We Live In Interesting Times

While waiting for the next move higher in long-term interest rates, the Dow decided to shed 1000+ points.  And that was only in the first eight trading days following the publication of the August Letter.

Complacency quickly turned to panic; isn’t everyone supposed to be on vacation?  After seemingly banging away at record prices for month after month, stocks sold off.

As I discussed last month, long-term interest rates are poised to move significantly higher from here, meaning prices are poised to move significantly lower.  This is because the trend for bond prices has changed; the trend for long-term bond prices is now lower.

Why is this the case?  Because long-term interest rate came to the end of their upward trend ( trend lasting thirty years) and now the trend is going the other way.  So why did stocks sell off?  Either they too have completed their long-term trend, or stocks soon will.

The message, for both stocks and bonds, is the long-term trend has changed (or soon will).  We have seen what trend change can do to markets (Gold, Oil, Silver).  I expect the market to wreak similar havoc in the stock and bond markets in the months to come. 

Buy and hold was not the mantra for stocks and bonds in 1981.  Buy and hold became the mantra over the years, particularly after the stock market crash in 1987 and the subsequent strong rebound into the 1990s.  Even the financial crisis in 2008 can be seen as just another reason to buy and hold.

Needless to say, I do not believe Buy and Hold will serve you well in a post trend change world.  Think back to 1981: after every rally you felt like you should sell because your experience (from the 1970s) told you to sell rallies.  Now turned on its head, at every swoon you feel like you should buy because your experience (over the past decades) tells you to buy dips.

Key difference: the amount of money you have invested is tremendously different from the amount of money you had invested in 1981.  With a change in trend you should not think about all the money you have invested; you should think about all the money you have at risk.

If you have to sell your investment in order to convert it to cash, then that investment is at risk.  Stocks, Real Estate, Commodities (Oil, Gold, Silver), Mutual Funds, Hedge Funds, Managed Money and long-term Bonds all qualify as at risk.  We have seen how trend change can affect Oil, Gold and Silver.  Do not let this happen to the bulk of your investments.  You deserve better.

Market forces are very powerful.  Do not underestimate the downside damage that may occur.  Years ago, one of my largest clients would gig me by saying, “Well Smith, the market bailed you out again.”  In the rising market of the 1990s, all boats floated.  Trend change will have the opposite effect: many boats will sink.  Do not underestimate the downside effects of trend change.

Cash is in the process of becoming King.  Gone will be the days in which you can create Cash by picking up the phone.  For some in the oil patch, those days are already here.  As trend change settles in, this phenomenon will spread.  High prices is when you (now), not later when your options are limited or gone.

I believe one should  not be afraid to own and hold a lot of Cash.  For investors that hold a substantial portion of assets at risk (see above), one should be cognizant that selling at higher prices is preferable to selling at lower prices.  Now is a good time to  assess your investments, be wowed by your good investment fortune over these past few years, and seriously consider your options.

Why is this time different?  As I discussed last month, I am taking my cues from the bond market.  Unlike the stock market, the bond market has spent many years in a topping process leading to a reversal of a long-term trend in prices.  With $39 trillion in US bonds outstanding(per SIFMA), a fair amount would be at risk for significant price decline as the trend towards higher interest rates continues.

Now that the stock market is entering the conversation regarding trend change, notice how few, if any, of the pundits mention the new trend in long-term interest rates.  The stock market is just that…a market.  As such, the stock market is subject to the same risk of trend change as we have seen in every other market these past several years.

In 2012, very few investors believed interest rates were beginning to reverse course and change a thirty year trend.  Likewise for the stock market today.  I do not know if the recent turn in the stock market is THE turn, but given the behavior of the bond market these past three years, I do believe the cost of money is going higher, perhaps significantly so, because that is how markets behave.

I maintain that our strategy, in place for many years, offers opportunities not available in other markets.  As Cash becomes King, I expect our daily universe of municipal bonds available to cherry-pick should continue to grow.  Do not be concerned with high Cash levels as I continue to maintain a high threshold for value in the selection of short-term municipal bonds.