I think the biggest reason why it's so hard to read the current state of U.S. markets is because there are a few key, unusual things going on right now. Namely; stocks, Treasury securities, and gold are all up YTD. REITs and Bitcoin are up strongly this year. Even the popular exchange traded fund that tracks emerging markets, EEM, is up YTD too. We should all be celebrating, right? I mean, why bother with the reasons behind the rallies?
I'll tell you why. Because this is a symptom of a money printing cycle that has gone on so long that it's losing - err, lost - its potency. You see, the whole point of diversification between different asset classes is that while they are all expected to show a positive return over long stretches of time, they could move in opposite directions of short periods of time. But since you supposedly have exposure to different asset classes, the short term ups and downs should offset each other somewhat over the short and intermediate term. Not this year. Why bother rebalancing your portfolio - selling holdings that are over represented in your portfolio in favor of those that have become under represented - when the adjustments would be minuscule at most? Diversification, in my book, is still a good thing. But it works when some assets zig while others zag. If diversification is broken, my sense it won't stay broken for long.
But looking under the surface, the story begins to look a little different. Stocks are barely up over the last 12 months. German and Japanese stocks are down, about 10% and 5% respectively, over that same time. But gold is up A LOT, 25%. Long term Treasury's, as measured by TLT, are up over 20% in the last 12 months. Stocks, it turns out, have been at the bottom of the heap in the battle of the asset classes over the last 12 months.
OK, so where am I going with this picture? Gold and Treasury's rally and stocks under-perform when there's a flight to safe-haven assets. That's exactly what's happening right now. But I think investors see stocks as leading the asset classes higher because they're up this year about 15/16%. But this years rally only gets stocks back to even over the last full year; which was possible only because stocks tumbled 20% at the end of last year. In other words, this year's stock market rally was a bounce, not a rally. New highs have thus far proven to be illusive; the longer that goes on, the harder it will to breach those old highs.
I couldn't help but get the feeling that something in the financial system is broken. You see, this week, the short term rates that banks are charged to borrow money overnight spiked above the Federal Reserve's target rate, called the Federal Funds Rate. Some short term rates even spiked to 10%. The blame for this, which seems somewhat dismissive to me, is that this is from a cash crunch within banks because their corporate customers had to pay taxes and partly due to mild incompetence on the part of the NY Federal Reserve branch. Maybe. No, probably. Or did it have something to do with the timing of oil spiking 15% at the same time; last Monday. 10 years ago, a spike in banks' overnight lending rates meant that some over leveraged financial institution was blowing up. I remember during the summer of 2007 when two Bear Stearn hedge funds that invested in subprime loans failed on the same Friday afternoon. No one realized back then that was the moment when the financial crisis began.
Hey, I know this is a pretty harsh way to judge things. Maybe a little paranoid too. But gold is screaming inflation while bonds are screaming recession. Stocks are making a lot of noise but have simply round-tripped in the last year. Countries with negative interest rates have moribund economies.
This is what makes economics and markets so fascinating to me. They try to trick you into thinking that this time, the old signals don't mean anything anymore. Don't get me wrong. This doesn't mean I'm out of stocks. I invest my clients assets according to their unique risk tolerance, time horizon, and goals. But I maintain their stock exposure in a range and at present time, I'm simply closer to the lower end of the range. So, if a client's portfolio is to be invested in stocks in a range of 70% to 90%, we'd be closer to 70, as an example.
Who's right; gold, bonds, or stocks? Usually, only one of the three could be right. I think it pays to be patient while we wait and see.
Now, check out my video "Invest in GOLD?!" below.
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