March 6, 2018
The Investment View from Prescott, Arizona
Janet Yellen’s service as the Chairwoman of the Federal Reserve Bank was ended on February 3rd by President Trump who disagreed with Yellen’s policies. Most Fed Chairs serve eight years or longer, and the last term of less than eight years was that of G. William Miller who served for one year, 1978-79, and whose ineffectiveness was blamed for the double-digit inflation that ran into the early 1980s.
The Fed’s actions during the last week of Yellen’s tenure seem to be at the root of the stock market decline that began at that time. Both the timing and circumstances around the Fed action lead me to speculate that Yellen gave Trump a goodbye wave that did not include all of her fingers.
Let me give you a brief background. As my friend and newsletter writer, Tom McClellan (McOscillator.com), says, “There are only two things that matter in investing. How much money there is and how willing investors are to become buyers with it.” Remember, the Fed is in the business of regulating the country’s money supply.
The Fed rescued our banking system in the wake of the 2007-09 financial collapse with a series of bond purchases which took bonds from the economy and replaced them with cash that went into the economy. That flood of investable dollars, as high as $85 billion per month, is what reignited our housing and stock markets over the next few years.
Fast forward to late 2017 when, due to a strong economy, the Fed began to reverse the money flows into the markets by selling bonds and in doing so, removing cash from the economy at the rate of $10 billion per month. Their intention was to increase that amount to $20 billion per month in the first quarter of 2018. This action takes cash out of the economy, cash that could be used to buy stocks.
For some reason, the Fed dumped a full month’s worth of bonds, $20 billion, during the last week of January, which just coincidentally happened to be Janet Yellen’s last week in office. This lack of liquidity (read, lack of buyers) is what created the stock market decline that we have seen over the past 5 weeks.
If the Fed were to trickle bonds back into the marketplace we might have avoided the volatility that has rocked the stock markets since late January, but instead the Fed seems to be selling bonds in big chunks, which is like doing a cannonball into the liquidity pool.
I would hope that the Fed will eventually realize that they are causing the stock market decline and take a different approach. But then, it is a government operation so who knows.
The talking heads on TV have loudly proclaimed that the recent market decline is caused by inflation fears. Don’t believe it.
One of the investments most sensitive to inflation, Treasury Inflation Protected Securities (Symbol: TIP) is down for the year and has declined since the stock market rolled over on January 27th. If investors really feared inflation, they would be piling into TIPs and the price would be soaring.
The other barometer of inflation is commodities (gold, oil, industrial metals, etc.). In looking at the nine commodity ETFs that hold more than $1 billion in assets, the average gain YTD through March 2nd is only .57%, again showing a tepid interest, at best, in buying commodities.
What is happening is a simple rise in interest rates caused by the Fed affecting the balance of buyers and sellers in the bond markets (See my Janet Yellen article elsewhere in this newsletter). For the first time in six years an investor can get more cash flow from interest on 10-Year Treasury Bonds than on dividends from the S&P 500** Index. That makes bonds more attractive to income-oriented investors.
For several years I have been telling readers to avoid buying bonds, knowing that this kind of interest rate rise, and related loses for bond holders, was inevitable. But please don’t think my comments about bonds becoming more attractive are a signal to buy bonds. Interest rates on 10-Year Treasuries have still only risen to half of the historical average rate, so there will be more carnage to come in the bond market.
All of the major stock market indices lost money in February as the S&P 500** Index lost 10% from a previous high faster than I have ever seen it. Most of the world markets are posting losses or fractional gains at best YTD through March 2nd. The lone exception is Russia which is up over 9% YTD through March 2nd. Go figure.
I consider high yield (junk) bonds a good leading indicator for the stock market, and junk is still weak. This may be an indicator of future economic weakness or just telling us that junk bond investors are moving some money into now-higher yielding Treasuries. I am watching this indicator closely.
Gold markets have been chopping sideways in a narrow trading range since mid-January.
Oil’s relentless price rise since mid-2017 stopped about the same time the stock market went on the rocks in late January. Weaker industrial demand? Possibly. But the bottom line is that energy is also chopping sideways and has no well-defined trend at the moment.
