Editor’s Note: Today’s special Daily begins in the Palm Beach mailbag… as we address a common question perplexing almost everyone today: How do we navigate today’s bizarre investment landscape safely?
 |
From Marion S.: I find it really difficult to figure out exactly what everyone in your group is saying. I’m talking about all the advisers at Palm Beach Research Group and its affiliates.
There are mixed messages daily… Buy gold. Buy cryptocurrencies. Buy Legacy stocks under their buy-up-to prices. Stay away from bonds. It goes on and on.
Your messages are too confusing—thus creating the possibility of huge losses. Can you please be clearer? Thank you.
Reeves’ Comment: Thanks for your letter, Marion. Your concern is one we hear a lot. Let me try to clear things up a bit.
There’s a reason you see what appears to be conflicting recommendations from our editors and analysts. It’s because we’re such strong proponents of intelligent asset allocation.
This means spreading your money across different asset classes… like stocks, bonds, real estate, and precious metals.
Asset diversification doesn’t expose you to huge losses… it helps prevents them. When one asset class is in a downtrend (for instance, stocks), another is often in an uptrend (for instance, cash).
After the trend reverses, you can use those “strong” dollars to buy stocks or other depressed assets “on the cheap.” Keeping your assets diversified ensures you always remain secure on a net basis.
And in today’s “upside-down” markets, the type of allocation we recommend is more important than it’s ever been…
| Recommended Link | ||
|
||
| — |
A New Monetary Epoch
We’ve entered a time of unprecedented uncertainty in the markets…
Now, I’m not talking about traditional uncertainties such as whether the economy is growing… if unemployment is coming down… or if the latest earnings data will beat analysts’ expectations.
Today’s uncertainty deals with the fundamental fabric of the markets themselves.
We’ve reached a point where the markets themselves are breaking down.
Price Action
Let’s look at the core component of all markets: prices.
Prices exist at the intersection of supply and demand. They signal whether a market is in equilibrium.
In general, when demand is high and supply is low, prices spike. And when demand is low and supply is high, prices plunge.
You can see this price action after a natural disaster hits. Often, demand for clean water increases while supply decreases—so water prices increase.
Some will see this as an opportunity. They’ll bring fresh water into the market as fast as possible to capture those high prices.
As the water supply increases, prices fall. Soon, the market has all the fresh water it needs, at prices most people are used to paying.
Prices let the market’s supply and demand forces reach equilibrium.
But all that breaks down when you start tinkering with the value of money… which is what the world’s central banks do. By raising and lowering the supply of money and credit, they send prices to places natural market forces never could.
For example, the banks can raise and lower the price of goods and services even as their supply and demand stays constant. They do this by distorting the supply and demand of money.
The markets misinterpret these signals. The result is a terrible string of unintended consequences. And we’re seeing their effect on the global economy today…
Overwhelming Money
Over the last eight years, central banks have tried to “save” the world economy by creating trillions of dollars out of thin air. (From 2008-15, the U.S. Federal Reserve alone bought $3.7 trillion in bonds.)
It’s been the largest boom in money and credit creation in history. All that fresh money in the system starts distorting natural market prices.
As I mentioned in last Friday’s Daily, central bank policies are about one thing—manipulating the numbers on balance sheets.
They want to force everyone into a more favorable lending setup. Because for them, more lending equals more “growth.”
But so much money has entered the system, we’re now witnessing the markets’ inability to signal what are legitimate cues on goods’ supply and demand… and what is further monetary intervention distortion.
Lost
Zero Hedge reports titan European investment bank Credit Suisse’s traders have lost touch with the markets. Strategist Andrew Garthwaite admits:
|
We have never had so many client meetings starting with statements such as ‘we are totally lost.’ |
He’s not alone.
The table below comes from Statistical Ideas. The website tracked the abysmal track record of active-managed funds over the last several years (this chart shows 2015 performance).
Managed funds edged out their benchmarks in only 2 of 15 key segments. And the two that did beat their benchmarks only did so by less than 1%.
The fund managers are unable to divine normal price cues. Central bank money printing has distorted them beyond recognition.
| Recommended Link | ||
|
||
| — |
Upside Down
Under normal circumstances, when bad economic news is reported, markets fall…
When bad economic news emerges today, markets rise… in anticipation of more central bank “accommodation” (i.e., more money printing to “correct” this negative data).
