Category Archives: Investing Money

Why the Bond Market Could Blow Up Any Day Now…

My Comments: The SKY IS FALLING! Actually, it’s not, but many of the headlines suggest it might be. This was published 3 months ago and as you probably know, the bond market has not yet blown up. Lots of things have changed but the bond market is just as boring today as it was then.

Just don’t begin to think it will NEVER BLOW UP. It will change, and you should hope that the change will be gradual. That gives all of us a chance to adjust and become adapted to a different world. Unfortunately, that’s not always how the markets work. Just remember, there are ways to profit from all this, and I can help you, but not with many guarantees.

Brad Johnson, 19SEP14

Since the recession, $900 billion has poured into the bond market because bonds were viewed as a safe place to put money.

But after multiple years of the Fed’s low-interest rate policies, it looks like there is only one direction for bonds to go…


Bonds lose value as interest rates rise.

You already know this… but most consumers don’t.

Already, the Fed is talking about raising interest rates in spring of 2015. Of course, news of an increase will be priced in long before rates actually rise.

What’s the actual impact of rising rates on the bond market?

Just look at the PIMCO Total Return Fund. It’s the largest bond fund in the world.

From May 1st to June 24th (2014), interest rates went up about 1%. At the same time, the Total Return Fund decreased by around 6%.

If a 1% increase in interest rates causes a 6% decline in the value of bonds, what would happen if interest rates went up 2%… 3%… or more?

Keep in mind, this is not a linear progression. At some point panic sets in and the bond market collapses as investors run for the doors. Bloomberg Businessweek reports:

“Wall Street firms are warning clients that if fund investors who view bonds as safe are hit with sudden losses, there could be something akin to a run on the bond market.

“The worry isn’t only that investors’ bottom lines would take a hit. It’s that a mass selloff could swamp the market, with demands for redemptions forcing fund managers to unload their bonds at rock-bottom prices. The ensuing losses would encourage even more investors to redeem, perpetuating the downward spiral.”

The Wall Of Worry, Illustrated

My Comments: Readers of this blog post over the past six months have noted my concerns about a coming market crash and what it might do to your ‘nest egg’. Perhaps you remember my comments about a wall of worry, a phrase that gained traction in past years as the market climbed and climbed and climbed. The image here is a chart of the S&P500 since the major dip in 2009. You will have to decide if it’s real or whether it’s different this time.

James Osborne, Nov. 18, 2014

“The market climbs a wall of worry.” You’ve heard it hundreds of times. It sticks around because it’s true. And we know it is true, at some level. But it is always in the moments of true worry that we want to discount this (and all other) time-hardened wisdom.

Because we will forget, here’s what the Wall of Worry has looked like over the past five and a half years.

a) Unemployment is 9%. Corporate earnings fell 90% over the last 12 months. 10 major banks went bankrupt or sold at fire-sale prices in the last 9 months in the United States alone. The ultimate blue chip GE just announced it is cutting its dividend by 66%.
b) Unemployment is still going up! The US Dollar is absolutely tanking. There’s no way this dead cat bounce is legit.
c) Deficit spending is out of control! We are on a path to ruin.
d) Dodd-Frank will cripple the financial industry and permanently slow economic growth.
e) The US is going to hit the debt ceiling and default on its obligations. We will lose our position as the world’s reserve currency and life as we know it will be over.
f) The “Arab Spring” is destabilizing the Middle East and will lead to international war.
g) China’s “hard landing” will have a ripple effect on the global economy, which is not strong enough to take such a big blow.
h) Greece. Italy. Spain. Portugal. The Euro is a failed experiment. The “Grexit” will cripple already-weak European countries. A lack of stability will lead us all back into a global recession.
i) Too much “uncertainty” surrounding Obamacare is preventing US companies from reinvesting in their own growth.
j) More “uncertainty” surrounding US politics as we head into the 2012 elections. If Obama wins, the country’s economy will be in tatters.
k) North Korea is threatening the world with nuclear weapons. It’s not “safe” to be in the markets.
l) The Boston bombings claim the lives of 3 people and injure hundreds more.
m) Unable to produce a spending bill, the US Federal Government shuts down. Our country is clearly too dysfunctional to invest right now.
n) Russia invades Ukraine. We are on the brink of a possible global war. Only fools would be invested now.
o) Ebola outbreaks reach the US. A spread could decimate the global economy.