I began moving our Shock Absorber Growth* (our 100% growth model) portfolios to a more defensive posture only a few days into the decline that began on January 27th. This has cushioned our portfolios and kept losses to about ½ of what the S&P 500** Index experienced. One of my basic objectives is to reduce losses for you during major market declines, which can ultimately lead to greater long-term gains, and this is how that process begins.
As of March 2nd, our growth portfolios have about 30% cash, and a hedge that goes up if the index goes down, keeping our market risk to less than half of the major indexes. If the market continues down we should outperform the indexes, and if it begins to recover, I will reduce the hedge or put our cash to work buying new stocks to get in sync with that new trend.
Flexible Income* (100% income oriented) portfolios gave back January’s gains during February and produced small losses (in the 2% range) YTD through February 28th. However, since recent portfolio adjustments in mid-February we have again been making gains.
Adaptive Growth* Portfolios are currently allocated with 80% Shock Absorber Growth* and 20% Flexible Income*. If the market continues to weaken you will see me use my Adaptive Market Signal to adjust this allocation to 70/30 and then 60/40, etc., to reduce risk in the portfolio. This tactic is where the term “adaptive” comes from and keeps us on the right side of major market trends.
Adaptive Balance* is currently allocated 50/50, and that allocation will be adapted to current market conditions as needed, like its big brother, Adaptive Growth*.
- Shock Absorber Growth is our 100% growth portfolio.
- Flexible Income is our 100% income portfolio.
- Adaptive Growth Portfolios are currently allocated with 80% Shock Absorber Growth and 20% Flexible Income.
- Adaptive Balance is 50/50 between growth and income.
If you haven’t had a review of your account for a while, please call the office to arrange a time to talk in person or on the phone. The number is 928-778-4000.
T. Boone Pickens (legendary investor and hedge fund operator) was asked what his thoughts were on Cryptocurrency. He replied “At 89, anything with the word ‘crypt’ in it is a real turnoff for me.”
With our Flexible Income Strategy we strive to provide high total return consistent with Capital Preservation.
Your money will be invested in bond mutual funds and exchange traded funds (ETFs), including inverse and leveraged funds, currency funds, including precious metals that may be used as currencies and income producing stocks whose price trend is up. If the price cycles down, holdings are replaced with new investments that are going up, repeating as needed. Growth stocks are not used.
Click here to read more about Flexible Income.
I’ve been discovering ideas, insights and investment tips for over 30 years, and last year I finally got off my duff and began the brain dump that has been crafted into my new book, Why Bad Things Happen to Good Investments: How You Can Invest Successfully.
We have a bulk shipment arriving at our Prescott office today. If you are a client, stop by the office to get your free autographed book, or call to have one sent to you. If you are not a client, I’ll be happy to autograph a book for you, but the retail price is $19.95. Sorry. Membership has its privileges.
If is more convenient, you can get your copy of Why Bad Things Happen to Good Investments on Amazon in both print and e-book versions.
With the market becoming shaky and reviews that are good, sales are taking off. I haven’t been this excited about something in a long time. Order your book now!
* The model accounts mentioned in this article are hypothetical examples of how the strategy may work as designed. Performance and 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.
** Indexes are unmanaged lists of stocks considered representative of a broad stock market segment. Investors cannot invest directly in an Index.
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.
In all investing, past performance cannot assure future results, and as such, our efforts are not guaranteed. Losses can occur. All strategies offered by Hepburn Capital Management, LLC, adapt to changes in the markets by changing the investments they hold, therefore, comparisons to broad stock market indexes such as the unmanaged indexes mentioned may not be appropriate. Sometimes client accounts are invested in stocks or markets not included in these indexes. Past performance does not guarantee future results. Investment return and principal value will vary so that when redeemed, an investor’s account values may be worth more or less than when purchased. Mutual fund shares and other investments used in our managed accounts are not insured by the FDIC or any other agency, are not obligations of or guaranteed by any financial institution and involve investment risk, including possible loss of principal. Advisory services offered through Hepburn Capital Management, LLC, an Arizona Registered Investment Advisor. Adviser will not transact business unless properly registered and licensed in the potential client’s state of residence.
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