Bond markets

Everyone expects to be a winner (and all children will be above average)

I’m reposting this here from the Heisenberg Report. According to this study, essentially everyone thinks the stock markets will finish higher in one year.

Such a high level of optimism is some kind of record.

My guess is that we got here because EVERYONE expects the central banks to intervene forever. Having painted themselves into this particular social expectation corner, it’s going to be interesting to see what the central banks do next.

Way back in the days of free markets, we were taught that extremes of market consensus are danger zones, and that “the consensus is often wrong”. But as I wrote on August 1st, traditional diversification has been proven unnecessary for so many years that investors could be forgiven for it’s just gonna stay like this forever.

My plan is to stay diversified and keep searching for bargains.

A problem with reality

Is that sometimes it is so irrational. The financial markets are currently radiating “market bubble” and I’m reading a very well written quarterly update by the managers of the Forester Value Fund. It captures all the data which suggests that we are currently at market highs and we are at risk of a coming downturn in both the bond and stock arenas.

But there’s a problem. Forester Value Fund TOTALLY ROCKED our stock market declines in 2000 and 2008. And they also lagged horribly while markets recovered. Why? Probably because they are rational, intelligent, insightful managers who have managed their mutual funds with thoughtful awareness of market indicators. In other words, they’ve done everything courageously, and right. We don’t own the fund now, because we couldn’t lag like that. Instead we’ve used asset allocation mutual funds and international mutual funds to successfully participate at least partially in growing markets.

Yes, Virginia, the financial markets are bat-spam crazy, and many of our politicians are beyond incompetent. But the lower interest rates delivered by central banks have trumped everything else, so markets have continued to rise. By staying diversified and partially invested we’ve accrued a substantial part of the financial markets’ gains. But even as I watch us making good money, I have to shake my head.

Read Forester Value’s superb quarterly update here.

The Biggest Iceberg Of Unrecognized Risk

It’s a ship-killer.

While we obsess about the stock market, an even-bigger financial challenge is possibly looming in the future. Yet few people are paying attention.

Debt has once again risen to outlandish proportions. Especially, state-driven debt and pension obligations may have reached a level which is impossible to pay back.

Read more about yet another state’s financial struggle here.

Why don’t we clearly know if these massive commitments are fundable?

Because we don’t know how much the economy will grow in the future.

Also we don’t know if sanity will emerge and spending will be reduced.

And, finally, we don’t know what actuaries will define as future contribution requirements for the large pension plans.

All this has deep implications for our economy and especially our bond markets. As investors, diversification is key, since we can’t really know where and when debt defaults might occur, if ever.

To help with this, we’re keep municipal bond investors diversified into nation-wide municipal bond mutual funds and not just state-of-residence-only mutual funds. Yes, you’ll pay a bit more taxes, but you’ll probably be safer.

In the taxable bond arena, we’ll keep most of our long term bonds in our asset allocation funds, so the managers have a non-bond place to run if a crisis suddenly pops up.

Most likely we’ll simply muddle by, as tends to happen. Patience, courage, and discipline.

Have a great weekend.

Why the economy isn’t thriving: more insight

Last week we were in San Francisco listening to a presentation by Schwab’s chief economist, Liz Ann Saunders. My takeaway was that the economy is not thriving because of

a. excessive debt in the system.
b. complexity.

The excessive debt may or may not have prevented a depression but its legacy is gargantuan payments to keep from defaulting. These will only become larger as interest rates rise.

The complexity is due to technological change and off-the-charts over-regulation. Distractions have grown and regulatory uncertainty is rife.

What will happen? We don’t know. Here’s bond guru Bill Gross’ latest comment.

Is inflation the only way out?

At the end of a busy day of study and action, I’m looking at overall debt loads and interest rates. I’m wondering if, perhaps, the US government might seek to “accidentally” create runaway inflation for a short period to reduce the real cost of their soaring debt load. Otherwise, when interest rates go up, it’s going to be very difficult to repay. It worked for Germany in the 1920’s. No, wait, it didn’t work, did it? Still, it will be tempting when the bills come due.

Explore German hyper-inflation here.

Out of energy, into financial stocks.

We have largely exited our energy holdings. Most of these were profitable. We have cut our gold exposure in half after a very successful run. Our overall holdings in technology and health care remain in place. Now we are newly invested in bank stocks, both foreign and domestic. The challenge of financial stocks currently is that they are a very uncertain and high-risk position, dependent upon both interest rates rising and economies not stalling. We can’t really guess what will happen. For example European bank stocks…of which we own a dollop…were hammered today with bad Euro-economic news (Is there any other kind?) I’m thinking that patience and humility may help us produce outsized gains in this unloved, ignored sector. Meanwhile billionaire bond trader Jeff Gundlach says sell everything, even the kids. I’m inclined to keep the kids. Stay patient.

Read this article simply to see what billionaires think is happening…and it’s not pretty. 

Singapore’s Sovereign Fund is expecting what the bond markets are already predicting

That would be at least a decade of slow growth. The article is attached. As I read this, I’m struck by how fortunate we are that we didn’t go to cash back when it seemed that cash was best. I’m interpreting this article as a prediction (and you know how well those work) that index funds won’t uniformly perform optimally. (That’s investment-speak for “They might lag.”). There will still be very attractive sectors, if we have the wisdom to see them and the courage to invest in them.

Read the article here.