Let’s not forget that all along the last five years we’ve had hand-wringing over unemployment (which was over 9% two years after the recession ended), home prices, wage growth, Fed activity, lazy millennials, idiot politicians, global unrest, trade imbalances, peak oil (and now the horrors of falling oil prices), and my favorite, endless “uncertainty.”

So when the next bear market comes, when things get scary again and you try to tell yourself that it was “easier” back in the bull market, pull this back up. It’s never easy. There is always uncertainty. There is always a great reason to sit on the sidelines and wait for better economic conditions. Except that the better conditions never come, and in the process you miss the incredible power of long-term compounded returns.

Fear Lower Oil (prices)

My Comments: Frankly, I enjoy paying less to fill up the car with gas. There is more cash left in my wallet for me to deal with other things I need to buy. At the macroeconomic level, it will help retailers have a stronger holiday shopping season. That will help the economy. But like most things in life, what gets added with one hand results in something being taken from the other.

The following comments are by someone who speaks a language that few of us understand. I’ve highlighted one sentence in para 4 that I think is a takeaway from this. While you may like the idea of shale producers going bankrupt, it’s not a good sign for down the road.

Additionally, the comments in the last paragraph help me better understand why it’s been so hard for investment clients to participate in the historic climb of the DOW and the S&P500 these past two years. The Fed’s activities have overridden the usual strategies to participate without being over exposed to risk. That risk is now more meaningful than ever.

By Michael A. Gayed, CFA  /  Nov. 17, 2014

• The Utilities sector, perhaps the most predictive sector of the stock market, broke down meaningfully.
• The faster Utilities underperform, the more likely on a short-term rolling basis in the coming weeks they are to outperform.
• Wall Street seems to be under the impression the year is over, forgetting that the last time QE1 and QE2 ended, stocks corrected severely a month later.

The S&P 500 (NYSEARCA:SPY) stocks held on to moderate gains as the average stock was flat to down in a week that on the surface looked uneventful, but from a sector standpoint had important movements take place. The Utilities sector (NYSEARCA:XLU), perhaps the most predictive sector of the stock market, broke down meaningfully relative to the broader stock market starting Wednesday. At first glance, one might think after reading the 2014 Dow Award paper on Utilities (click here) that this is inherently bullish for stocks given that when the Utilities sector underperforms, historically going back to 1926 stock market volatility drops and equities rally.

And while this is true, the issue is the speed of underperformance. The faster Utilities underperform, the more likely on a short-term rolling basis in the coming weeks they are to outperform as that lower relative level dictates the soon to come change in rate of change. This means that while Utilities breaking down is bullish, the speed may actually be a set up for another pulse of risk-off strength, potentially at the tail end of November for another trigger to get defensive through either an all-in rotation to defensive sectors away from cyclicals (as our equity beta rotation strategy does), or an all-in rotation out of equities into Treasuries (as our inflation rotation strategy does).

We are only a few short weeks after the end of Quantitative Easing, and Wall Street seems to be under the impression the year is over, forgetting that the last time QE1 and QE2 ended, stocks corrected severely a month later. That would imply December may actually be a high risk month. Ten-year Treasuries (NYSEARCA:IEF), which have held in a tight range just above 2.3% are still signaling concern about US growth and inflation, as yields still seem to ignore what tends to be negative seasonality for Treasuries that begins in November. Combined with Junk debt taking another relative hit, the precursors to a meaningful breakdown seem to be taking place potentially as credit spreads widen and fail to confirm overall bullish sentiment into year-end.

