Another Step Closer

Markets go up and markets go down.  We all know this.  We should also know that we are fortunate to live in an era in which markets have trended higher for decades.  Unfortunately we now live in an age of asset bubbles with the largest bubbles of all, Stocks and Bonds, on the verge of a massive popping.

We have watched the popping of two asset bubbles over the past several years: According to Bloomberg, Precious Metals (Gold & Silver) and Oil.  Gold peaked in September 2011 at $1920 an ounce, falling 45% over the following four years to a $1046 low.  Silver almost touched $50 an ounce for the second time in its history and sold off to below $14.  Oil peaked at $147 in 2008 but sold at $107 just nineteen months ago and below $27 last month.  Markets do go up and down, but in today’s age of asset bubbles, one must be ever mindful of the tremendous downside risks that exist.

Stocks are the last (and latest) asset class to perhaps finish the topping process and remind investors that markets can move in two directions.  While most of the major stock market indexes appear to have topped, it may only be a correction.  We will not know for sure until after Stocks break dramatically downward as we saw with Gold below $1500 or Oil below $70.  The warning signs are present.  Bottom-line, if the stock market performance so far in 2016 is almost too much for you to bear, it is nothing compared to the downside devastation that may result once the downward break occurs.

To think about the damage of a fall in stock prices, think of yourself in the oil business.  One way to look at it is that you invest in oil expecting to receive income from the sale of the oil produced.  A fall in the price of oil from $100 to $30 certainly reduces your income and perhaps whether your investment will ever be profitable, but it is far from devastating.  Devastation can occur when the price of oil drops from $100 to $30 but you borrowed money to do it.  Somehow you must continue to make payments on your loan and at $30 this probably doesn’t happen.  Unfortunately loans, leverage and leverage acquisitions are not only oil industry issues — these are issues for the entire world economy.  Debt matters and I believe we will see the ramifications in Stocks and Bonds in the coming months and years.

So turning to debt, we look at how Bonds are performing of late.  My contention is the bear market for Bonds began in the second half of 2012.  With a quick sell-off in 2013, Bonds have generally performed quite well.  Junk corporate bonds, energy debt and Puerto Rico bonds are the exception and have continued to sink in price while higher quality bonds have generally rallied and investors appear to be as bullish today as they were near the 2012 top.  This, to me, is consistent with the end of a correction and, like Stocks, Bonds are positioned at a very risky perch preceding a dramatic plunge in prices.

Just a couple of months ago the Federal Reserve raised rates for the first time in years and it appeared rates would continue to move higher.  Today there is talk of negative interest rates and the odds of further interest rate hikes appear to have disappeared.  This is how markets work: investors appear to all move to one side of the boat, only to have the market turn the other way.  With bond investors all looking for lower rates, I look for interest rates to move higher from here…for many, many years as we correct thirty years of bond market bull.

Each month I present you with representative yields for high quality municipal bonds across a wide maturity range.  We all know interest rates are low and one look at the bottom of this letter will all but confirm this sentiment.  I can also tell you that I believe very few investors are doing what I would recommend: sell bonds that look anything like the yields on the Bonds below.

There is a time to buy and a time to sell when it comes to Stocks and Bonds, particularly in an era of asset bubbles.  This is not the 1980s or the 1990s.  This is the age of bubbles and I don’t need to remind you of 2000 or 2008.  What I want to impress upon you is you have a credible option here at The Select Approach^TM.  In my opinion, the rewards of Stocks and Bonds do not justify their risks at this point, so cash alternatives should continue to grow in importance.

Whether Stocks and Bonds are able to eke out a new high from here, I am not certain.  But as we have seen in the Oil markets and in the energy sector, the plunging price of oil quickly had a devastating effect on the price of their Stocks and Bonds.  I believe the trend has already changed in Bonds and a twenty percent decline in Stock prices will ultimately be seen as a mere blip with more to come.