Fed’s Twist Results in Deep Crash: Independent Financial Advice
Market Conditions Impeach the Credibility of the Fed
The ten year U.S. Treasury yield has gone from 2.07% on Friday the 16th down to 1.72% today. This is a stunning breakthrough in rates that is a symptom that the market believes we are going into a depression. Even more shocking is that this was caused by the Fed’s actions. It is a gigantic vote of no confidence by the market against the Fed. This almost at the level of the 10 year Japan Treasury bond. The U.S. has fallen into a Japan style Soft Depression.
I strongly believe the bond market pricing is logical, fair and is not a bubble. It is the equity market that attracts irrational investors who often hijack it and drive into a bubble territory. By contrast the bond market is driven by level headed professional institutional investors who avoid the unjust prejudices of retail stock market investors. I simply don’t sense that retail investors are hysterically clamoring to buy bonds. Instead bonds are being purchased by professionals because that is the right thing to do.
The 30 year Treasury is at 2.79%. The 30 year German Treasury is 2.46%, the 30 year Japan Treasury at 1.9%.
Commodities are down sharply, signifying a repeat of the crash of 2008. Oil is down 6%, copper down 9%. This confirms what I have been saying that inflation hedges are costly, risky, a bubble, and won’t work.
The Fed has used up all of its ammunition and has now been exposed as lacking power and credibility. The Congress is determined not to increase deficit spending, which is the Keynesian tool used to get out of recessions. Further, the huge amount of government debt is without precedent and is so much larger than that of the Depression era that the Keynesian deficit stimulus techniques won’t work. (See my article "Ricardian equivalence"). So there is no way the government can get the economy back to normal.
Only 20% of the jobs lost in the 2008 crash have been restored despite the tremendous stimulus used by the government, and new homes sales are at 20% of the (population adjusted levels) of the 50 year average.
Better to sit in cash than lose money in stocks
What Investments Work Best in These Conditions?
During a depression once stocks have reached the bottom then they will become a good investment – but not before. The Q ratio implies they are still 40% overpriced, implying that the SP’s value is 800 points. At that level the dividend yields will be very attractive. During the 1930’s Depression dividends were 6%, so if you bought after the crash the compound effect of a 6% yield over a decade was enormous. During the Depression there was still demand for commodities – the catch is that an investor had to wait to buy them at the bottom and not buy too early at the top.
Investment grade bonds are my favorite investment because they are the closest thing to cash without having the 0% yield of cash. However, bonds are not cash, because there is risk that over time a bond could suffer a credit quality downgrade or suffer from an increase in market interest rates which would make bond prices go down. There is room for long term Treasury rates to go down another 30 BP, but there is risk they could eventually go up in a few years, so buying these levels would be a short or intermediate term trade, not a buy and hold investment.
While waiting for the market bottom to be reached there will be the risk that many good quality investments, that are owned by highly levered hedge funds, whose owners will forced to sell them even if they don’t want to, in order to meet a sudden instantaneous margin call. So be prepared for sudden price declines of quality, non-bubbly stocks. Remember the crash of October 19, 1987 and the Flash Crash of May, 2010? Those crashes can still happen even with stock market circuit breakers that limit trading during a crash. There will be irrational investors who will wrongly sell off good assets and there will be automated flash crashes and forced sales by over-leveraged hedge funds that will make good quality reasonably priced investments go down for no reason. The only defenses (besides being in cash) is to get the best quality, most conservative investments, avoid owning over-priced investments, avoid leverage, don’t sell in a downturn, get macroeconomic advice to avoid the wrong asset class.
Investors should invest in building their investment skills in the area of patience, self-confidence, modesty, rather than attempt to chase after yield or chase after windfall profits. By this I mean learn to tune out the masses who say things like "buy a stock with a 3% dividend because it pays more than bond", and instead consider that if stocks drop 40% then you would be better off owning an investment grade bond with a very low yield rather than losing money in stocks.
I have written “Fed's Twist: how does it affect Foreign Bonds?"
Investors should seek independent financial advice.