In Arkansas last week, I did a presentation on our award winning papers, and someone in the audience was joking sarcastically with a prior speaker that lower Oil is deflationary, making fun of the idea that saving money is bearish. When I got up, before beginning, I addressed his point quickly and said “be careful what you wish for” when it comes to lower Oil. The meme out there is that lower Oil is bullish, but that completely disregards the speed with which Oil breaks down. Historically, meaningful declines in equities have been preceded by Oil breakdowns.

Furthermore, the faster Oil (NYSEARCA:USO) breaks, the more likely highly leveraged shale producers go bust. Popular junk debt ETFs (NYSEARCA:JNK) and indicies have Oil and Gas as the heaviest sector overweight within those averages. Collapsing Oil could set off a deflationary butterfly effect whereby spreads widen and filter through to all corporates, which in turn would be a form of credit tightening forced by the market as opposed to the Fed.

For us, we believe the post QE3 environment is extremely positive for the types of aggressively defensive rotations both of our main strategies (one alternative, one equity) favor. Both are based on proven historical indicators of coming regime changes in stock market volatility. The challenge since QE3 began has been that the Fed steamrolled any kind of a “risk trigger,” causing any warning signs of volatility changes to be ignored by markets. With that distorting factor out of the way, it stands to reason volatility and correlations revert to historical cause and effect.

Three Visual Ways To Educate Clients In A Bull Market

My Comments: Much of the evidence we see these days tells us we are experiencing a bull market. The DOW hit a new all time historic high yesterday, which is dramatic. Some pundits believe this time it’s ‘different’ and a downturn is unlikely. I’m not one of them.

I’ve been playing this game for almost 40 years now and I can tell you with absolute certainty that a downturn is coming. What I can’t tell you is when it will arrive nor how deep it will be. Just that you better plan for it.S&P500-1993-2014

The chart above shows the S&P500 over the past 20 years. If you don’t believe the next direction is down, I’ll be happy to listen to your logic. As an advisor, my role is to help clients and prospective clients better understand what they have to do to keep their money growing. Here are 3 ideas I came across a few months ago. They are good ideas and I use some of them, but the visual above is pretty compelling too.

August 26, 2014 • Christophe Gauthron

In the face of a relentless bull market in equities, advisors have the difficult task to justify balanced allocations to clients who have grown increasingly ambitious on returns. As the memories of the 2008 crisis start to fade, investors have become less realistic and more greedy.

Financial advisors have stated that some their clients at the start of 2014 have demanded of them why don¹t you allocate more of my portfolio to stocks? Advisors have naturally justified their choices by pointing to the allocations agreed upon in the policy statement. Often this reasoning is insufficient to preserve the client¹s trust and satisfaction.

A mid-year review in 2014 now brings on the same line of questioning as financial advisors must manage their clients risk and expectations in a bull market. A recent study of mass affluent investors by AssetMark finds critical gaps in knowledge and expectations between advisors and their clients. Nearly half of the study respondents say they would risk 25 percent to 100 percent of their portfolios for commensurate returns, yet the vast majority claims to be moderate to low risk takers.

On a positive note, the study reveals that investors want to be more educated about risk by their advisors. However risk is difficult to measure and communicate. What is the best way to explain risk, negotiate risk/reward tradeoffs and set realistic expectations? Or would you rather have your client educate themselves on social media? After conversing with many financial advisors on this topic, it appears that judicious use of portfolio analytics ¬ backing your arguments with easy to understand metrics and rich visuals ¬ may significantly improve your communication and trust with clients. To create this valuable opportunity, you must become a story-teller to your client. The following three visual analytics will greatly educate your clients in a bull market:

• Present risk/reward visuals for long term periods. Over a 10 years or even 20 years horizon, balanced allocations have done nearly as well as pure equity portfolios but with less volatility. The risk/reward visual is simple to understand and puts risk and return on an equal footing. The risk metric used is typically the portfolio volatility. Astute investors may point out that volatility of investments going up in value (like recent equities) is a good thing. Explain that the faster an investment has gone up, the faster it can go down, so high volatility – even on the upside ¬ is a still a sign of risk. To drive the point home, highlight investments with high volatility on the upside in the tech sector of the stock market just before the crash of 2000.

