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My Gut Feeling For Today, May 10, 2022:  It’s a Bear Market ...  For Bonds

My Gut Feeling For Today, May 10, 2022: It’s a Bear Market ... For Bonds

May 10, 2022
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I have been in this business an exceptionally long time, all but the early years of my post-college professional career when I worked at Price Waterhouse. Every time we have a major sell-off as we are now engaged in, there is a moment of extreme panic that sets in. Let me say that as it pertains to Growth, and only Growth, these past three trading days are the worst I have ever experienced. Much worse than October 1987, and that says plenty.

 

The reason we have never seen this type of stock market action has to do with the bond market. For the first time ever in my professional (or even actual) lifetime, we are witnessing the end of a Bull Market in Bonds. The Bull Market in Stocks still has a long way to go; another five to nine years, at least. For bonds, that great Bull Market which began in the early 1980s is over, dead, has no detectible heartbeat. Call the rabbi, priest, or other cleric in your family, if you must, but they will not be able to resuscitate the bond market. If you want to buy bonds, brokers will sell them to you all day long. If you want to sell them, be prepared to get ripped off.

 

The 10-yer US Government bond went from a low of 1.60% about a year ago to about 3.07% now. That is a total return loss of about 11% including interest. The 30-year US Government bond went from a yield of 2.32% about a year ago to about 3.21% now. That is a loss of about 17% including interest. Of course, those are for the least risky investment on the planet – US Government Treasury Bonds. The returns are deeper in the corporate bond market where most retail investors buy into or bond funds where most brokers stuff client money into. Just as a random example, the Fidelity Corporate Bond Fund (FCBNX), has lost 13.9% in the last year and has an average maturity of 11.3 years. In the last year, the S&P 500 (SPX) is off about 5% and the more growth heavy NASDAQ 100 is off about 9%. However, those stock index returns are deceptive as both are masked by mega-cap growth stocks like Apple (AAPL), Tesla (TSLA) and Microsoft (MSFT) which are up in the past year. The Russell 2000 Growth Index (RUO) declined a staggering 28% in the last year. That sector of stocks added tremendously to performance in 2019-2021 when the Growth market was hot. At this point in time, I am considering switching my Growth benchmark because using the SPX may no longer be a good fit. It is a discussion I plan to have with colleagues at Kingswood and in the industry. [For ease of presentation, I have rounded all returns to the nearest percent.]

 

Let us not forget Dividend-Value stocks, which we have made an important part of our investment offerings to clients. While those stocks are feeling a little pinch from the increase in interest rates, they do add a considerable amount of risk balancing when matched together with Growth stocks. Not to beat a dead horse, but I have been saying for some time now to book profits in Growth and move to the Dividend-Value portfolio. Those who took my advice are happy and made out very well in 2021 and have not sustained significant losses in 2022.The past two year thereabouts, I have suggested that new clients split their investments between those two strategies. That is still a promising idea but any wholesale trade from Growth to Dividend may be over and reversing course may be appropriate. I will have more to discuss on that subject later.

So let us talk about these past few days and then we can look at the longer-term picture. There are a few forces at work this past week. Until a few days ago, Growth stocks had a nice bounce-back after a drubbing in April. That continued as the Federal Reserve raised its target interest rate last Wednesday, as expected by fifty basis points and the market warmly welcomed Chairman Powell’s comments. Through the end of business Wednesday, that RUO index rose nearly 5% in May. Then financial markets got spooked as worries of slow growth, higher interest rates and inflation had Wall Street analysts put the scare into retail investors who in turn did there best Henny Penny imitations. Nobody involved in the financial markets – institutional or retail – regardless of party affiliation - has any faith in or respect for the current administration in Washington DC.  Put another way, they cannot wait for November’s elections to come fast enough.

