Proceed with Caution. The Financial markets have risen over the past twelve months due to continued Federal Reserve stimulus and improving job and housing data. Something about increasing the Federal Reserve holdings from $825 billion to $3.7 trillion has spurred significant growth in monetary reserves and eventually money supply growth. The sheer wealth effect of maintaining historically low interest rates and the subsequent rise in stock prices will translate into better economic times for the immediate future. The great rotation from bonds to stocks is occurring as bond funds are experiencing outflows since May. We believe the recent rise in bond yields maybe the forefront of higher long term rates.
Road Narrows. The stock market has risen beyond even the most positive investment prognostications from 2009. Price earnings ratios have risen from 11 times in 2009 to 14 times earnings in 2013. Interest rates remain low despite the recent rise in the 10 and 30 year U.S. Treasury bond yields. Concern that rising mortgage will curtail people from buying new homes should be noted. Yet, any rise in economic activity in the next six months should alleviate the higher mortgage rates.
Soft Shoulder. Any recovery in China, Brazil and Russia will be icing on the cake. However, many US stocks are priced to perfection. Similar to, but not exactly the same circumstances, the stock market feels much like 1999 to 2000. Great financial uncertainty regarding the year 2000 changeover gripped the world with fear that the semiconductor was flawed convincing many policy makers that great financial peril would follow. Of course, it was all hype. Although, there is no immediate type of event pending, the market has risen without the aid of the U.S. retail investor. Great suspicion still clouds the tremendous move in stocks since March 2009. Enjoy the ride.
Men at Work. Housing must rebound. On any measure, home mortgage rates remain very low on a long term basis. The structural unemployment rate may have risen to 5.5% to 6%, yet any movement by housing to attain 1.3 to 1.5 million housing starts on an annualized basis would really heat the economy up! Recent data indicates that current housing starts remain below 1 million on an annual basis. Since 2009, the trend to rent has supplanted the new home sales markets. Rental homes and apartments have proliferated since 2009. The other Great Rotation would be renters becoming home owners in the next 24 months. In order for this to happen, the new younger generation must step forward to own a home. This has not happened as of yet.
Watch for Ice on Bridges. An early winter is in the offing. August was one of the milder summer months in the recent modern history. The Arctic Polar Ice Cap is growing at a rampant pace. The Farmers’ Almanac is predicting a piercing bitter winter. Of course, most meterologists get paid whether they are right or wrong! We do believe the winter will draw down oil and natural gas supplies in a meaningful way. We did have a decent supply going into the summer and gasoline prices have dropped an average of 20 cents a gallon. Regardless, should the winter be a colder one than usual, energy supplies should tighten and prices rise. We would further argue that the easy money policy of all Central banks should be followed by higher levels of inflation eroding the purchasing power of all paper currencies. We believe that inflation will rise over the coming months.
Speed Bump Ahead. Going into the fourth quarter, we believe that bonds remain under pressure and believe investors should avoid long term bonds and bond funds due to rising inflation expectations. We do like long term commitments to common stocks. Historically, stocks have always been a better hedge during inflationary times. Large capitalization stocks will be affected by inflation. Yields should rise and price earnings ratios should decline. The sweet spot for stocks will be the mid-capitalization and small capitalization companies. Inflation increases corporate cash flow for smaller companies, usually! Additionally, economically sensitive issues will fare better as economic activity should remain static during this period.
Street Closed. The recent discussions by Sandy Weill, former CEO of Citigroup, regarding the breaking up of the large banks have fallen on deaf ears. We believe that commercial banks should be in the business of lending money and maintaining checking and savings accounts. In 1999, the Clinton administration repealed the Glass Stegall Act of 1933. Glass Stegall was passed to separate investment banking activities and commercial banking activities after the Great Crash of 1929. We believe that this needs to be reinstituted to strengthen banking in the U.S. Investment banking should be a private institution. We believe the current financial leverage in the large money center banks remains potently high and poses similar risks that cause the financial meltdown in 2008.
Dead End. We confess that we never purchased financial stocks during the crisis of 2008-2009. As a former banking examiner, we believed that bank stocks were not good investments then and believe that astute investors should avoid bank stocks at this juncture as rising interest rates will adversely affect bank profits for the foreseeable future.
Slippery When Wet. We do believe many stocks to be overvalued at this juncture. After an 125% rise in stock prices since March, 2009, we believe the time is near to wait on a modest stock market correction and build cash positions at this juncture. Investors need to take a good hard look at their holdings and reduce bond holdings and keep their financial powder dry.
Narrow Bridge. Over the past five years, the financial markets have now proven that buy and hold investment strategies pay large dividends. The patient investor has been handsomely rewarded. We consider an honor to serve as your investment advisor and welcome meetings with you in the future.
Russell L. Robinson
Robinson Investment Group
5301 Virginia Way, Suite 150
Brentwood, Tennessee 37027