• Emphasize the maximum drawdown on return charts. The maximum drawdown is the amount of loss from a portfolio peak value, to the portfolio lowest value within a given period. Since this is a measure of the actual amount of money lost, the client can relate to this better than volatility. The maximum drawdown is best shown on a return chart. To emphasize the loss, highlight not only the depth of the draw, but the length of time it takes to recover from the draw. Ask the client if they will have the nerve to cope with a steady decline over several months or even years.

• Stress test the clients portfolio. This may be the most effective visual to remind clients that adverse events (black swans) causing crashes can happen at anytime, and by nature these events can’t be forecasted. To quantify the effect of adverse events, present the client with a portfolio stress test. How much would the portfolio lose in case of a currency crisis? a war? a liquidity crisis? Portfolio stress tests have been used by institutional investors for years.

More recently, stress test features have been made available in more affordable and easy-to-use packages for financial advisors. With these packages you can construct hypothetical scenarios, but for simplicity you may also use historical scenarios such as the tech bubble in 2000 and the financial crisis. Historical scenarios have the advantage of requiring no setup, they can be presented in seconds for any portfolio and they are easy to relate to. A side-by-side A/B comparison of portfolios is always the most powerful way to educate the client.

At the end of this presentation, your message to the client should express, “Let us construct a strategy that conforms to your long-term goals, not to a hot market.” Successful advisor-client relationships is a two-way street. Just as clients seek educated financial advisors to manage their investments, advisors should seek resources that not only provide safe returns to clients but educates them as well.

Christophe Gauthron, CFA, is founder of Kwanti, a software provider serving financial advisors and investment managers.

‘Risk On’ for Now

financial freedomMy Comments: Continuing with the theme that if you have exposure to the markets you need to be very careful, here is another metric from someone who knows how to read the tea leaves.

I’m reluctant to continually use fear to motivate people to act. But if you are not now in cash, then you need to be able to move to cash quickly. As an added benefit, if you also have the ability to move further and make money while others are losing theirs, you just may come out the other side as a happy camper. At least that’s the plan.

November 07, 2014 Commentary by Scott Minerd, Chairman of Investments and Global Chief Investment Officer – Guggenheim Investments

Last week’s investment roller coaster was something we had been expecting—U.S. stocks delivered their usual bout of seasonal volatility right on cue. For now, recent spread widening in high-yield bonds and leveraged bank loans seems to be over, and it also appears that equities have regained their footing after a turbulent week.

With the anticipated seasonal pattern of higher volatility in September and October now largely fulfilled, we anticipate more positive seasonal factors over the next two months. Over the last 68 years, the S&P 500 has averaged monthly gains of 0.9 percent in October, followed by even stronger increases of 1.2 percent in November and 1.8 percent in December.

The current dark cloud that hangs over Europe is a serious threat and something that investors should closely monitor. If the anticipated seasonal strength—which is typically driven by an influx of cash into pension funds that their managers are keen to put to work—is not forthcoming, investors should seriously question how much further the current bull market can run. As of now, we remain cautiously optimistic as we await some crucial economic data.

Chart of the Week

Can U.S. Equities Sustain this Rally?

Despite the Dow Jones Industrial Average high made on Nov. 6, the New York Stock Exchange Cumulative Advance/Decline line remains 1.1 percent lower than its peak on Aug. 29. Historically, a persistent divergence between the DJIA and the Advance/Decline line usually leads to a major correction in equities. Whether or not the Advance/Decline line can catch up with the increase in equity prices over the next few weeks will determine whether the current rally is sustainable.

Economic Collapse Scenario

investmentsMy Comments: I know, I know, I sound like a broken record. Last Friday I spoke to a gathering of about 100 retired people. And fear of the markets was shared by almost all. For many, uncertainty itself causes fear, but when added to the doubts about how to avoid the inevitable, it becomes palpable.

I first heard about Harry Dent in the 90’s when he published a book that talked about the DOW at 20,000. By the time 2001 arrived, that idea had been pushed onto the dustheap of history. Only now it’s not so far fetched given the markets highs reached last week.