Everyone I speak with in the institutional business – that is the grey bearded bunch of professional investors and analysts that I talk with on a regular basis – see about the same conditions or phenomena taking place:

  • Selling is mostly coming from retail investors.
  • Institutions are still on the sidelines when it comes to large scale buying
  • Volatility is rising but we will not know if a volatility spike occurred until volatility subsides. In other words, volatility may get worse, or the worst is over.
  • Margin calls are causing a significant part of recent declines and volatility. Margin calls take place when investors borrow money only to find that the collateral, i.e. stocks they hold is not sufficient to pay back their margin loans and are forced to sell stock.
  • The risk in the bond market is overshadowed by recent stock declines

Here is what you likely do not know, but I am factoring into my forward thinking:

  • Corporations have issued debt in record amounts so far this year, after a banner year last year. They have raised them at lower interest rates, thanks to pension managers (yes, your pension manager at TIAA-CREF or CalPERS) or foreign central banks or even bond funds like the FCBNX. They soaked up those offerings like drunken sailors on shore leave. Now companies like AAPL are paying interest rates on their borrowing 1.5-2.0% below market rates.
  • Here is the good news, corporate buybacks will hit record levels this year and are likely to begin, if they did not do so already (in a small fashion). That will further widen the disparity in returns between the mega-cap and smaller cap growth stocks.
  • Those Robinhoodistas, [ see MGF January 31, 2021 and February 11, 2021 who thought that meme stocks, margin buying and options trading were a free lunch are now barely holding on for dear life. I have seen some of these accounts and they are classic textbook examples of what not to do.
  • Speaking of what not to do – speculate in cryptocurrency like Bitcoin and Ethereum. It is a fool’s game, always was and always will be. Bitcoin peaked on November 11, 2021, at $65,466 on a closing basis and at $68,789 on an intra-day basis. Yesterday it closed at $30,740. A great deal of investment in the crypto market was done using margin or credit card loans. Now the piper must be paid back, and crypto speculators are forced to sell stock to make up their losses. Now I am beginning to think that the red headed step child to cryptocurrency – NFTs – [see MGF July 27, 2021: Don’t Buy Fake ]– is coming to an end. Buyer beware.
  • The Old 70/30 Sleight of hand. These funds come under many names and descriptions. Fidelity (I am not picking on them, but that firm has such a nice diverse offering that it makes for easy reference) has an Asset Manager 70% Fund (FASGX). That fund is targeted at 70-85% equity investment and the rest in bonds. When forced to reprice the portfolio due to bond price declines or raise capital it must sell bonds – but it also must sell stock, in greater amounts. Stocks become the innocent bystander. Most investors do not see this or know about it but there are hundred of billions of dollars in such funds and stocks are paying the price as bonds decline in value.
  • Capitulation - What exactly is capitulation? According to Investopedia https://www.investopedia.com/terms/c/capitulation.asp,

 “Capitulation is when investors give up any previous gains in any security or market by selling their positions during periods of declines. Capitulation can happen at any time, but typically happens during high volume trading and extended declines for securities. A market correction or bear market often leads investors to capitulate or panic sell. The term is a derived from a military term which refers to surrender.

After capitulation selling, many traders think there are bargain buying opportunities. The belief is that everyone who wants to sell a stock for any reason, including forced selling due to margin calls, has already sold. The price should then, theoretically, reverse or bounce off the lows. In other words, some investors believe that capitulation is the sign of a bottom.

Of course you never know when capitulation has ended, until markets reverse course however the greybeards think we are at or near the end of capitulation, though it is a matter of volume that will be the final determinant.

Finally, there is the age-old Panic Syndrome taking place. I see it all around. Good stocks are being sold with the lousy ones It is the “get me out at any price” mentality. It only helps the buyers not the sellers. As my friend and colleague Jim Cramer (yes of CNBC fame) says, “nobody ever made a dime by panicking.”

As I have written so often and experienced, these irrational selloffs create opportunities. It did so in 1987 Stock Market Crash, 1989 Mini UAL Stock Crash, 1990 Invasion of Kuwait, 1998 Asian Contagion / Long Term Capital Crises, 2008-09 Financial Crisis, 2013 Taper Tantrum, 2018 fourth quarter Powell Plunge, and the most recent 2020 Covid Pandemic.

