Saturday, July 16, 2016

Today’s investment climate – playing musical chairs?

As readers may know by now, I think our economy is heavily influenced by demographics.  There are other things as well such as the traumatic experience of being highly leveraged in the 2008 U.S. real estate market – that makes you think twice to buy houses with 5% or less down!
So right now, everyone has been cowed into saving and avoiding to borrow. This is true for business (except share buy-back loans – oh irony) and home owners alike. Then there are the lenders who have become increasingly conservative.  To top it off, baby boomers are in a stage of life where they borrow less and save more. You can blame central banks for low interest rates, but millenniums have seen what happened to their over-leveraged parents and their parent’s retirement money that was invested in employer shares as well as in stocks in general.
So saturated consumer markets; risk averse millenniums; money-socking-away boomers and… emerging markets with too much debt priced in expensive U.S. dollars, with overbuild infrastructure and falling labor markets due to automation.  No wonder we have low economic growth and inflation or better stagflation.
You may say: “Inflation? What the heck are you talking about. Better say deflation, the consumer price index in North America and the one in Europe are just up 1% this year.  That is true, but consumer prices are not the only expression of inflation.  What about rising real estate values say in Vancouver and Toronto or, as I found out on my latest European trip, in Amsterdam?  Yes, it seems to be a big city phenomenon, rising real estate valuations supported by low financing costs as well as a way to hide cash by foreign citizens from their governments such as the Chinese. Yes, when people earn 3 or 4% of the property value in net rent (after all non-financing costs are deducted, i.e. cap rate) that would be a lot better yield than say interest of 0.75% from a 3 year GIC; especially if your property value goes up annually by 5 to 10%!
The term: “Asset inflation’ comes to mind. Same with the prices of shares of blue-chip dividend paying companies – they have been on the rise since the lows of 2009. Oops and have you checked bond prices lately? They have gone through the roof as well!
To top it all off there are the interest rates. There is so much demand for government bonds and even for risky corporate bonds that we have real negative interest rates and 13 trillion dollars of debt has even negative nominal interest rates. Why? Because central banks with quantitative easing have bought up an enormous amount of government debt (treasuries or bonds). The government is issuing debt to finance their spending habits which is bought by their central banks using freshly printed money. Talking about Ponzi schemes!  What the central banks don’t buy is bought by banks and insurance companies to invest their capital reserves in.  
All those retirees and other savers who want interest income and ‘safe’ investments are buying what is left at near zero or negative interest rates. That is until the bubble bursts. Then their fixed income investments will lose value faster than air coming out of a pierced balloon.  Thus their purchasing power is currently inflated away and soon they will lose their investments when interest rates rise. By how much will a bond fall if interest rates rise?  We know that if long term bond yield rises from 1 to 2%, the bond will lose 50% in value. What about from 0.25 to 2%?  Yes, the bonds will fall to 1/8th of their earlier investment value and when rates from 0 or worse from negative rates go up to 2%?  So who says there is no inflation?
No wonder, gold is becoming so popular and of course gold mines. The latter are currently rising from the depths of a gruesome multiyear bear market with other commodities not far behind. Own more and more real assets not paper investments susceptible to massive currency fluctuations and the mood of central bankers or irrational elections such as Brexit. In fact, if the scenario described above is true then a gold bullion price increase from $1170 to $1350 is modest. No wonder some gold bugs expect $2000 gold and even $10,000 gold! 
Unfortunately, dividend paying shares have been seen by many as ‘ersatz’ fixed income but what will happen when interest rates rise not due to a good economy but because of rampant inflation? If in the past, bonds were used as a safe haven against stock market crashes, the two may now be closely correlated!  This is not the time to invest full out in the stock market. Banks and insurance companies have relative poor earnings due to an extremely low spread between short and long term interest rates. What will happen if rates suddenly shoot up because of a collapsing bond market?  It will be difficult to figure out the impact but it is probably not going to be pleasant. So, start reducing your holdings in the financial sector.
Yes, all this may blow over, but I suggest it is better to play it safe by having lots of cash and gold, silver, platinum and other commodities. No wonder everybody frets about the economy and stock markets that have been suppressed during the last couple of years. Especially for Canadians investors.  Those that invested in the U.S. have done better since 2008 but now that seems to level off big time while markets of commodity rich countries such as Canada have been doing great this year. But Canada’s stock markets are also top heavy with companies in the financial sector and the bloom may be off that.
Whenever there was a stock market correction, central bankers lowered interest rates and performed quantitative easing. Now that medicine may have lost its potency. We have had the last two years a muted bear market in the U.S. but what will the future bring?   The markets reach new highs but we’re also in an earnings recession caused by a super strong U.S. dollar. If the Sh..t hits the fan, will the U.S. be seen as a safe haven and will the dollar strengthen even further?  Or, with a collapsing bond market is everybody running to precious metals creating there a new ‘bubble’?

These are very difficult investment times. I don’t know the answer, but I suggest you to be cautious, diversified and don’t trust new highs in the stock market nor bond markets. Now more than ever we seem to play musical chairs. Be ready to run at the earliest signs of trouble - have a game plan. 

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