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TERADIME MONTHLY NEWSLETTER - JUNE
2004 Topic:
Stock & Bond Market Review Today's
stock and bond markets appear to be reliving the year 1994. '94 overall was a flat year for stocks.
It started out bullish, changed direction to a bear market by the summer, and
then snapped back up by the fall to finish within 2% from where it started. The current situation is not that much
different. Conservative investors
should have reduced or sold off their stock position in March (re-read my
earlier e-mails) and should currently be in cash since, by my definition, the
market is still neutral-to-bearish. The
bond market sold off during the last 2 months due to signs of inflation and the
expectation that the Fed will raise the short-term rates as early as June
30th. The yield on the 10-year note
has risen from 3.7% in March to 4.7% now.
What does this mean to a bondholder and to your bond portfolio (i.e. your
long maturity bond mutual fund)? In
March, $100 in your bond mutual fund was yielding you 3.7% annual return or
$3.70 Today,
the same $3.70 has to represent 4.7% in yield ($3.70 ->
4.7%) So,
$X must represent 100% ($X ->
100%) Therefore,
if you actually held a 10-year note (versus a bond fund) you could only return
$78.72 for it, plus the interest accrued over these 3 months (maybe a
$1.30). In any case, my point is
that if you had to sell your 10-year bond now you would lose 20% in only 3
months. This is that "very safe" US
Treasury bond you've often heard about.
People who actually follow this newsletter would have read the following
statement in our March edition, available in the archives: The
moral of the story - inflation is bad for bonds. Buy bonds when the rates are going down,
you will get your original coupon plus the price appreciation, and sell bonds
when the rates start moving up. So,
we need to be in stocks - WRONG.
Inflation is bad for stocks too.
To "fight" inflation the fed will start raising rates. That means that every new bond will pay
a higher interest rate. Sound
familiar? If not, this might serve
as a good time to go back and review the March newsletter. I have noted that inflation is also bad
for stocks, but I think you can see that for yourselves. So,
what should a poor investor do to make sure that he/she does not stay poor
forever? Focus on developing a
strong asset allocation strategy and follow it; bond and stock markets will
continue to rise and fall and there's really nothing we can do about it. However, if you are reading this
newsletter then you must have a desire to actually play the market and I'd like
to show you what I am currently doing: I
just took a short position in EWH (Honk Kong), which is the easiest way to play
China's stock market. EWH is
already in the bear market by my definition. I would also like to start shorting QQQ
but it is still in the neutral market. I better follow the rules or I will lose
just like I did with my earlier DDE trade. The Chinese government is trying to
slow down their economy and, for now, all Asian markets believe it - note the
dramatic sell-off. Japan should be
joining China in the bear territory very soon if everything goes according to my
calculations (unfortunately, nothing seems to go according to my calculations as
of late L). Anyway, a bearish Japan should give us
some good trading opportunities.
If
you are a conservative investor and do not wish to "short" markets, I would
suggest keeping your money in money market funds because they will slowly begin
to pay higher interest (ING Direct and Charter One already raised interest rates
starting in June). Do NOT, however,
buy CDs with maturities of over 1 or 2 years. WHY?? The best short-term investment strategy
in a rising interest rate environment is to keep your money in money market
funds. If
everything goes according to my expectation, in 2 to 3 years we will see the
homeowner-bubble burst and you will be ready with your cash to buy some
investment properties. The idea is
simple: rates go higher and people cannot afford their housing payments because
they borrowed through an ARM (Adjustable Rate Mortgage). The result is they are forced to sell
their home and start renting. You buy the property (at a reduced price �
motivated seller) because you were collecting cash for the previous three years
and have enough for a substantial down-payment. The people who then rent from
you will pay for your mortgage expenses and provide some additional monthly cash
flow. This
is not the scenario that the Federal Reserve (our central bank) wants to
see. On one hand the Fed has
indicated that it is going to start raising rates to control inflation (You
don't think inflations already here?
Go check your grocery bill.).
On the other hand, Mr. Greenspan has yet to move the short-term rates
up. The problem that the Fed has is
that we (Americans) are "leveraged" (in debt) up to our ears. The only way that we can still make our
monthly payments is because the rates are so low. If the Fed moves the rates up sharply
like it did in 1994, the long end bond market will have an initial, dramatic
sell-off and then recover with the belief that the Fed is serious about keeping
inflation in check. Credit card
debt will put many Americans into bankruptcy, the housing market will slow down
sharply, and everybody who borrowed using an ARM and cannot continue making the
monthly payments will be forced to sell.
And since our economy is consumer-driven, all of this will put us into a
recession. The Fed does not want to
put us into a recession, especially during the election year when George W.
promised to re-appoint Mr. Greenspan for another term. The
logical solution to the Fed's predicament is to let inflation run to a point
where your debt, in nominal dollars, is more affordable. I personally do not believe in this
solution, because it assumes that Americans will realize they've borrowed too
much and stop or slow down their borrowing until inflation bails them out. Mr. Greenspan, we are not going to stop
borrowing! It's like telling an
alcoholic not to drink or a smoker not to smoke because it is bad for him. Americans need to feel the pain to
understand that excessive debt is wrong for them, but the Fed will not provide
this jolt fast enough. Here's
the bottom line: Long
term portfolio - stick with your asset allocation plan. If you do not have one, get one from a
fee only financial advisor! Please, do not buy any life insurance or
annuity from American Express or some other investment firm. Go to an independent advisor and make
sure they are not getting any kickbacks from the mutual fund companies. Your advisor must advise you to invest
in passive, index-based mutual funds or ETF. If they suggest you buy mutual funds
with fees over 1% or pay loads, you have your queue to move on to another
advisor. Short-term
portfolios - stay in cash and cash equivalents (money market). Be patient, as investment opportunities
will present themselves. The rates
on money market accounts are already going up. Remember that inflation is bad for both
stocks and bonds; it is only good for Gold and it may, with time, bail out your
overpriced real estate investment. "Kerry met with Ralph Nader last week.
Both sides of every issue were discussed - then Nader spoke." Jay
Leno "The
Olympic Committee is telling American athletes not to wave the American flag at
this year's Olympics because it might be seen as boasting. Other countries can
wave their flags, just not us. Which is ironic - because, if it hadn't been for
us, a lot of these countries would be waving different flags from what they are
now." Leno "Al
Gore has endorsed the global warming movie �The Day After Tomorrow'. Let's hope
that works out better than his Howard Dean endorsement." Jay
Leno |