Where to Invest?

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Some of the equity indexes are at all-time highs. As the Fed’s QE program continues, Yellen has made it clear that zero interest rates are here to stay for the long-term. Geopolitical situations and global economic volatility continues to bubble and jolt the market on any given day. So, where to invest, what to do, what to expect? These are all good questions and the answers will be found with reason and logic, while removing hope and ideological or even patriotic beliefs. Investors have two goals, increase the value of their investments and protect the principal. A successful investor is also a realist and can’t get caught up in politics of investing or “Buy America” because it is the morally or patriotic thing to do. If you vote with your wallet, you will lose. Ask all those people that worked for GM and bought GM stock to support the company; how did they do? I know how they did, I only had to ask my grandmother (currently 98 years old). Buying into a company she worked for in order to support the company was foolish. She lost all her money in the stock and company bonds, then her pension and healthcare were cut. If you want to be patriotic, go out and vote, volunteer in the community, join the military, do something for your country. However, as an investor, we must invest wisely and not patriotically or politically.

Where to invest?

I was recently asked whether I believe the best market for investing is in equities, bonds, or commodities. That is a good question, but my answer is not as black-and-white as the poser of the question had hoped.

Equity Markets

The equity markets (both domestic and globally) will always offer the best opportunities. The main reason is that one is offered far more transparency in many factors. We can see, experience, touch, and buy the products and services companies offer. You’re interested in retail; walk into Walmart or Target. Interested in Fast Food; go through a drive through. Interested in technology; buy a smart phone or computer. I make this point because the equity markets can be made very tangible to the investor in many ways and we can make a very acute observation from experiencing the products and services they offer. We are also given an opportunity every quarter to review their earnings. How much did they sell? What markets are strong and which are weak? Is the top line growing? What are the costs? Do they have debt? Did they issue a bond? There are many questions that are easily answered in the earnings period, which gives us even more transparency as to whether or not we should invest.

Courtesy of The Pulse72+

Beyond the individual factors that drive each company, which is reported quarterly, there is a broader economic environment that impacts companies. There are seasonal effects, geopolitical impacts, trade relations, currency risk, and, of course, inflation risk. These all create volatility to the individual companies; however, a solid and strong, well run individual company will be able to ride out almost any volatile event and one should look at those volatile events as buying opportunities. Sometimes, as they say, the baby is thrown out with the bath water – go get that baby!

Government Factor

Yet there is one new factor at play in the equity market, making it harder to objectively analyze the real value of the company or their future opportunity. This factor has masked and clouded most reasonable and logical analysis. This factor is our Federal Reserve and our Federal Government. For the first time in US history the federal government and Federal Reserve have not just regulated our markets, but have directly intervened. I am not going to argue the merits of whether they should have or not, but, regardless of where you fall in this intervention into the markets, we can’t deny that it has had a massive impact on our markets.

Courtesy of The American

The Federal Government nationalized dozens of businesses and bailed out dozens more. It is still deeply invested in some of our biggest markets including the financial sector and mortgage markets. Freddie and Fannie, GSE’s once thought to be autonomous are now government owned and run enterprises with trillions in liabilities on their balance sheet (the government calls these liabilities, “assets”). However, it has been the ongoing Federal Reserve program “QE” for the last several years that have brought forth the biggest intervention into the equity markets. While one could argue they have not been involved in the equity markets, the truth is that because of their TRILLIONS of printed money and supporting the bond market, they have driven trillions out of bonds and into equities. This proof is simple, over 80% of all gross US treasury issuance is purchased by the Federal Reserve. So if investors are not buying treasuries, what are they buying? The answer has been equities. The second factor driving equities higher is short-term interest rates set by the Fed at ZERO. If you can borrow from your broker to buy on margin and the interest is next to nothing, this creates an opportunity to buy more. As I pointed out yesterday, the NYSE margin is now over $450 billion and at an all-time high. Think about that for a second, $450 billion of the NYSE stock market is based margin, or another name for that is debt. The last two times we got to all-time highs in equity market debt was in 1999 and 2007. Now I want you to think about the Fed and Federal Government NOT intervening in the market and interest rates at historical mean of 4 or 5%. Where do you think the equity market would be? I personally think we would have rallied, but nothing like we have done in recent years.

