- The biggest issues we are facing.
- Understanding two very different messages from bonds and stocks about the economy.
- Why the bond market is usually right.
Since the beginning of this year, stocks have been like a crazy patient who forgot to take their meds. One day up 100, the next down the same. No wonder investors are nervous and rightfully so.
The two big issues we've been facing are the Federal Reserve's tapering of the bond buying fiscal stimulus that has buoyed this market since the crash, and whether the economy is rebounding and strong enough to sustain itself in its absence.
In the face of all this, we have had two very different messages from bonds and stocks about the economy. If the economy were getting stronger, interest rates would be rising because it would create more demand for capital and thus produce inflation. Rates, however, have defied practically everybody the last few months by falling to their lowest levels in over a year, with the 10 year US Treasury at about 2.50%. That sends the message that the economy is not strengthening or even holding its own, but weakening.
On the other side, we have been seeing a stronger stock market, although on a very selective basis. The large cap indexes are rising, but the small cap sectors are getting crushed, with the Russell 2000 index now down over 10%. This concerns me, for when we see such a divergence it is often a topping pattern. Although in general, when stocks rise, it is sending the message that the economy is improving because it will lead to stronger corporate earnings, which is the true driver of stocks.
In my 30 years as a financial advisor I have come to learn, oftentimes the hard way, that the bond market is usually right. The clearly negative demographics of not only the US but most of the developed world, which I explain in "Facing Goliath - How to Triumph in the Dangerous Market Ahead," is having a severe impact. An economy needs more spenders to grow, but with our rapidly aging population our spenders are decreasing rapidly. 10,000 baby boomers are hitting 65 years old every single day and the next generation of spenders, called the echo-boomers, are still 5-8 years away from their peak spending years. For those not prepared, there could be some tough times ahead.
To add to this evidence (or some may call it paranoia), on Monday two Federal Reserve officials, William Dudley and Dennis Lockhart, expressed disappointment with the pace of the U.S. recovery, saying that the economy is too weak for the central bank to pull back its stimulus. "The economy still needs the support of a very accommodative monetary policy," said Dudley, who has a vote on the Fed's policy making committee.
My guess is that we will know soon if this summer will bring pleasure or heartache. My concern is that people have become complacent again, and with the incredible speed that money can come out of the stock market these days, investors need to be invested but with a very active and tactical hands-on approach to managing their portfolio. If you are retired or close to retirement, it is even more important to graduate to a qualified retirement advisor. This is a dangerous neurotic market, and buy-and-hold investors will get killed. The price for being wrong is too great, so be the expert or hire one!
Corrections and bear markets may be normal, but you don't have to ride them all the way up and down to prosper. The rotation from small caps to large and from growth to value is underway, and tactical investors will be rewarded most. Buy-and-hold investors, otherwise known as buy-and-hope investors, will feel the pain.
Nimble traders can ride the earnings train for a few more weeks in strong growth names like Apple (NASDAQ:AAPL), which will surprise on the upside; Microsoft (NASDAQ:MSFT), which is the staple for every computer made; Google (GOOG, GOOGL), whose earnings were once again in the stratosphere; Facebook (NASDAQ:FB), which is the social media staple and is winning over the older crowd - the very people with money and who will not be upset by their ads. Or simply buy the market ETFs like QQQ and SPY. After earnings season, aggressive traders should be out of these names and/or hedging with Proshares Short S&P 500 (NYSEARCA:SH) or the iPath S&P 500 VIX short-term (NYSEARCA:VXX).