Nevertheless, Mr. Dent is a prodigious economic thought leader and these comments sound all too familiar. If you haven’t yet put your money where it will be protected from the next downturn, you should. Talk with me.

Harry Dent Nov. 5, 2014

• From late 2014 to early 2015, the scene will be ripe for a major shift in the markets.
• Global growth has been declining steadily from a peak in late 2009 of 5% to a low of 2.2% in mid-2012 and 2.7% recently.
• Stocks from emerging markets represented by EEM are down 20%+ in recent weeks with its pattern suggesting a drop to at least $27 in the coming year.

The third round of QE is finally over. And stocks keep edging up. They’ve been slower than in 2013 and the recent correction took them temporarily into negative territory. The trend currently is that investors simply have nowhere else to go with bonds fluctuating constantly and commodities faring even worse.

Despite the slowing of affluent spending ahead in the U.S., it continues to look stronger than Europe. China’s economy is consistently slowing and Germany is not doing well at all… these are all things we’ve warned were coming.

But even after the 10% setback into October 15 for stocks, they’ve roared back stronger than ever. This may be the final hoorah for the “market on crack.” The Fed has rigged the markets so there’s nowhere else to go, but stocks and the bulls keep running… and they’ll run until they’re out of steam, which looks like it’ll be very soon at this point.

Today’s latest surge comes from another doubling down on QE from the most desperate country in the world, Japan. This is insanity!!!

I see a big shift coming by looking at chart patterns across financial sectors… The clearest one is the Megaphone pattern on the Dow (and many other sectors like the Russell 2000 for small-cap stocks).
megaphone 1995-2020Each bubble over the past 14 years has taken the markets to new highs in 2000, 2007 and now 2014, but each crash has also taken us to new lows. I’ve been predicting the Dow would peak just over 17,000 and then fall to a level between 5,500 and 6,500 depending on when the bottom trend line above is tested.

Throughout 2013, the Dow gained 25%. Yet if you look at the last bull run from mid-November 2012 to the end of 2013, the Dow gained 33% – from 12,500 to 16,600. At its top on September 19 of this year and the retest of that today on October 31, the Dow only gained 4.2% at best.

Why? It’s hitting resistance at the top trend line of this massive Megaphone pattern… and the Fed is tapering and taking away the punch bowl.

Not including China, the emerging markets are the only ones that still have strong demographic trends, but they’ve stayed consistently down since early 2011. Why? They correlate much more with commodity prices than with the U.S. and other developed countries stock markets.

Commodity prices are down about 27% since late April 2011 and stocks from emerging markets represented by the iShares MSCI Emerging Markets ETF (NYSEARCA:EEM) below are down 20%+ in recent weeks. Look how EEM has traded between $36 and $45 since September of 2011 in a long A-B-C-D-E sideways channel.

This consolidation should be about over and it should break strongly, regardless of whether it is up or down. The best interpretation was that the recent high peak (E) that broke back to the top of the channel at $46 was the final wave up.

This pattern suggests a drop to at least $27 in the coming year, especially if it pushes below that $36 level ahead convincingly. That’s 41% down from the recent high… and that’s just the next drop coming most likely in the next year. That would only be consistent with a continued fall in global growth.

In respect to gold, most people are keenly aware that its prices have been plodding along in a sideways pattern since May of 2012, with a distinct line in the sand around the two bottoms it hit when it neared $1,180. Gold broke below that level today. Hence, another drop is likely approaching with the next support at around $700. Oil is also close to breaking down from a long sideways pattern at just below $79. It could fall as low as $10 to $20 in the next several years.

Another commodity that best represents global growth is copper. Its horizontal movement has been going on since about May of 2013. It’s been hovering near $3 recently, but keeps bouncing off of $3. If it falls much below $2.90… it’ll be curtains for copper, commodities in general and global growth.

Global growth has been declining steadily from a peak in late 2009 of 5% to a low of 2.2% in mid-2012 and 2.7% recently.

