Monday, May 25, 2009

Investment Update -- Stocks, Stuff, and the Bond Bubble

This is a good time to look at where we've been to help figure out where we're going.

For months now I have been very worried that the U.S. Treasury bonds that so many frightened investors have flocked to seeking safety are not safe at all.

I've also talked about how it’s a time of great risk and great opportunity. About how it’s not time to be bullish or bearish but it’s time to be smart. About how that means owning stocks and stuff—quality technology companies with proprietary, productivity enhancing products, consumer staples, and emerging markets on the stock side and commodities, basic materials, infrastructure products, and energy on the stuff side.

The underlying thesis has been that we are in a deep recession where debt-strapped people and companies will only buy necessities and value-added products. We are in a bad demographic place in the U.S. with too many of us old fogies who will live way too long and be net takers from society and the economy so it’s better to invest in countries where there are more young people.

We have a president who says he is committed to building infrastructure, clean energy technology, and saving the economy at all costs. ALL costs.

Since early in the previous administration, the U.S. has been printing trillions of dollars with no tax revenues to back those pieces of paper up. Once we reached the the brink of financial collapse, those efforts were ramped up even further. As a result, the cost of stuff is about to go up and our loan sharks (the institutions and countries that buy our debt) will demand much higher interest rates going forward.

No matter which party is in control, we will never raise enough tax revenue to service and pay down our debt so the Treasury will simply print more dollars with nothing to back them to give our creditors the “money” they have coming. We won’t default—we will just inflate.

As usual, the experts and pundits have been clueless. All of the cable conversation been about whether the stimulus will work (whatever that means), whether the banks will all go broke (as the stock market seemed to predict two months ago), whether the banks will all come storming back (as the stock market has been predicting lately), whether Obama is a socialist, whether Nancy Pelosi is a liar, whether Rush Limbaugh or Colin Powell is a better Republican (just the fact that they’re having the conversation is scary), and a whole bunch of other stuff that range from inane to not a big deal.

Here's what's important. The economy is terrible. Tens of millions of Americans are hopelessly in debt, out of work, or underemployed. But things have started to get worse at a slower pace and eventually things will get better. That's because Obama has decided to take a complete financial collapse and economic depression off the table for now by printing money. The price we will pay for that in the future is not totally clear but some things are getting clearer by the day.

The long-term borrowing costs for the U.S. government have increased by well over 50 percent during the last few months and will go higher. The value of “safe, guaranteed, and risk-free” treasury bonds has dropped sharply during that period. These are the holdings in the funds battered investors turned to in March to get away from the volatility of risky equities. Since then, the stock market has soared (to great fanfare) while sharp drop in the Treasury market has gone relatively unnoticed.

Short term interest rates—which the Federal Reserve can control—have remained near zero. But the free-market forces in the long-term bond market are suddenly making it very clear that even with the Fed out there buying hundreds of billions of dollars worth of bonds, there is still way more supply than demand at these interest rate levels. The yield on 10-year notes has jumped from 2.00 percent to 3.45 percent and the 30-year rates have gone from 2.50 to 4.30 percent since the first of the year.

The rise in rates could provide the catalyst that many are looking for to trigger the correction that most investors are expecting after the recent straight-up move of more than 30 percent in most stock averages.

But something else could be going on.

It may well be that with all its problems, the economy is at least on the right track and will, albeit in fits and starts, keep moving in the right direction. It could also be that the mountain of money that moved into cash and bond funds earlier this year will start moving into stocks and that correction everyone is now expecting will come from much higher levels.

We have already seen cash lose its buying power as those who own oil, gas, gold, silver, copper, and other raw materials are demanding more dollars for the same amount of stuff. Did anybody out there check out gas prices over the weekend? As the cost of stuff goes higher, the cost of essential products will go up as well. The value of the companies that make those products could go up with the tide.

That assessment may only be partly right and things may not unfold exactly that way. The fact that we don’t really know is why we diversify.

I'd want to keep owning stocks and stuff and buy more if we get the pullback in prices that everyone has been predicting--which is why we might not get it.

It’s time to look past all the stupid chatter coming from the media and be smart. I’m here for you and anxious to talk about how to invest in this very challenging environment. Everybody's investment objectives and risk tolerance are unique. There are a lot of question marks out there, but smart is still smart.

Be well and stay in touch.


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