Will they or won’t they? Can we or can’t we?
In this quarterly message I will try and explain the crosscurrents which are occurring in the various financial markets around the world. Notice I did not say just stock and bond markets since there are 8 to 10 other markets/asset categories.
In hindsight, the past six and half years have been fairly easy to understand and ascribe cause-and-effect. The Federal Reserve reduced interest rates which caused stock prices to increase. The Fed’s intent was to create a wealth effect which would spill over into the general economy. (The wealth effect describes a situation where the consumer has extra money they will spend, thus increasing GDP.)
Currently, we are sort of in a holding pattern. The zero interest rate policy embarked on by the Fed in response to the 2008 financial crisis and copied by the rest the world seems not to have the intended wealth/GDP effects. GDP's around the world are stagnant and the United States is the cleanest shirt in the laundry basket.
So the questions I would ask to decipher the future are twofold.
First; Will they or won’t they?
I am speaking about the Federal Reserve and their perennial promise to raise short-term interest rates. Last year the Fed forecast 3 to 4 interest rate increases for this year. Currently there have been no interest rate raises this year. We are now hearing from Ms. Yellen, the Federal Reserve chairperson, that they may raise short-term interest rates in December. If they raise rates will it be one and done or will it be the start of normalization? Meaning interest rates should rise to about 3%. This would actually benefit savers since they would make some interest on their short-term deposits.
In my opinion, the stock market, for the past six and half years, has been based on low interest rates. You can invest in short-term bonds and get 0% return or negative returns or you can invest in stocks. Since most people only invest in stocks and bonds, There Is No Alternative to Stocks. (TINA) For most investors, the stock market is where most of their investment returns come from. But if interest rates rise substantially, now stocks have competition. We could possibly say goodbye to TINA.
Most importantly; Can we or can’t we?
As I mentioned above, the United States has been one of the best performing economies in the world. When the economy is growing that means companies are selling product which means companies are making profits which should mean stock prices go up. Japan and Europe have had flat GDP or been near deflation. (Deflation is when the cost of goods goes down over time, that includes stock ,real estate and most any asset.)
So the real question is, can we grow and get back to having inflation vs. flirting with deflation which has blanketed the world with an oversupply of goods and services?
Currently the stock market is pivoting from low interest rates and TINA, to anticipating government stimulation (fiscal stimulus). Which means the US may be spending more money, which the US doesn’t have, increasing thus our debt.(www.usdebtclock.org) If the US government spends a lot of money in an effort to stimulate the economy we could see several more years of stock market gains and some inflation. Also, if interest rates rise, values of bonds will fall.
Families with a Billion Dollars
IF you want to see what the big money is doing, watch the behavior of people who invest their own money.
Recently I spoke at a conference in New York City comprised primarily of family offices and multi family offices like ours. When your net worth is $500 million to several billion dollars you create your own Family Office to manage your accounting, legal, tax, charitable giving, estate planning as well as all aspects of your financial and personal life.
What struck me was the event sponsor stated that on average, family offices have 30% of their assets in cash. You need to think about that statement for a second. There may be 100 family offices in the country each handling several hundred million to several billion dollars for the family who owns the office. The big money is getting VERY conservative with their own investments.
At breakfast before the conference started, I spoke with one of the family office owners and he was cautious on the economy. He told me he had sold off about one-third of his real estate and had the money parked in cash. Unbeknownst to me, he was one of the speakers and his family had $3 billion managed by his office. Ergo, he has $1 billion in cash waiting for better investment opportunities.
A few months ago we reduced our stock positions to neutral from overweight and raised cash waiting for a buying opportunity and better valuations.
At some point the bill for this low interest rate, accommodative Fed and possible fiscal stimulus will come due. The question is when will the bill come due and how much pain will we have to endure. This investment party will not continue forever and when the music stops, my goal is to make sure we have a seat and are not out of the game. The goal of true diversification* (beyond only stocks and bonds) is to reduce stock & bond correlation in your portfolio. As I always say: The best way to make money is to not lose it.
At Handwerk Multi Family Office we are working with families with a net worth of 5-50 million dollars. So please do not worry about the economy, interest rates, advanced planning items or investments. That is our job. Your job is to enjoy life.
*A diversified portfolio does not assure a profit or protect against loss in a declining market.
The views stated in this letter are not necessarily the opinion of Cetera Advisors LLC and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Due to volatility within the markets mentioned, opinions are subject to change without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. Past performance does not guarantee future results.
Investments in securities do not offer a fix rate of return. Principal, yield and/or share price will fluctuate with changes in market conditions and, when sold or redeemed, you may receive more or less than originally invested. No system or financial planning strategy can guarantee future results. Therefore, no current or prospective client should assume that future performance or any specific investment, investment strategy or product will be profitable.