The stock market has been on an upward streak for the past two years, with the Dow and S&P near their all-time highs. Recently, though, they've shown signs of topping. And certainly, the macroeconomic risks loom larger than ever. Where are equity prices most likely to go from here?
Interest rates on bonds have nearly doubled off of their historic lows from a year ago. That puts downward pressure on bond market prices, as well as a tremendous number of other important asset classes, like housing. Where are interest rates most likely to move next?
For these (and other) reasons, the current environment is extremely challenging for investors. The pick-a-sector-and-then-buy-and-hold strategy that has worked well for many of the past several decades is no longer prudent. Investing in today's markets requires more fundamental analysis at the individual company level, as well as a willingness to defensively build up "dry powder" reserves to deploy if indeed (as we expect) a major downward market correction brings assets prices down to much lower levels.
In this week's podcast, Chris talks with the team at New Harbor Financial about the current outlook for the market and what they think investors should be prioritizing:
It is clear that after five to six years of intervention here, the results that we are so somewhat sought and promised are not being delivered. We are having pathetic rebounds and job recoveries and GDP growth. The evidence speaks for itself.
The reality is that most folks forget that the stock market is a forward-looking machine, if you will. Let’s not forget the stock market began rallying back 2009. We have had a pretty long rally here. And for folks to now be saying if the economy starts to get better, that means the stock market will go higher, a lot of that possible future improvement is already more than priced into the gains and the stock market over the last several years since the 2009 low.
Most folks fail to realize that to stock market usually rebounds when economic news is getting worse, not when it is getting better. We think that story is more than played out to an excessive level. Even with the improvements in the economy, we are likely to see a major pullback in the stock market.
And the ten-year note, the world watches the yield on the ten-year U.S. Treasury bond. It really drives the interest rates on so many very important vehicles, not the least of which is home mortgages. Last year, in roughly August of last year, the ten-year bond yield bottomed out at 1.39%, about 1.4%. And most recently, as I look at it right now, it’s at 2.8%. So that is an increase. It is really almost a doubling, actually, if you look at it that way. It really literally is a doubling from about 1.4% to 2.8%, or to put it another way, an increase of 1.4%.
This has had the effect of driving mortgage rates up over a point. Average mortgage rates now are up around 4.6%. They were in the mid 3%’s not too long ago, maybe about six months ago. As interest rates rise, it essentially is toxic for the economy and the stock market, because business owners and consumers are less likely to borrow and reinvest. Homeowners are less likely to borrow and build that addition or move to a bigger home. Companies are less likely to borrow and finance the purchases of other companies, even investing in new plants and equipment. So, it’s just something that everyone is watching. It is something that we are watching closely. Frankly, it is one of the hostile syndromes that John Hussman – another person that we admire and read quite closely. He has a site, hussmanfunds.com – he talks about a toxic syndrome, a more dangerous syndrome in the stock market, and one of those is interest rates rising quickly over the past six-month period. That’s exactly what we are seeing.
This is a huge warning flag. The other day Bill Gross said we have got no one to sell to but ourselves. All assets are inflated. So, certainly it has got us very, very cautious and very defensive.
At this time, New Harbor urges the discipline to be defensive:
Over the next couple of years, returns are likely to be negative in the stock market. It is a very challenging time, to say the least. A very challenging time for us as money managers to continue to do what we think is the right thing. We would urge people that are listening to this podcast: you really have to avoid the urge to make decisions just for the sake of doing something. Everyone wants to do something. They always want their money to be working for them. They want to be in this stock or that stock or that bond or this commodity future.
Sometimes – especially in an era like now where all assets pretty much have been moving in tandem and they are all priced off a risk free rate of 0%, so they are priced to return very poorly at present times because the risk premium has been stripped away from them – you really need to just think about sitting in cash or allocating a good portion of your portfolio to cash. Cash really, truly, is king sometimes. It is an investment decision to sit in cash. If you do not have some cash, you are not going to have the ability to buy at better valuations. Most of your long-term success as an investor – and this applies to money managers who have been hired to invest money for people – is going to be dictated by how well you stick to your discipline and where you deploy money and where valuations are at. So, you really have to think about patience, and that is a hard thing to do.
We as money managers are sitting on a very large amount of cash, in some portfolios over 50% cash. That is really something that not many money managers like to do. That is not something that many retail investors like to do. But money managers have something called ‘career risk’ where they are constantly having to make sure they are staying ahead of or keeping up with the various indices. They are really afraid to hold onto cash, because holding a large cash position is precisely what threatens their livelihood more than anything. Clients do not sit with a money manager that is holding cash. And, invariably, if you sit on cash, you are going to be early, like we are this year. You are going to be early, and you are going to miss a little bit of a run up. But it is really the only way that we know to produce above-average returns over the long-term. You have to be early. It is better to be early than even a little bit late. We have heard you say that often. Especially when the market reaches extremes, you have to be preemptive.
I talked a little bit earlier about the low-volatility environment. We are not predicting this is going to happen or happen right away, but we could very well have a sharp drop like we did in October of 1987. There is no way to get out of the way of something like that unless you are preemptive and hold a large cash position. So we would urge people to really think about holding a core position in cash and waiting to deploy those assets at a better time.
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cheers,
Adam
It should go without saying: this discussion should not be construed as individual financial advice by those listening to it. The content should be taken as informational and educational in nature only. Investment advice must be tailored to your specific personal situation (which Chris and his guests are obviously unaware of) and should be obtained directly from a financial adviser you trust. Before acting on any of the statements made in this podcast, we advise you do just that.
Click the play button below to listen to Chris' interview with New Harbor Financial (43m:29s):
by hughk 
