Where to Invest When Volatile Asset Bubbles Are Everywhere
Optimistic prognosticators are claiming the worst recession in a century is finally beginning to show signs of recovery.
Yet other key indicators still make some of us a bit nervous.
With more than a 70% increase in the number of Americans on food stamps since 2008, it makes the “recovery” seem a bit less sustainable in the short-term.
In fact, indications of volatile bubbling assets are all around us. Corporate and public bonds, equities and even the recently failed real estate market are having some think another bubble burst is on its way. First let’s discuss the signs that another collapse could occur and how individual investors may be able to prepare and avoid potential losses.
Massive Flock to Bonds
Safe-haven investors, like those in retirement, have been chasing steady returns like mad. With interest rates at record lows and volatility at record highs, the lucky benefactor of this activity has been the bond market. Most analysts agree that the bond market has had an extra normal flood of activity in recent years that bears the tell-tale warning signs of a bubble.
The most disingenuous aspect of the bond market are the rates themselves.
Rising Interest Rates Could Spell Losses for Bond Holders
Since interest rates have never been lower, there is literally no place to have them go but north. Any purveyor of bonds knows bond prices decrease when rates rise. Thus, investors holding bonds run the risk of massive devaluations in their bond portfolios if rates should rise. Here are some potential pointers for bond holders in the current fray:
- Junk Bonds. Historically, in times of rising rates, junk bonds tend to fare better than their AAA counterparts. There are a couple of issues with junk bonds, however. First, they inherently carry more risk. Second, history doesn’t always repeat itself. For instance, historically mortgage-backed securities were a safe investment. Where did that get us?
- Avoid Frequent Trades. Especially in times of rapidly increasing rates, trading frequently will mean greater losses. In times of rapidly increasing rates, current holdings determine loses. As rates rise, it’s best to make the trade and get out quickly.
- Be Ready for Cash. Cash is not a great thing to hold when inflation is rampant, but having cash on hands to buy real goods can be an excellent move, especially if rates take off.
The bond market is nearly $100 trillion worldwide. That’s a huge number. If you thought the disruption in the housing market was big, a bond implosion would be catastrophic. Let’s hope it doesn’t happen, but be ready with a quick draw on the trigger if you begin to see the signs.
Equities Rise Again
The latest in the string of foreseeable bubbles occurring is happening in the equities market. The smaller, by more than half, version of bonds, equities have generally carried more volatility. Interestingly enough, they also carry a great deal of Federal “easy money” behind them. Thanks to the Fed’s pump priming, many of the country’s largest corporations have extremely large amounts of cash sitting dormant on their balance sheets.
Like many retail investors, they have waited for the right investments with decent returns to throw their money into.
Since, none have been reinvesting, the cash continues to sit there. And why should they worry, inflation doesn’t seem on the horizon—at least in the short-term. Another effect of the Quantitative Easing performed by the Fed has been the boost in Price to Earnings Ratios.
Price to Earnings, or P/E ratios is a simple calculation derived from the company’s stock used to tell what future expectations about the company’s performance will be. Many actually believe historical P/E ratios have been bloated for years, but they have actually ticked up in recent vintage, indicating the money printing has had taken its hold.
There are a couple of questions to ask.
First, can the current levels be maintained long-term, especially with so many Americans lacking the purchasing power of the past?
Second, will they keep up their current high perch even if the Fed stops pumping money into the market?
The “by no arbitrage” rule may not apply everywhere, but for the individual investor, it is certainly best to treat the markets as such. That often means holding the market and hoping there’s not an eventual cliff on the horizon.
Real Estate is Propped
Several articles I’ve read recently were entitled “housing bubble 2.0” and they indicated yet another bubble in real estate may be upon us. The main gist: real estate is currently propped-up by investors.
With 10,000 baby boomers retiring each day, most 65+ are looking to retire. In addition, the 18 to 30 age bracket has been the hardest group hit by the recession and those we would expect to be borrowing and buying their first homes. The economics of supply/demand don’t make sense. The recovery is a fake one, funded by investors looking to get a return and cash flow from low rates and willing renters.
There is one redeeming quality about the real estate market, however.
If inflation does take off and interest rates do begin to rise, then those holding hard assets like real estate on loans for <4% may be somewhat sheltered from the storm.
The interesting dilemma here is how everything is so interconnected. It’s not like everyone running from bonds will flock to real estate as about 26% of bonds are real estate-related.
Equities, while half the size in actual dollar terms of bonds, cannot effectively take the brunt of the run on bonds. So, where will the money go?
Gold is not a bad option, especially in times of rising rates. But it certainly has its limitations and it has risen more recently than ever before.
Hard assets, in general, are always a good option. Others are claiming foreign investments, including foreign currency is a good avenue. My personal thought is that if one goes, they all go. Let’s just hope unemployment ticks down before we get another implosion on our hands.
Because if it does occur, there aren’t too many other directions to run.
