September 5, 2017
Bull Markets Don’t Die of Old Age, They Die of Fright
The Investment View from Prescott, Arizona
Last month, right after my article “How Far Can This Bull Run” was published, Investment News carried a piece focusing on what actually caused the last 9 bull markets to finally roll over into bear markets. It seems that fear among investors is the biggest reason that triggers bear markets.
Here is a listing of bear markets since WWII and the biggest worries of those days:
1946-47: Investors feared the return of the Great Depression as factory jobs disappeared when war production stopped.
1961-62: Labor unrest and rising Cold War fears, including the Cuban missile crisis, gripped the nation.
1966: War worries in Southeast Asia escalate as the US bombs Hanoi and sends more troops to Vietnam.
1968-70: Political turmoil as anti-war demonstrations, race riots and assassinations dominate the news.
1973-74: The Arab oil embargoes laid bare a great weakness in the US economy, and Watergate shook our political foundations.
1980-82: Soaring inflation caused the prime rate to rise to 21% and unemployment to rise to over 10%.
1987: Inflation jitters caused a 50% spike in interest rates, setting the stage for the sharpest one day drop in stock market history, 23%. A similar drop today would take the Dow down nearly 5,000 points.
2000-2002: After a sigh of relief that Y2K did not bring the world to a halt, realization that many of the high flying stocks of the day did not have earnings caused a massive sell off of technology stocks. This may be one instance where the bull did die of old age – either that or massively inflated valuations.
2007-09: The housing market and banking collapse affects just about everyone. Business failures at Lehman Brothers, GM and more cause a massive unemployment spike. Record numbers of foreclosures cost many homeowners their homes.
My point in recounting all these horror stories is to point out that right now we are not experiencing double digit inflation, banking collapses or economy-crippling oil shortages. Overall, things are looking pretty good, so any stock market pullbacks should not be much to worry about.
Breathe. Be happy!
Why Bad Things Happen to Good Investments
For several years my to-do list has included an idea to put my 30+ years of experience into book form. A couple of months ago I decided to use the slow summer months to get started on this project with the working title being Why Bad Things Happen to Good Investments.
The book is coming along nicely with 23 chapters done and a few more to go. I expect that it will be published within a few months. Complimentary copies will be available for clients, so stay tuned!
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What We Were Saying Back Then
I have written about Tesla stock a couple of times over the years (October 8, 2013 and August 2, 2016) calling it a story stock, not a true investment. The difference is that an investment has assets that can be valued and earns money for shareholders. Tesla has no earnings, just a good story and more debt than cash. With Tesla stock up over 50% in the past 12 months, am I wrong? I don’t think so.
True, Elon Musk, Tesla’s brilliant promoter/president has developed a brand that is wildly popular, but the true test of whether something is a fad or a lasting brand is time and Tesla simply has not been around long enough to pass the test of time.
Tesla is borrowing money like crazy to create manufacturing capabilities it desperately needs to compete in the auto market. At their latest borrowing few weeks ago, Tesla’s bond rating was reaffirmed by Standard & Poor’s as B-, deep into junk bond territory.
It is not just weak finances that is affecting Tesla’s credit rating, there is crushing competition unfolding from BMW, Nissan, Kia, Chevy, Ford, Mercedes and Fiat who already have electric vehicles in a showroom near you. With Honda, Toyota, Audi, Porsche, and Jaguar also set to unveil new electric vehicles in the next year, the world as Tesla has known it is changing rapidly.
Being first to market with an idea might work in the Internet business where Musk first found success, but in the capital intensive auto industry, manufacturing and sales infrastructure are critical to success. Tesla has very little of that.
There are a lot of arguments that could be made about Tesla’s bright future, but any way you look at it this stock is very expensive, and very, very risky to own.
What the Markets Are Doing
The stock markets have entered summertime doldrums and have been drifting downward for the past few weeks. Some of the primary stock market cycles that I follow have been pointing to down cycles, so this is not unexpected. Knowing cycles like these gives me a heads up on what might be getting ready to happen.
Decadial Cycle: Years ending in a 7 such as in 2017 have a reputation for sharp summer declines, and even leaving 1987 out of the data to avoid having the huge crash in October 1987 skew the data, the trend appears to be a durable one.