Here’s the bottom line. From late 2014 to early 2015, the scene will be ripe for a major shift in the markets. The chart patterns and our fundamental indicators and cycles all strongly suggest it will begin slipping down starting in early 2015 at the latest.

Be selling on rallies, especially as the Dow hits one more new high at 17,400+. Look to get out a little before rather than after a peak as bubbles like this one will burst quickly… just as gold’s did in early 2013.

The Fiendish Bond Market Needs a Radical Rethink

My Comments: In keeping with my recent posts that suggest a strong market correction is coming soon, some readers have suggested the solution is to shift away from stocks into more bonds. I remind them that interest rates have been declining since 1981 and they too will reverse course at some point. When they do, you do not want to hold ANY long term bond positions.

The dilemma is that short term bonds have such lousy returns that they are almost meaningless. By the time you’ve paid taxes on the earnings, assuming they are not municipal bonds, and dealt with inflation, you have gone broke safely.

So this is an interesting read. Not sure it will or can happen. But if you are worried, we need to talk as there is a glimmer of hope that you can take advantage of.

Stephen Foley / October 29, 2014 4:42 pm

A trader works on the floor of the New York Stock Exchange minutes after a Federal Reserve announcement on January 29, 2014 in New York City. This was another Fed announcement of another reduction in its monthly bond buying program.

Shares in Verizon rose. Or they fell. Whichever, the point is that it is easy to keep track. The US telecoms group has one kind of share, whose price zips along the bottom of business news channel screens or pops up when you hover in stories. Would that it were so simple to keep track in the bond market.

Companies issue such a dizzying number of different bonds that it is impossible to focus the same light on the fixed income market as on equities. In the past, although bond investors grumbled, the opacity did not matter to companies one jot. But the market has changed and it matters now.

There are $7.7tn of corporate bonds outstanding in the US alone, financing business investment and economic growth (as well as, more recently, share buybacks that have plumped up equity markets). Fixing the market’s flaws is vital. It is time for a radical rethink of how companies issue debt.

Verizon, which holds the record for the most money raised on a single day in the bond market, has more than 70 kinds of bond out. When it sold $49bn of debt last year it did so in eight slices, each a different kind of bond paying a different interest rate and maturing on a different date. In the market last week, it raised another $6.5bn with bonds maturing in seven, 10 and 20 years. And Verizon is one of the more restrained issuers.

General Electric, whose shares are among the most widely held in the US, has more than 900 kinds of bond outstanding. Banks have even more: Citigroup had 1,865 separate types when Barclays counted them in April.

The inevitable result is that trading in any one bond issue is very thin, especially in those sold more than a year ago. Finding another investor who wants to buy the exact type of bond you are selling is no easy task at the best of times. If the end of quantitative easing marks the start of rising interest rates, which hurt bond prices, then investors’ 30-year love affair with fixed income may cool, and the market could become dicey indeed. Regulators worry about potential systemic risks in the event that sharp price falls in illiquid bond markets lead to big investor losses.

What is required is for corporate bonds to be standardised so that there are fewer of them trading more frequently. It is the principle adopted by the biggest debt issuer in the world – the US Treasury, which auctions new bonds on a strict timetable and whose 10-year Treasury note is the de facto benchmark for the fixed income market. The derivatives market, often described as the Wild West of the financial markets, is also highly uniform in parts.

Companies ought to increase the size of each individual bond issue to boost secondary market liquidity. They ought to adopt common interest payment dates. And they ought to issue debt on a regular timetable, perhaps quarterly for the biggest issuers, so that all bonds mature on the same dates. The easier it is for investors to make like-for-like comparisons, the more willing they will be to trade.

Corporate treasurers might ask what is in it for them. Right now they dip into the market opportunistically, trying to time it to catch the lowest possible borrowing costs. The trade-off is that standardised bonds that are more readily tradable by investors are likely to attract more demand, which itself will lower companies’ borrowing costs. Reducing complexity should also cut research and administration costs for borrower and bond investor alike.