Now, I am not saying that equities are not a good investment, quite the contrary, I think they are one of the best. However, I think we have all become far too comfortable with the general market rally that has lifted all boats. Going forward I think we need to be far more selective and prepare for some volatility. There are some great stories in the global corporate world with top-line revenue growth and sales. There are new technologies out there in the Cloud, Big-Data, and 3D printing. However, as the Fed has lifted all boats, if they trip, stumble, or do something that the market doesn’t like, it could just as easily sink all boats. We shouldn’t panic, but when this does come, look for opportunities. We must also realize that because there is a massive amount of margin (debt) in the equity market, that if we do get some big selling pressure and volatility, it could quickly turn into panic if we see margin calls start hitting the market. Don’t be surprised if this happens.

I would always make sure to use options in my equity portfolio to lock in gains and try to also increase yield. You can also use them as stock segregates if you want to be bullish, but remove the big principal risk that equities can sometimes create.

What about bonds?

Bonds come in several flavors; treasury, Munis, and corp. There are others, but these are the ones that investors mostly watch.

Us Treasuries?

Courtesy of About.com

I can tell you with certainty that I would avoid treasuries. While considered the safest, they also pay far less than the rate of inflation and the upside potential is limited. Prior to maturity, I believe treasuries could become one of the more risky assets. Remember, over 80% of the gross issuance in treasuries is purchased by the Federal Reserve. They have single handedly pushed treasuries as high as they can go, in the short-term. I guess short-term treasuries could go higher, but then we would have negative yield. I would argue that the treasury market yield is not accurately reflecting the risk in the market. It is simply because one player has FIXED the market and in their own words taken “extraordinary measures” to try to boost borrowing and spending. I don’t see that treasuries can go much higher at their current yield. They can’t even beat the government’s false measure of artificially low inflation. Think about that for a second, if you are skeptical of the CPI as an accurate measure of inflation and treasury bonds can’t even beat THAT rate of inflation, then why would you ever buy them? You wouldn’t. Neither would China. Back in 2009 the Fed started QE and China stated that they would no longer buy any more US treasuries with NEW money. They had $1 trillion in US treasuries when Bush was president and those holdings haven’t changed. They are only rolling their money into short-term treasuries as the current ones mature. In fact, there is no single nation that has ramped up buying US treasuries since the QE program started. If the major players are not buying them, why would you as an individual investor? Treasuries are losing bet.


Courtesy of Money Morning

So what about Munis? Well they do have some nice tax advantages, but after seeing city after city fail, haircuts, and elevated risk levels, I am not sure they are a very safe place at all. I spent time reviewing Meredith Whitney’s prediction on Munis and her conclusion was certainly correct. The math looks ugly and many of these states, counties, cities are significantly at the edge of failure. Chicago has raised taxes and so have others. Cities are cutting pension programs and staff to plug the holes in their leaking balance sheets. Unlike the equity markets, the muni market is not nearly as transparent. I also have little faith that politicians (on either side of the political fence) will manage their balance sheets in a responsible and accountable manner. Remember, their primary focus is getting votes and thus the temptation to risk the balance sheet to acquire votes to stay in power is just too strong. Meredith’s analysis is correct; however, her timing was significantly wrong. What she didn’t take into account was the ability for these markets to “kick-the-can” and juggle their books. Since the start of the credit crisis, California has twice issued IOU’s to state employees in order to make sure to stay solvent in their bond market. I think Muni’s are a risk and not nearly as transparent as equities. Oh, I almost forgot, when the liquidity dries up, which can and has happened, good luck getting out. Ask those in Detroit how they are doing. I think we could see more Detroit’s, but I also think we could see the Federal Government come to the bailout game again. However, we see that the government puts creditors (bond holders) in last position and state workers (voters) first. Remember what I said, it’s all about the votes. Clearly (legally), bond holders are first in line, but if you are a politician and are looking for votes, they quickly move to the back of the line in favor of VOTERS (unions, state employees, etc.). Agree or not, it is not a risk worth taking.