Presidential Cycle: The markets this year have been acting just the opposite of how they do during most first term presidencies. The presidential cycle, compiled from S&P 500** data when there is a new president in office, also calls for a sharp decline over the next month or two. However, if the actual market activity continues to run opposite from the normal cycle this could suggest a stock market rally in September.
Annual Cycle: September is one of the weakest months of the year in stock market performance, but we had a huge rally in February this year which also tends to be a weak month, so stranger things have happened than a strong September stock market.
It is pretty normal to have conflicting indicators as we do right now, but I don’t invest based upon speculation like I just presented. I wait until I see the trend reflected in actual stock market performance. Will the market go down as suggested by the presidential cycle? Or, will it go up in opposition to the historic cycle as it has all year? I can’t say for sure, but I am confident that I will recognize the move when it happens and be able to participate.
The bond market has resumed its uptrend following the lead of Treasury Bond prices which have risen as yields have fallen this year. Many media commentators who warned of dire rate increases due to the turning up of the 60 year interest rate cycle last year are confounded.
I do believe the interest rate lows of 1.37% for 10 Year Treasury Notes on July 6 of last year will indeed mark the cycle low, and rates will rise for perhaps 30 years as the cycle suggests. Ten-year Treasury rates are 2.16% as of this writing on August 29th, down from 2.62% in March.
However, the rise won’t be a straight line as some commentators have assumed. It will zigzag like the stock market giving the interest rate markets a texture, sort of a two steps up and one step down affair. In this case the decline in rates is just a step down before we get a few steps back up.
This may present a good time for bond and bond fund holders to take some profits since prices have risen for several months, and they will still be facing a 30 year headwind on bond returns.
Gold is also confounding pundits who have called for a continuation of its 6-year decline. I’ll admit that the strong levels of gold buying has the market appearing overbought, meaning the number of buyers has been reduced by all the recent buying. As the balance of buyers and sellers shift, price directions will change also. Perhaps gold is being recognized as a hedge against rising political risk, but maybe the gold market is fundamentally changing too.
My new gold strategy has worked extremely well this year, keeping us well ahead of the price of gold itself. I note on my charts that gold prices appear to be breaking out from the long term downtrend that has persisted since 2011, so maybe the gold market is just responding to this new trend. At this writing on August 29, I continue to like gold.
What’s Going on In Your Portfolio
As the stock market slowed down over the past month or so (I am writing this on August 30th to get it to you before the Labor Day Holiday) the S&P 500 Index** is down a bit, and each of HCM’s strategies is up, so I am counting August as a good month for us.
Each time the stock market dipped, I took the opportunity to weed our garden of investments and sell weaker holdings, adding cash and increasing our hedges in the Shock Absorber Growth* portfolio. Hedges are an investment that goes up when the indexes are going down, sort of like a shock absorber on the wheel of your car smoothes out the ride, hence the name of the portfolio.
Currently I have our growth portfolios conservatively positioned, with our stock market exposure being only 47%. This means that if the index goes up or down a buck, we should only move 47 cents.
It’s easy to lose less in a down stock market if you have less invested in it, but to actually be making profits with only 47% exposure shows that my stock selection is good because we are doing better than our market exposure would suggest.
With that said, we are going into September with a conservatively positioned stock portfolio.
As mentioned elsewhere, our gold strategy is rocking! All model portfolios have some gold funds in them, so we are all benefiting from the new gold strategy that I implemented in February.
Flexible Income* Portfolios keep making money slowly, which is what you expect from an income oriented portfolio. Ditto for our Municipal Income* portfolio.
Adaptive Growth* Portfolios are currently allocated with 80% Shock Absorber Growth* and 20% Flexible Income*. Adaptive Balance* is 50/50.
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Fundamentals of Investing for Retirees
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Our Spotlight Strategy – Future Technologies
With our Shock Absorber Growth strategy, we strive to provide an acceptable rate of capital appreciation while experiencing one half of the risk of the S&P 500 Stock Index*, using primarily equity investments.
Your money will be invested primarily in stocks and commodities mutual funds and ETFs, both foreign and domestic, inverse and leveraged, and a money market fund. The proprietary HCM Safety Net indicator is designed to warn of potentially sudden declines in which case stock market exposure may be quickly reduced.
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