The Next Investment Bubble to Burst?
The world's largest and most powerful fixed-income managers are starting to take sides regarding the risk of owning $7.8 trillion worth of government bonds. With interest rates at near zero levels, and in some cases below zero, governments can afford to pay the interest and are refinancing old higher interest bonds into the new low rate bonds to take advantage of this.
All of these bond refinancings keep government spending going. But when will the payback come?
The average rate paid on 10 Year US Treasury Bonds over the past 53 years is 6.32%.
Currently (May 27, 2016), 10 Year Treasuries pay 1.85%. What happens when the interest we must pay on bonds moves back to the historic average, essentially quadrupling from current levels? In fiscal 2016, the US has budgeted almost a quarter of a trillion dollars for interest alone. If interest rates return to the average, our interest payments will balloon to $1 trillion or so.
To put this amount in perspective, $1 trillion is greater than current discretionary government spending for things like military, education, health, environment, veterans programs, administering Medicare and running the government.
No one, not even the governments, are more powerful than the free markets. Sure, for short periods command economies can look good. Post WWII Japan boomed for 30 years, but reality caught up with them in about 1990 and their markets and economy have been in the doldrums continually for over 25 years since then.
When (not if, when) interest rates begin to rise toward normal levels, governments will lose the ability to pay higher and higher interest costs that will threaten budgets for national security, health and entitlements and consume entire budgets. Politicians will be forced to decide between caring for the voters that keep them in power and paying investors. Which do you think they will choose?
In this environment, 10 year Treasury bonds, paying 1.85% at this writing, will lose over 1/3 of their resale value if interest rates return to their historic average, because no one will want to buy a low yielding 1.85% bond when they can then get 6.7% yields instead. Fewer buyers mean dropping prices.
In this market, it is crazy to own bonds or bond funds with a buy and hold intent. Yields are tiny, and risk is huge. Active management of bond portfolios is a smart investment move in this dangerous market.
At HCM, all of our income strategies have active sell disciplines. At the first sign of decline, your moneys are moved to cash or better performing investments. If you just buy and hope it works out, or your financial adviser is not very pro-active, the next rise in interest rates could prove disastrous for you.
Call the office at 928-778-4000 for an appointment to see how proactive bond management can save your retirement.
What the Markets are doing
Stock markets had a good week last week, and are again at a resistance point. From here markets could turn back down like they have from this level seven times in the past year. Clearly this is a market that is struggling to overcome its addiction to cheap money after the Fed quit printing money in late 2014.
However, there are encouraging indicators and historical precedents that say if this market can poke its head above this resistance point, it just may keep going. What we have is a trader’s market. The nimble can be invested when the time is right, but can pull back if the market weakness continues. I count myself among the nimble.
Treasury bond markets appear to have stalled out over the past 3 months amid the Fed’s talk of raising interest rates. This weakness is offset by strength in the corporate bond market with both high quality bonds and high yield (junk) bonds doing well recently. Averaging everything out, the bond markets still have a slightly upward bias.
Gold has dropped about 6% in the past month as cyclical forces seem to be pulling gold down. Our gold strategy has been short gold so it has shown a profit during gold’s recent decline.
Slice of Life
Shakespeare in the Pines
The Highlands Center for Natural History is producing two evenings of Shakespeare’s All’s Well That Ends Well in their open air amphitheater on June 24th and 25th. This is a fundraiser for the Center and will include a reception with appetizers and dessert before the performance, all for $60.
Rich Lederer, a poker buddy, writer and host of verbivore.com, wrote a recent piece on Shakespeare for the Mensa Bulletin that describes the first-ever use of more than 1,700 words in Shakespeare’s plays. He literally made up over 8% of his written vocabulary, just like kids today keep making up slang faster than I can keep up. But his slang has legs.
Shakespeare bequeathed to the English language many now familiar double plays such as barefaced, cold comfort, faint-hearted, foul play, half-cocked, heartsick, leapfrog, primrose path, tongue-tied and dozens more.
