The markets moved lower early in the week, only to reverse course and close with modest losses. For the week, the Dow and S&P both lost 1.0% while the Nasdaq declined 0.4%. The benchmark government bond index at one point hit its highest level in 16 months (so yields hit the lowest level in that time period). Gold did well on the weakness in stocks, rising 1.4%. Oil sold off strongly again, hitting its lowest level in over two years to close the week down 3.6% at $82.75 per barrel. The international Brent oil, used in much of our gas here in the East, hit its lowest price in four years to close at $86.10 per barrel.
Source: Yahoo Finance
With stocks dropping sharply in recent weeks, investors were extremely nervous when the market continued to fall in the early part of this week. The decline put stocks into negative territory or flat for the year, depending on the index. However, it looks like they may have turned the corner – at least in the near term – as they found their footing and closed out the week on a positive note.
The question is, what has been behind the large drops and the subsequent gains? There wasn’t any news out of the ordinary, with economic data mixed and unremarkable this week. No, we think the reason is clear. As usual, it’s all about the central banks.
The Fed is in the process of ending a part of its stimulus policy where they printed money to buy bonds, pushing down yields to stimulate borrowing. This program has been implemented several times before and stocks rose each time. As each one ended, though, stocks sold off. The chart below illustrates this phenomenon (the chart may be difficult to read clearly, but this was the most updated chart we could find. The downturns in the market coincide with periods when the Fed is not printing money).
The question is, what has been behind the large drops and the subsequent gains? There wasn’t any news out of the ordinary, with economic data mixed and unremarkable this week. No, we think the reason is clear. As usual, it’s all about the central banks.
The Fed is in the process of ending a part of its stimulus policy where they printed money to buy bonds, pushing down yields to stimulate borrowing. This program has been implemented several times before and stocks rose each time. As each one ended, though, stocks sold off. The chart below illustrates this phenomenon (the chart may be difficult to read clearly, but this was the most updated chart we could find. The downturns in the market coincide with periods when the Fed is not printing money).
We believe the recent sell-off is largely due to this reason, similar to every other time the Fed ended this bond buying program.
To support this view, the negative mood changed this week when a regional Fed president suggested the Fed not end its bond buying (money printing) program this month. The comment told investors that the Fed was committed to helping markets higher, giving stocks the support they needed. It shows just how addicted the market is to stimulus.
It also shows that a higher stock market is another goal of policymakers. They want stocks higher so people feel wealthier and spend more. We caution that it is an extremely dangerous undertaking when markets are used as a tool for social policy. It always ends badly.
Weakness in Europe was another issue weighing on markets. An inflation metric followed by European central bankers (yes, again with central bankers) hit the lowest level in a decade.
To central bankers, inflation is necessary for economic growth. The lack of inflation was blamed on lower gas prices, which were described as “dangerous.” Imagine, low gas prices are dangerous? This flies in the face of common sense, but is what central bankers believe (and it explains why central bankers have failed to bring about growth despite record-breaking amounts of stimulus).
The weakness in Europe has increased the call for governments to do more spending to stimulate the economy. This in itself is creating problems.
Remember with the Euro, the individual countries must come together to find one common solution. The countries favoring more stimulus are the least solvent, while the strong countries like Germany are firmly against it. Like we saw with the European debt crisis in 2011, these rifts have the potential to tear the Euro apart, which is also frightening the markets.
Finally, corporate earnings came in at a steady pace this week. You wouldn’t know it, though, since the market paid little attention to them in their wild swings. Earnings are coming in line with expectations and their projections for next quarter seem decent.
Next Week
Data wise, next week appears to be another uneventful one. We’ll get info on housing and inflation at the consumer level. Additionally, corporate earnings releases will come in at a steady pace. As we saw with an uneventful week for data this week, the market can still be a volatile one.
Investment Strategy
Comments from the Fed supported the market this week, but it shows how addicted the market is to stimulus. Investors see that the Fed is there to boost stocks higher, which gives investors confidence to buy more stocks. But as we saw over the last several weeks, eventually the stimulus must end and stocks will fall.
Our view is in the short run, stocks may continue to move higher. We did some buying this week because of that.
The addiction to stimulus has us worried in the longer term – though we are increasingly worried that it could be nearer than many expect. Stocks and bonds appear overvalued on that longer-term perspective, especially as stimulus disappears. Europe is another worry as they drift back into recession with record levels of overvalued debt. At some point we see this correcting in a painful way, but it is anyone’s guess as to when this will occur.
As for the bond market, bond prices rose again this week (so yields fell) as stocks sold off. Many investors see bonds as overpriced are looking for them to fall in value. A short position would be the trade to make (where your profit increases when prices fall), though it has done poorly recently as bond prices continue to climb. A short position may make for a nice hedge, but this should be a longer-term trade as the potential for profit seems low at this time. Floating rate bonds are another trade to consider in this scenario, but they tend to be riskier, so caution is warranted.
European bonds look extremely expensive at the moment and also look like fantastic short opportunities. This trade has done well recently as some of the riskier countries saw the bonds fall in value (so yields rose).
