million, plus $200,000 to fuel it.
These private efforts were spurred on last year by a series of actions by the federal government and a president who has long harbored a soft spot in his heart for space. The difference this time around is that President Trump, while rededicating the U.S. to the exploration and utilization of the moon, Mars, and space in general, will rely on private companies to achieve that goal. He wants to make the U.S. "the most attractive jurisdiction in the world for private-sector investment and innovation in outer space."
Space exploration is a goal that all of us can get excited about, something that could pull us together again and provide an enormous pay-off in ways we cannot even begin to imagine. I don't care how we get there, just as long as we do. As one of my heroes once said "to infinity and beyond" – let's do it!
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@theMarket: Markets Have Best Week in Five Years
Stocks have had what is called a "V" shaped recovery this week. The indexes climbed every day at least one percent or more. Will it continue or ...
It wouldn't surprise me if stocks took a breather about now. A bout of profit-taking after the stupendous come-back we have had would be entirely reasonable. If the S&P 500 Index, for example, fell back 2-3 percent over the next week or so that would be healthy.
Remember, we are still in that period of the markets where investors are driven by the fear of missing out. As interest rates continue to climb and bond investors experience losses, the natural thing would be to sell bonds and buy equities.
In a lesson in reverse psychology, investors over the past week have talked themselves into believing that higher rates and a pick-up in inflation is actually good for the markets. Last week that same set of variables spelt doom for the stock market.
For me, the pullback was part of the natural rhythm of the equities market. Expect more of the same as the year goes by. However, these market dips will be supported by the accelerating growth of the global economy. That growth should climb this year to about 3.7 percent, while the U.S. economy should grow by almost 3 percent. We will also see inflation begin to climb to a 2.5 percent rate (give or take), which is higher than we have seen for many years.
The market is not wrong when they say a little inflation can be good for the economy. Everything is good in moderation. It is sudden spikes, whether in interest rates or inflation, that unsettles the market.
Since prior to the Republican tax cut, I have been saying that the danger would be that the tax cut really did what the president promised: increase investment and boost employment. If, on the other hand, the $1.5 trillion was simply a mass redistribution of wealth out of the pockets of Main Street and into the coffers of corporations and the rich then the stock market has little to worry about.
The money will simply be used to buy back stock and increase dividends. Since 84 percent of all stocks are owned by the wealthy (including Trump and almost all senators and congressmen), not only will these beneficiaries gain on a lower tax rate, but their investments will also gain.
As for the economy, it will do quite nicely without the additional fiscal stimulus. Unemployment is already approaching historical lows. So, from an economic point of view, the tax cut was eight years too late and is a needless addition to an already-huge government deficit.
So far the evidence points to the tax cut as a redistribution of wealth. Since the tax cut announcement, corporate buybacks have gone through the roof. Year to date, (and we are only in February) the amount totals $170.8 billion (17 percent of the tax cut) versus $75.7 billion for all of last year.
As for investing the tax cut into plant, equipment, and new jobs, well, 70 percent of corporations polled have no intention of investing the money, while the other 30 percent had plans to invest anyway prior to the new tax cut.
The final and most recent fiscal spending proposal on the nation's infrastructure announced this week is much-needed. However, the scheme, as presented, would mean the federal government would put in "seed money" of $250 billion, while the states and private sector would put in $750 billion.
Given that the tax cut was an enormous economic blow to states that have their own income tax, asking them to now ante up $750 billion for much-needed infrastructure repairs is the height of lunacy. Of course, Trump knows this all too well, but it gives him an out to blame the states for not doing their fair share when his proposal goes belly-up.
As for the markets, remain invested. Increased volatility is no excuse to sell, only a reason not to look at your portfolio every day or week. Remember that the more red you see in your portfolio on any given day, the higher the probability that you will sell at the exact wrong moment.
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The Independent Investor: Time to Hedge Your Bets?
Over the last few weeks, the threat of rising inflation has triggered a great deal of concern among investors. Given that inflation has been at a low level for a number of years, their concern may be justified.
Many market pundits were surprised by the wage data in the non-farm payroll report for December, which was released two weeks ago, Friday. In that report, wages jumped far more than most expected coming in at a 2.9 percent annualized growth rate.