The only exception was the 1999 Dotcom Bust and subsequent Bear Market. That was created not by a credit induced crisis but by irrational pricing for technology stocks that had no earnings and no capital. They were the stock market version of the Great Tulip Bulb Mania of the 1700s. We are not in the middle of a technology mania or bear market in stocks. The conditions simply do not match up. Today’s technology stocks are well capitalized and make money.

We are experiencing a bit of Taper Tantrum and a bit of the Powell Plunge (I still believe he was the wrong choice as Fed Chair and should not have been reappointed) with a great deal of fiscal policy bunders in the White House causing record levels of inflation and low economic growth. It’s likely a repeat of the Carter Years [ see MGF May 13, 2021: That 70s Show  ] The problem is that I expected all of this a year ago and it did not materialize when I expected it to do so. I was correct but too early in my call.

So what are you to do and not do now? Here are my suggestions:

  1. Get out of the bond market. You might have a good day here or there in bonds but those will just be noise. I recently sold all my bonds. The money went to growth and dividend stocks. The 10-year US Government Treasury will earn a total of 16% to maturity the next ten years and not one iota more or less. I expect the SPX or NDX or RUO to do significantly better these next ten years. I expect it will begin to do so within the next few months.
  2. While I think that the outperformance in Dividend stocks over Growth stocks is ending, I do not think that you have to rush to the exits. You might consider rolling the money we reallocated into Dividend stocks from Growth stocks two years ago back into Growth stocks. However, I would move some of the sales from Bonds into a combination of Dividend and Growth stocks.
  3. Do not give up on Growth stocks. Doing so has never been a winning decision. Why is it when someone walks past a widow at say Macy’s (M) seeing a nice shirt selling for $100 they do not buy it? They wait till it goes on sale for $70 to buy it. Right now you are getting $100 stocks for $70 – buy them, do not sell them. Remember, we buy low sell high, not buy high sell low. If you have spare cash, then consider putting it into Growth stocks.
  4. Do not let taxes drive you to make any decisions. We have till December to do so. Plus you can only write off $3,000 per year on your Federal Tax return.
  5. Do not override what your investment manager is doing. Do not pick and choose stocks to buy or sell. I once had a client who decided to short sell in another account stocks that I would not sell. The client got creamed. A few other times, clients asked me to hedge their portfolio. The market rallied heavily thereafter. Hey, if you had a bet on say the Dallas Cowboys, would you call up the coach and suggest plays for them to run? I cannot tell you how many times a client asked me to buy a stock and against my own better judgement did so. Not once did those stocks make a dime. I stopped taking such suggestions.
  6. Stop staring at the news in the Ukraine. Yes, its horrible what Vladmir Putin and the Russians have done. It will only make you angry and question your investments. We made it past the invasion of Kuwait and subsequent war. The Russians are losing the war in Ukraine and its economy is in a negative spiral from which it may never pull out of unless it floods the world market with oil.
  7. Do not become a mathematician and start to i) only look at performance of a single account rather than all your investments and ii) measure performance from tops rather than discrete periods of time like months or years. Investment professionals look at the entirety of client investment portfolios and they measure performance on a monthly, quarterly, or annual basis and if possible, against a specific performance benchmark. Annual is the most important which is maintained in official records.

Lastly, if you want to talk do not hesitate to pick up the phone. Also, I ask that you never leave instructions for me or my team in a voice mail, email, or text message. All such communication will only be accepted by direct phone conversations.

 

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Disclosure: At the time of this commentary Scott Rothbort, his family and/or clients of LakeView Asset Management, LLC was long AAPL, SPY, SSO, SPXL, QQQ, QYLD, TQQQ, M, MSFT  and TSLA -  although positions can change at any time.
Scott Rothbort is the President & Founder of LakeView Asset Management, LLC, (LVAM) an investment advisor representative, specializing in high net worth private wealth management. LVAM is affiliated with Kingswood Wealth Advisors Services, a registered investment advisor. For more information on investing with LakeView Asset Management, LLC call us at 888-9LAKEVIEW or request more information by clicking on the contact button on the top right-hand corner of the website. LakeView Management, LLC is a Nevada LLC, with its principal office located in Henderson, NV and branch office located in Millburn, NJ

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