A student who attended a performance of Hamlet, came away complaining that the play “was nothing more than a bunch of clichés.” The reason for this reaction is that so many of Shakespeare’s expressions have become proverbial. In Hamlet alone was born: brevity is the soul of wit, to thine own self be true, it smells to heaven, the witching time, there is method in the madness, each dog will have its day, piece of work, the lady doth protest too much, the be-all and end-all and many more.
For a great evening with perhaps the history’s greatest wordsmith (sorry, Rich) join us at the Highland Center off Walker Road for an evening with
Shakespeare. Call (928) 776-9550 for tickets and information.
College Classes Coming
Understanding Investments – a fundamentals class
Begins on June 8th.
This course is designed to help investors become more confident about their financial decisions. In an easy-to-grasp format, this class provides a broad knowledge of investments preferred by investors approaching or already in retirement. Learn the ins and outs of stocks, bonds, mutual funds, annuities and more. Topics include recognizing risk, controlling the tax impact of IRA withdrawals, avoiding common investment mistakes and simple risk-reducing strategies that anyone can use.
Call the college at 717-7755 to register for course # SU16-116, offered on three Wednesdays from 3-5 p.m., beginning June 8th. Tuition is $65. And tell your friends.
What We Were Saying Back Then.
For more than a year, I have been talking about the weakness in the stock markets,
This weakness is exemplified by a lack of new highs over the past year or so. A rising stock market has to post frequent new highs as its price chart zigs and zags higher.
As of today (5/30/16), it has been 375 calendar days since the S&P 500 last set an all-time high on 5/21/15. In the 375 calendar days prior to 5/21/15, the S&P 500 set 50 new all-time highs.
What's Going On In Your Portfolio?
I shifted your portfolios from growth mode to capital preservation in August of 2015 and since then have made small steady gains for you while the stock markets had a wild and choppy ride.
When the S&P 500 Index dropped 11.17% from August 17-25 of last year, our Shock Absorber Growth portfolio only dropped 2.91%. Adaptive Balance, then 50% growth and 50% Flexible Income, dropped only .95% during the same period, saving you both money and worry.
The S&P 500 Index again lost 11.93% of its value between December 1, 2015 and February 10, 2016, a period during which all of my strategies were posting modest gains for you. Clearly, capital preservation was the superior objective in that market.
In February, the Stock market began to rally, and continues to show strength. My research indicates that the chances of a major market decline like I worried about last fall have lessened considerably, so I have begun to change the strategies to pursue more growth. Letting the clutch out, so to speak.
As a result, all of my strategies, and all of your accounts held at Trust Company of America have out-performed the S&P 500 over the past one month, year to date and one year periods. Please tell your friends.
Shock Absorber Growth portfolios currently have 45% of assets in my Future Technologies strategy, 35% in my Targeted Growth strategy, 10% in a gold strategy, and 10% in a Treasury Bond strategy.
Flexible Income portfolios include 50% in the Treasury Bond strategy, 30% in conservative income funds, 10% in high dividend stocks and 10% in a gold strategy.
All of my strategies include shock absorbers, which means the ability to make money in both up and down markets – assuming I can continue to correctly identify the trend.
Due to recent market strength, my Adaptive portfolios, including Adaptive Growth and Adaptive Balance have increased their growth components and currently have 70% and 40% respectively allocated to Shock Absorber Growth, with 30% and 60% respectively allocated to Flexible Income.
A couple of months ago, we were as conservative as 50%/50% growth and income for the Adaptive Growth portfolios, and 30%/70% for Adaptive Balance. So as you can see our exposure to growth has come up considerably. Maximum allocations to growth are 80% for A-Growth and 50% for A-Bal, so I don’t exactly have my foot to the floorboard, but we are picking up speed.
Our Spotlight Strategy - Adaptive Balance
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.
HOW WE DO IT
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.
CLIENT PROTECTION AND INVESTMENT DISCRETION
All accounts are held at a Qualified Custodian, providing SIPC protection for all accounts. Hepburn Capital does not hold client moneys. Accounts are managed on a discretionary basis with notification of account activity provided in monthly statements prepared by an independent custodian.
If you want to pursue high total return from a portfolio that focuses on growth investing but with more consistent returns and a lower surprise factor than is available through normal growth investments, the Shock Absorber Growth strategy may be for you.