Corporate Bonds

Corporate bonds, which I would also lump in here MLPs and REITS, offer better returns, better upside potential, and a more transparent risk profile. Not all Corporate bonds are worthy, but I believe there are significantly better opportunities in this market than with either treasuries or Munis. From a transparency perspective, corporate bonds are very much like stock, . You can review the earnings statements and products and services they sell. So you can make a far more detailed review of whether they are worth purchasing or not.


Courtesy of Munknee

Lastly, commodities – I believe this year and for the next couple of years could be the time of commodities. As inflation climbs, coupled with a constant increase in global consumption, commodities have some room to the upside. The commodities market came under pressure in the last couple of years as we saw investors jump into the equity markets. Now with the equity markets topping out, leverage and margin reaching all-time highs, and inflation on the horizon; it seems that commodities are a far better opportunity. Not all commodities will react the same, there are soft-commodities (agriculture) that will see more volatility and there are hard-commodities (metals) that will be less volatile, but may offer less short-term opportunities. There is also energy which has several categories. The geopolitical situation, coupled with fiscal issues that boost inflation risk, can push commodities higher, with a good dose of volatility. As I believe the hidden balloon of inflation is building, commodities are a long-term strategy that should be in your portfolio.


A good portfolio will have some solid equities in it (growing topline revenue, low debt, and possibly yield), corporate bonds / MLPs / REITS, and a larger commodities position. I think Yellen could keep the equity party rally going for a while longer, but at some point she must either end the QE program and raise rates OR she will face inflation which could quickly become hyper-inflation. The fact is, a QE exit strategy is coming or she will face a cram down – either way the QE party will end. When will it come? I am not sure, but I think the later part of 2014 will see the start of the battle between real-world supply & demand vs. Yellen’s Keynesian world of QE money printing. Supply and Demand always wins in the end. Supply & Demand has destroyed governments and empires. In our life time it has brought down the Berlin Wall. You can’t fight the tide; the problem is Keynesian’s like Yellen don’t know that. She has never been in the real world, only in the warm embrace of the theoretical halls of academia, and that frightens me. I don’t think she will give in easily and that could bring forth a higher risk of volatility in the dollar and inflation.

Courtesy of Economic Perspectives

Support & Resistance

INDU 16,250+
We continue to hold up well and I think we wait for the FOMC meeting before the market makes any trending decision.

NDX 3650+
We are moving parabolic and the index as a whole is getting a little frothy. There are some good companies in here, but I think one has to be very selective.

SPX 1850+
The VIX is holding up above 14 and, to me, is not fully buying into this break-out rally yet. Perhaps the market is waiting for the FOMC meeting.

RUT 1180+
I think we could pull back to 1180; however, it will be the Fed and Yellen that will set the tone going forward.

Fed Factor

Yellen has been the main actor in the Fed play. Her speech and testimony have left a lot of room for a change in the taper policy. The data has given her room to justify a slow-down in the taper or a halt all together. Yet, she may wait, but why?

The problem is there are no more tools in the tool box. Interest rates are at zero, so she can’t lower them anymore, so that leaves money printing and asset purchases. Right now they are tapering (reducing the amount they are buying), so her only course of action is to reduce the taper and increase the amount they are buying. However, this is her one trick pony, if she does it too early she will have nothing left to do but just print more. She is smart and while her ideology blinds her, she does know that inflation is a real risk factor.

I think the most we could expect is to halt further taper and keep it running at $65 billion per month. If she does taper, she would most likely slow it and reduce by $5 billion down to $60 billion per month.

There is some real math to the equation, how much MBS and Bonds do they have to purchase? If the US treasury is issuing more bonds, then they can’t taper. In fact, it is the MBS and Bond market that will determine how much she can taper, if at all. Frankly, the amount of tapering has nothing to do with economic data and everything to do with how much the government needs to borrow and how many MBS’s will be issued.

5 Responses to “Where to Invest?”

  1. Steve H. says:

    A very good good, thoughtful summary! Thanks!