InnOvation Capital & Management, LLC
IntelDigest
LAW – POLICY – FINANCE – MARKETS
INFORMATION FOR THE ENTERPRISE AND INVESTOR
NOVEMBER 2, 2016
Contact Richard Power with comments or questions. IntelDigest is intended for the use of our clients and colleagues. Material may not be reproduced, forwarded or shared without express permission.
This week in IntelDigest, we will discuss the financial markets … looking at expectations for the near term, as well as prospects for 2017.
In coming weeks, we will go into detail on the highlights of this discussion … examining the causes of an expected Bond Market downturn, and specific reasons for the expected surge in the Gold Market. We will also dive into discussions of Free Trade, and Technological Development, as well as outline Medicare regulations and requirements for those of our clients approaching retirement age.
Let’s start with The Election … we do not discuss politics in IntelDigest, but the results of an election have a major impact on the markets … at least in the near term … so we will discuss the impact of the November 8 results.
Election of a New President
It is generally expected that the election of Hillary Clinton has been assumed by market participants, and would result in a temporary lift in stocks. However, the FBI Director’s letter to Congress has roiled the markets over the last few days, causing uncertainty among investors. As we have stated several times in past issues, investors and companies HATE uncertainty, so stocks are in a defensive posture until the vote has been completed.
On the other hand, a win by Donald Trump will most likely cause an immediate downturn, perhaps as much as 10% in U.S. markets within a day or two. If foreign markets follow this downward path, the aftermath of a Trump election could reverberate around the globe and turn a 10% slide into a 15-20% global decline.
If that happens, The Federal Reserve would probably cancel the small interest rate increase which it has targeted for December.
Looking Forward to a New Year
After the dust settles and we move into 2017, certain economic themes are expected to play out, no matter who is elected President. One example is Gold. James Steel, chief precious metals analyst at HSBC Bank, believes that Gold is the only sure winner in the election. The spot price of Gold today is $1,307; Mr. Steel expects the price to end the year over $1,400 if Clinton is elected, and over $1,500 if Trump is President-Elect.
As reported in BloombergMarkets, “… both candidates have espoused trade policies that could stimulate demand, with gold offering a potential “protection against protectionism …” Both candidates are also on record as supporting significant stimulus programs. A Democratic sweep would almost certainly result in a large increase in federal spending. An increase in the federal deficit would underline a surge in the value of Gold.
Another 2017 theme is the danger in the Bond Market. There has been incredible movement into bond funds and ETFs (exchange-traded funds) this year. Inflows into Bond Funds/ETFs through the first nine months of 2016 have totaled $123 Billion … 4X the previous year … and much of that investment came out of Equity Funds and Money Market Funds.
The risk in Bond Funds … particularly the possibility of default … will be higher in the coming years than it has been in decades. Liquidity is a major issue for companies who have taken on vast amounts of Debt in the low-interest environment of the last seven years. Profits are decreasing across the board.
Bonds have sold off recently as interest rates rose, and many investors began dumping bond funds. The Wall Street Journal reported this week that investors pulled $2.2 billion from all junk bond ETFs last week. Nearly half of that sum came from just one ETF on a single day: $998 million flowed out of the iShares iBoxx High Yield Corporate Bond ETF (HYG). High-grade bonds were also affected; $1.7 billion was pulled from the iShares iBoxx Investment Grade Corporate Bond ETF (LQD), the biggest weekly outflow since inception.
A serious bond-market decline is expected in the coming year, and these recent outflows could be the first sign of much bigger problems to come.
You should be especially wary of junk bonds, or funds containing such bonds. The danger is that some combination of rising defaults and higher interest rates will trigger a bond-market panic. The risk of default is just too great!
Return of Inflation
Inflation is making a comeback, and that has a deleterious effect on Bonds. According to The Wall Street Journal, “… data released on Friday showed that core inflation, which excludes food and energy, hit a two-year high of 1.7%” last quarter.
Inflation is rising in Europe, and soaring in the U.K. The National Institute of Economic and Social Research (NIESR), a British think tank, warned that inflation could quadruple in the second half of next year.
As we know, higher prices are not good for the average person; for the Bond investor, inflation is disastrous! The typical Bond pays a fixed annual interest rate; as inflation goes higher, it eats into the “real” return on investment. If inflation leads to higher interest rates, then the market value of the Bond decreases.
Investors in long-term bonds are most at risk; the future payments of long-term bonds are more vulnerable to rising inflation and interest rates than bonds with shorter durations. Because they are riskier, long-term bonds pay higher yields. For example, the 30-year U.S. Treasury has yielded almost twice as much as the five-year U.S. Treasury over the last 10 years.
Investors have loaded up on long-term bonds in recent years because short-term bonds have paid next to nothing. As Bloomberg has reported, “… Investors seeking relief from central banks’ zero-interest-rate policies have poured into government debt due in a decade or more, swelling the amount worldwide by a record $733 billion this year. It’s more than doubled since 2009 to about $6 trillion, data compiled by Bloomberg and Bank of America Corp. show.”
Now, with inflation rising, many investors are fleeing from long-term bonds. As an example, the iShares 20+ Year Treasury Bond ETF (TLT), which tracks the performance of long-term U.S. Treasuries, is down 9% since July.
Things To Do Now
It’s time to sell (or stay away from) long-term bonds. If inflation keeps climbing, investors will sell more bonds, pushing yields higher, which could trigger even more selling. The global bond market is a $100 trillion market; these early signs of trouble have already spread to the stock market.
As the Wall Street Journal reported on Monday, “… the Dow Jones Industrial Average fell for a third consecutive month, its longest stretch of declines since 2011. The S&P 500 recorded its worst month since January, and the Nasdaq Composite snapped a three-month winning streak.”
It is also time to go to Cash; portfolio managers at several large institutions are recommending Cash right now, including Mohamed El-Erian of Allianz, one of the world’s biggest insurance companies. Among the reasons to cultivate Cash now: uncertainty about the election, overvaluation of equities, and falling bond prices as interest rates rise around the world.
Cash also allows you to avoid losses on positions which have declined, reduces the volatility of a portfolio, and maximizes “optionality” (choices) to enter and exit positions, and search for bargains, without having to worry about price.
Having more Cash than other investors allows you to shop for bargains when others are desperate to sell.