Welcome to the 01-12-2018 update from your Pocono Summit Certified Financial Planner and retirement planner, Mike Savage. Today, Mike discusses how to interpret the recent rise in bond values.
There is a lot of enthusiasm about the global stock markets and their upward trajectory which, to me, is a classic bubble formation where the assets had been rising slowly for a while and have now become almost parabolic recently. Part of the surprise is that virtually all stock markets globally are rising in tandem albeit at different levels.
Trying to find a bargain in this situation is like searching for a needle in a haystack. Having said that, however, many prices continue to rise in a rather unusual manner.
As has been the case in recent history, it is relatively few stocks that are driving these averages higher. As I have said this fits nicely with the theory of buying by central banks, sovereign wealth funds, large banks and hedge funds.
Many people are starting to notice that commodity prices have been rising which could lead to higher inflation and bond yields have been rising which, in normal times, would be signaling that higher inflation is expected. With the level of interference in virtually all markets I’m not so sure that any asset prices are actually telling us anything of value. I guess time will tell.
There are two well-respected bond managers- Bill Gross of Pimco fame and currently at Janus-Henderson and Jeffrey Gundlach- a multi-billion dollar bond fund manager (Double Line Capital) who have both cautioned that the 30 year bull market in bonds may be over. Bill Gross actually called it this week and Mr. Gundlach has said if the 1 year Treasury hits 3% it will be over.
So why is this so important? Because the asset values of real estate, stocks and bonds are all artificially high because the interest rates are so artificially low. If rates were to rise then people can afford less of a mortgage. They would also have to spend less on a car. Many projects that businesses have planned only work financially with near-zero interest rates. Many stock buybacks are implemented with low-rate loans. Many risky bonds (mainly European high yield bonds, sovereign bonds in many places) are artificially low because of central bank purchases. Do you know of any sane investor that would prefer a European junk bond that sports a lower yield than a 10 year US Treasury? Can you think of any scenario (outside of central banks purchasing the assets) where this scenario makes ANY sense?
Many people have asked me why this can’t last forever.
If interest rates continue to rise there could be an impact on all asset prices. If we are actually experiencing the global growth being reported then rates should be rising. If, however, some of these numbers may not be totally reliable, it could lead to some major disappointment in the near future and lead to a decent sized pullback in the equity markets. If rates continue to rise it could also take a large part of the funding that is propping up these same equity markets and lead to the same conclusion.
My take is that it is hard to watch what is happening here but I believe patience will be rewarded as we go forward.
There is one wild card that I also see here. There are reports that China will start its oil market where trades will be settled in the Chinese Yuan rather than the US dollar on January 18, 2018. Should this take place this could lead to US dollar weakness that is so severe (at least over time) that there could be higher prices in line for many stocks regardless of fundamentals. It could also lead to higher interest rates far sooner than anyone is anticipating to protect the value of our dollar.
In any case, I expect that some commodities and in particular gold and silver would outperform virtually all other assets in this scenario. Part of the reason is that those Chinese Yuan that are being used to settle oil trades can be exchanged into gold. In addition, as I have written many times, gold and silver have been managed lower by central banks and those (like major banks) that help them at least since the 1970s. What has taken place recently is unprecedented. Almost daily you can see sell orders at times that could only be meant to drive the price lower.
What I am anticipating is that there will likely be a reset of asset values where artificially high asset prices will reset lower- think of real estate where prices have been rising but incomes have not been. Houses will likely be more affordable (lower prices) after the reset.
On the other side, gold and silver have been relentlessly repressed. If you go to the USdebtclock.org and look at how many dollars are in existence in relation to the metals they are as follows:
Current In 1913
Dollars to 1 oz. silver 704 2.65
Dollars to 1 oz. gold 5502 28.78
Of course, the US dollar is no longer backed by gold or silver so this just shows money supply growth. It does, however, show that the dollars used to purchase these assets are being created in major amounts.
Historically, this has led to major currency devaluation and far higher prices for most goods and gold and silver prices.
While history doesn’t necessarily repeat it often rhymes.
This market action is eerily reminiscent of 1998-2000 where there was an unprecedented rise based upon what turned out to be nothing but emotion. Other than virtually free money and central bank intervention it appears the same this time. Last time it was eyeballs and clicks- today it is “money” conjured up out of nowhere with no real value- just about as valuable as those eyeballs turned out to be when March of 2000 rolled around.
It appears that this “money” has been deployed first in sovereign bonds, then more risky bonds, then stocks and who knows what else. One thing for sure- all of these “assets” have been purchased with debt- which remains and continues to grow in an unstable manner.
Since 2008 the debt has grown exponentially globally and any “bailouts or bailins” would also have to be exponentially larger when that time may come.
Mike Savage, ChFC, Financial Advisor
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