February 8, 2011
Avoiding The Next Investment Bubble
The Investment View from Prescott, Arizona
Bubbles always burst, and investment bubbles, created when markets go too far too quickly, always end badly when they burst.
What most folks don’t realize is that the losses from bursting investment bubbles don’t usually end until all of the gain from the run up in prices has been given back. All of it!
The time for recovery from a bursting investment bubble often means a whole generation of investors can be lost if they practice buy and hold investing. They either end up too broke to invest again or are so soured on investing that all they want to do is bury their money in the back yard.
Gold reached $800 an ounce in 1980 and then lost ¾ of its value and stayed in the $200 per ounce range for many years, ultimately taking 27 years to get back to even at $800.
The technology laden Nasdaq stock index** rose more than 700% from 1997-2000 before falling all the way back to 1997 levels again. Currently, after 14 years of recovery, the Nasdaq Index** is only halfway back to its 2000 levels.
Housing prices? That bubble is still unwinding, but according to the Case-Schiller Housing Index, home prices have declined 31% on average across the U.S., and it will be many, many years before prices get back to previous highs.
Bubbles, like so much in the investment world, can be both good and bad. They are good when going up, but really bad when they burst – something to be avoided, for sure.
Some investors say gold is again in a bubble, having gone too far too fast. That’s possible, but I don’t think so. Gold’s rise has been pretty orderly and has not yet entered a parabolic or a “damn-near straight up” phase that is characteristic of bubble markets.
Gold buyers still comprise a small portion of all investors, so even if the price were to decline, losses would be focused on a small number of people and the economy as a whole would not be impacted.
The real bubble, the one with the most risk, is in U.S. Treasury bonds which appear to be at the end of a 30 year upward run. While the stock market can theoretically go up forever, the bond market cannot.
What is driving the T-bond market right now is the Federal Reserve Board’s decision to hold interest rates down by buying Treasury bonds. If you remember the bond teeter-totter I refer to occasionally, when the price of bonds is bid up the interest rate goes down just like the other end of a teeter-totter.
The Federal Reserve Board is putting about $25 billion per month on the “bidding up prices” side, and expects to do so for 5 more months. This artificially holds bond prices up and interest rates down.
Right now, 90 T-Bills are paying .15%. Even Two-Year Treasury Notes are paying less than 1%. Ten Year Treasury Bonds are paying only 3.68%.
In addition to holding rates down, this injects cash into the economy as bonds are replaced and greases the wheels of commerce since cash usually gets spent or invested someplace.
I’ll agree that the weak economic recovery needs some kind of help, but periods of excessive monetary stimulus like we are seeing almost always end badly. The injections of cash in 2002-03 after 9-11, contributed to the housing bubble. In the late 70’s, interest rates held too low for too long, created excesses that led to double digit inflation and the gold bubble of 1980.
So, the Treasury bubble has clearly been expanding toward the breaking point. It may get messy when it finally bursts.
Growing up in Chicago, I have long been a Bears fan, so I was understandably disappointed when the Packers beat the Bears for the NFC championship a couple of weeks ago.
But considering that Green Bay had a 2008 population of 101,000, how they compete so well in a big money sport is beyond me.
So congratulations to the Packers in winning the Superbowl this past weekend. I love rooting for the underdogs.
And as a Bears fan, I’m used to waiting until next season. Sigh.
Q: Why can’t a bicycle stand on its own?
A: Because it is two tired.
LOL – (Laughing Out Loud)
I think I’m going to quit eating health food. I’m at an age where I need all the preservatives I can get.
New Credit Cards Vulnerable to ID Theft
To reduce credit card fraud, new cards are designed to be contactless. To pay for something, just wave your card near the reader and you have the security of never having to let your card out of your hand to use it. The technology is called RFID technology.
But in another example of technology creating unintended consequences, crooks are now arming themselves with RFID readers which allow them to simply walk by someone who has one of the new credit cards and read the credit card information right through your purse or wallet.
This three minute video explains the problem in vivid detail.
The solution is to carry credit cards in specially designed sleeves with a protective “Faraday screen” mesh. As an alternative, one could line their wallet or purse with tin foil.