Bonds to protect against inflation, or TIPs, remain a good long term hedge for inflation. They have not done well recently, but are intended to be a longer term investment. Some municipal bonds look attractive for the right client, but not as good as they did several months ago. We like buying individual, insured names for these bonds, avoiding muni index bonds if possible. We keep a longer term focus with these investments.
Gold is another good hedge for the portfolio. It is only a hedge at this point – rising on geopolitical worries and falling once they are out of the headlines. It hasn’t fared well lately, but remains a good hedge for the long run.
We like other commodities for the long term, especially due to weaker currencies around the globe. This is a longer-term play, so buying on the dips may work with a longer time horizon.
Finally, in international stocks, we see weakness around the globe and favor neither the developed or emerging markets.
Please note, these day-to-day and week-to-week fluctuations have little impact on positions we intend to hold for several years or longer. Our short and medium term investments are the only positions affected by these daily and weekly fluctuations.
This commentary is for informational purposes and is not investment advice, an indicator of future performance, a solicitation, an offer to buy or sell, or a recommendation for any security. It should not be used as a primary basis for making investment decisions. Consider your own financial circumstances and goals carefully before investing. Past performance cannot guarantee results.
To support this view, the negative mood changed this week when a regional Fed president suggested the Fed not end its bond buying (money printing) program this month. The comment told investors that the Fed was committed to helping markets higher, giving stocks the support they needed. It shows just how addicted the market is to stimulus.
It also shows that a higher stock market is another goal of policymakers. They want stocks higher so people feel wealthier and spend more. We caution that it is an extremely dangerous undertaking when markets are used as a tool for social policy. It always ends badly.
Weakness in Europe was another issue weighing on markets. An inflation metric followed by European central bankers (yes, again with central bankers) hit the lowest level in a decade.
To central bankers, inflation is necessary for economic growth. The lack of inflation was blamed on lower gas prices, which were described as “dangerous.” Imagine, low gas prices are dangerous? This flies in the face of common sense, but is what central bankers believe (and it explains why central bankers have failed to bring about growth despite record-breaking amounts of stimulus).
The weakness in Europe has increased the call for governments to do more spending to stimulate the economy. This in itself is creating problems.
Remember with the Euro, the individual countries must come together to find one common solution. The countries favoring more stimulus are the least solvent, while the strong countries like Germany are firmly against it. Like we saw with the European debt crisis in 2011, these rifts have the potential to tear the Euro apart, which is also frightening the markets.
Finally, corporate earnings came in at a steady pace this week. You wouldn’t know it, though, since the market paid little attention to them in their wild swings. Earnings are coming in line with expectations and their projections for next quarter seem decent.
Next Week
Data wise, next week appears to be another uneventful one. We’ll get info on housing and inflation at the consumer level. Additionally, corporate earnings releases will come in at a steady pace. As we saw with an uneventful week for data this week, the market can still be a volatile one.
Investment Strategy
Comments from the Fed supported the market this week, but it shows how addicted the market is to stimulus. Investors see that the Fed is there to boost stocks higher, which gives investors confidence to buy more stocks. But as we saw over the last several weeks, eventually the stimulus must end and stocks will fall.
Our view is in the short run, stocks may continue to move higher. We did some buying this week because of that.
The addiction to stimulus has us worried in the longer term – though we are increasingly worried that it could be nearer than many expect. Stocks and bonds appear overvalued on that longer-term perspective, especially as stimulus disappears. Europe is another worry as they drift back into recession with record levels of overvalued debt. At some point we see this correcting in a painful way, but it is anyone’s guess as to when this will occur.
As for the bond market, bond prices rose again this week (so yields fell) as stocks sold off. Many investors see bonds as overpriced are looking for them to fall in value. A short position would be the trade to make (where your profit increases when prices fall), though it has done poorly recently as bond prices continue to climb. A short position may make for a nice hedge, but this should be a longer-term trade as the potential for profit seems low at this time. Floating rate bonds are another trade to consider in this scenario, but they tend to be riskier, so caution is warranted.
European bonds look extremely expensive at the moment and also look like fantastic short opportunities. This trade has done well recently as some of the riskier countries saw the bonds fall in value (so yields rose).
Bonds to protect against inflation, or TIPs, remain a good long term hedge for inflation. They have not done well recently, but are intended to be a longer term investment. Some municipal bonds look attractive for the right client, but not as good as they did several months ago. We like buying individual, insured names for these bonds, avoiding muni index bonds if possible. We keep a longer term focus with these investments.
Gold is another good hedge for the portfolio. It is only a hedge at this point – rising on geopolitical worries and falling once they are out of the headlines. It hasn’t fared well lately, but remains a good hedge for the long run.
We like other commodities for the long term, especially due to weaker currencies around the globe. This is a longer-term play, so buying on the dips may work with a longer time horizon.
Finally, in international stocks, we see weakness around the globe and favor neither the developed or emerging markets.
Please note, these day-to-day and week-to-week fluctuations have little impact on positions we intend to hold for several years or longer. Our short and medium term investments are the only positions affected by these daily and weekly fluctuations.
This commentary is for informational purposes and is not investment advice, an indicator of future performance, a solicitation, an offer to buy or sell, or a recommendation for any security. It should not be used as a primary basis for making investment decisions. Consider your own financial circumstances and goals carefully before investing. Past performance cannot guarantee results.