Given that our central bank monitors wages as one of their key indicators to gauge future inflation, that number sent the bond and stock markets into a tizzy. Again this week, investors received another inflationary surprise when the most recent Consumer Price Index (CPI) jumped 0.5 percent in January. The gains were broad-based in everything from energy to apparel.
This news was not taken too well in the bond market where the U.S. 10-year Treasury bond rose to above 2.9 percent, the highest level it has been in several years. Many economists believe that a further rise to 3 percent is inevitable. Yet, none of these numbers spell doom for the economy or even the stock market. From a historical perspective, both inflation and interest rates are still at incredibly low levels. But the markets tend to look ahead.
What, they ask, will the rate of inflation be by the end of this year or next year? Here, things get a bit dicey. You see these recent inflation numbers do not reflect the impact of the $1.5 trillion tax cut, nor the increase in the nation's deficit. Neither do they include this week's presidential announcement that an infrastructure package worth another $1 trillion is in the works.
If you add all of this spending up, in addition to an economy that is already growing at 3 percent while unemployment is at rock bottom levels, there is a danger that the economy might overheat. If this were to occur, the Fed would be forced to raise interest rates sharply. That would be bad news for stock and bond holders.
However, in a scenario where inflation expectations are rising, commodities do quite well, at least for a year or so before the Fed takes away the punch bowl by raising rates. When most investors fear inflation, they buy gold as a hedge. It has worked well through past cycles.
Looking at the price of gold over the past decade or so, gold's up cycle began back in 2002. It peaked in 2011 when the price per ounce touched $2,000. Since then, it has fallen by almost half, finally bottoming out in 2013 at around $1,200 an ounce. It has gradually creeped higher (by about $200 per ounce) in fits and starts until now. For the last year or so it has been in a trading range of $1,310-$1,370.
While we won't know whether those predicting higher inflation will prove to be correct, it might be a good idea to at least hedge your portfolio. A little gold exposure, via a precious metal fund, commodity fund, or a combination of the two, might not be a bad idea. Since
commodities are speculative, provide no interest or dividends, and are much more volatile than either stocks or bonds, buyers should beware. If you decide to hedge against inflation, I would limit exposure to no more than 2-5 percent of any portfolio.
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The Independent Investor: How to Handle a Pullback
The stock market is in turmoil. Several hundred point swings in the Dow and other averages has investors on edge. The indexes are suffering 1-2 percent point swings per day. How are you dealing with it?
Over the last several months, I have written several columns preparing you for this day. I thought it might be useful to give readers a refresher course on coping. Here are some useful tips on avoiding that worst of all reactions—selling on the lows.
Number one: do not check your portfolio. The more often you do, the greater the probability that you will panic and sell. Every time you check your investments in a freefall decline like this one, you will feel terrible. The only way you can stop the pain (you will say to yourself) is to sell. Don't do it.
You see, we humans are really not built for investing. Our primal instinct when we face danger is to run. That fear and flee response has been saving our butts ever since the first sabre-tooth tiger chased us out of our caves. But putting some distance between you and that predator doesn't work very well when it comes to investing.
We are more comfortable thinking in the short term. No never mind that stocks may come back next month or next quarter, most of us can't take our eyes or our minds off what happened today and what may happen tomorrow. How many of you remember the back-to-back declines we had in the first quarter of 2016? Not many, I would wager.
For some, this is an opportunity. Given that many of us receive bonuses in the first quarter of the year, we may have some cash sitting on the sidelines. This is the kind of opportunity that most investors hope for. Baron Rothschild once said "buy when the blood is running in the streets." Now is your chance to put that money to work. Buy a little on every down draft and be patient.
But doing that takes courage and willpower. You have to fight that instinct to simply husband that cash and "wait until the market recovers," but by then it will be too late. Do it now when panicky traders are giving away stocks at great prices. There is nothing fundamentally wrong with the markets or the economy. We are simply experiencing a long-overdue correction in stock prices.
But the markets have never experienced these kinds of declines, you might say. The headlines may scream "1,000 point drop on the Dow" but they fail to remind us that the Dow has gained much more than that over the last year. By the time the dust clears, we will have discovered that the total percentage loss of the main equity indexes will be no more or less than what we normally see in corrections.
As I have written many, many times before: this too shall pass. You trusted me then, so I am asking you to trust me now. You won't be sorry you did.
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