One of my credit cards has this technology, so I just ordered a new wallet with a built in Faraday screen. My 15 year old wallet was due for a replacement, anyway. There are many websites available that offer wallets with these protective screens, so you can shop around for a style that suits you.
If any of your credit cards have this symbol on them, they are RFID equipped cards that need protecting.
Oh, one more thing. Passports issued after 2006 have the same security weakness.
How’s The Market Doing?
It appears that the stock market’s uptrend has reasserted itself. The market correction I was expecting in January looks like it was limited to a 2% or 5% dip, depending on which market index you measure it by.
Some leading stocks fell pretty hard, but overall it appears to have been a very minor and routine correction.
It was enough, however, to resolve the growing imbalance between buyers and sellers that had developed earlier in January, and it is the balance between buyers and sellers that keeps the market from getting too goofy.
When someone invests, they change from being a potential buyer who can push the market up, to being a potential seller whose action would push the market down. Too many buyers in a short time can create an excess of potential sellers and drive the market down.
The measurements of these imbalances are called over-bought and over-sold, and those indicators have fallen back to acceptable levels after the recent correction.
The Fed’s buying of Treasury bonds, replacing them with cash that then needs to be reinvested, appears to be “the thumb on the scale” causing the markets to defy gravity for the past couple of months. That has made many market indicators less effective than they normally are.
That dynamic, combined with favorable market cycles makes me as much of an optimistic about the market as I get. Things could change this summer, but now the market is clearly in an uptrend and that is a good time to be invested.
What’s Going On In Your Portfolio?
My #1 investment objective has always been to manage and reduce the risk of being invested, making good returns easier to achieve just by missing the big declines in the market. I managed risk, and the returns just came along.
That approach changed two weeks ago as I implemented some changes in my Careful Growth* strategies that I have been planning, programming and discussing in the past couple of newsletters. Now I am managing more for return than I used to.
The time to implement changes like this is at turning points in the market such as we had at the end of January’s market correction.
The main change involves being much quicker to reinvest after a correction. Waiting for additional confirmation that an uptrend has resumed means watching gains go by for a while before declaring “Yep, this is it”. Although risk of being wrong is lower doing that, reward is lower, too, which is what held us back last year.
Moving out of the money market fund to fully invested more quickly means there is more risk that the corrections may not really be over, so I also made some changes to my risk controls to offset that added risk.
So far, since the changes were implemented on January 27, we have out-performed the S&P 500 index** by several percentage points. I am excited by the results. Ten days does not really make a trend, but so far so good.
As of Friday, February 4th, the Careful Growth* model portfolio has 96% of assets in stocks, including 30% exposure to international markets, and 40% in “hard assets” including gold, energy and natural resources. Technology and construction related stocks make up the rest of the portfolio.
The Flexible Income* model portfolio is also fully invested with currency funds and gold; bonds funds including corporate, high yield and floating rate funds; and a couple of high dividend stocks rounding out the portfolio.
Balanced* accounts, of course have a 50-50 blend of both models.
Our Spotlight Strategy
We strive to provide high total return in our Balanced Strategy. Your money will be invested in a 50/50 mix of HCM’s Flexible Income* and Careful Growth* strategies, described separately.
* The model accounts mentioned in this article are hypothetical examples of how the strategy may work as designed. Activity in client accounts may be different from that in the model in amount of each investment, specific timing of trades, and actual security used, which may vary from account to account. Not all trades are profitable. It should not be assumed that current or future holdings will be profitable. A list of all trades in these accounts for the past 12 months will be provided upon written request.
** The S&P 500 and Nasdaq Indexes are unmanaged lists of stocks considered representative of the broad stock market. Investors cannot invest directly in the S&P 500 Index.
Balanced Strategy Description and Performance Information
Careful Growth Strategy Description and Performance Information
Flexible Income Strategy Description and Performance Information
This newsletter may contain forward-looking statements, including, but not limited to, statements as to future events that involve various risks and uncertainties. Forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause actual events or results to differ materially from those that were forecasted. Information in this newsletter may be derived from sources deemed to be reliable; however we cannot guarantee its accuracy. Please discuss any legal or tax matters with your advisors in those areas. Neither the information presented nor any opinions expressed herein constitute a solicitation for the purchase or sale of any security.