It’s flashing warning signs all over the place…
As we’ve covered in these pages before, U.S. companies have been in a profits recession for several quarters.
But despite lower profits, we’re seeing higher bids in the stock market. The S&P 500 is hitting historic valuation levels…
According to The Wall Street Journal, the S&P 500’s price-to-earnings (P/E) ratio is now over 25. That means investors are willing to pay $25 for every $1 in current earnings today. That’s 56% higher than the historic average P/E of 16.
These sky-high valuations are signaling trouble…
Since 1870, the market’s P/E ratio has been higher than 25 on two other occasions: during the 2008-09 financial crisis and the dot-com boom and bust in the 2000s.
Longtime Daily readers know extreme valuations always “revert to the mean.” It’s only a matter of time.
And since the data continue to show lower earnings ahead… the price of the market will correct downward at some point. Unfortunately many average investors will be caught unawares because of the breakdown of the markets’ pricing cues.
“Sell Everything”
There are more disturbing indicators of just how distorted the markets have become…
Legendary $100 billion bond trader Jeff Gundlach has reached a new degree of bearishness. In a recent phone interview with Reuters, Gundlach said:
|
The artist Christopher Wool has a word painting, ‘Sell the house, sell the car, sell the kids.’ That’s exactly how I feel – sell everything. Nothing here looks good. |
He also says he’s hit a point of “maximum negative” on U.S. Treasuries. That’s why Gundlach—a fixed-income specialist—is holding gold and speculative gold mining stocks in his portfolio today. It’s one of the only hedges left against the insanity we’re seeing in world markets today.
Think about it… everywhere we look, reckless central bank policies have managed to subvert the natural order in some astonishing ways…
-
Due to negative interest rate policies (NIRP), more than $13 billion in bonds trade at negative rates around the world. Negative rates mean you pay to lend your money to a borrower…
-
Quantitative easing (QE, banker speak for money printing) programs have blown an unprecedented bubble in world bond markets. Today, the U.S. 10-year note yields less (1.54%) than the S&P 500’s dividend rate (2.11%). So investors use the bond markets for capital gains and the stock markets to provide income…
-
“Bubble blowing” has turned gold mining stocks—the most volatile securities in the market—into a “safe speculation”… while priming the markets’ overbought “blue-chip” stocks for a fall.
Maximum Defense
So Marion, I hope you can see by now why PBRG’s official position has been “maximum defense” for the better part of two years.
That’s meant following our risk-management protocol to the letter. And paramount among its directives is intelligent asset allocation.
It’s the only way to protect your wealth from a central bank-induced economic shock. We recommend eight distinct asset classes as a way to “compartmentalize” your wealth for maximum safety.
We’re All Speculators Now
Even in conventional times, no one has a crystal ball. To be safe, your assets need to stay diversified.
But in today’s extraordinary environment, investors must be prepared to leverage one component of their asset allocation mix more than they ever have before. It’s the same thing Jeff Gundlach has been forced to do.
I’m talking about speculations.
Now before I go on, I want to emphasize something absolutely critical to your wealth:
Speculations must remain a tiny portion of your investable wealth.
NEVER place more than 5% of your net investable wealth into speculations. Placing anything more than this into speculative positions will—sooner or later—wipe you out.
This is why PBRG has long kept most speculative plays under lock and key. But central banks’ breakdown of the markets’ normal pricing mechanism presents us with a stark new reality:
We’re all speculators now anyway.
It’s bizarre… but today, central banks have even managed to turn speculative plays into “quasi-chaos hedges.” They are as much a type of insurance against market disintegration as they are a chance at staggering gains.
| Recommended Link | ||
|
||
| — |
Next week, Tom and Teeka will cover some of speculative opportunities they’re uncovering. These are asymmetric bets only (ones where you risk $1 to earn $5 to $10). (If you can’t wait, you can get expert speculative gold recommendations right here.)
At PBRG, we’re just as selective when finding speculations as we are when we look for elite dividend stocks. We maintain a relentless focus on the downside of the trade. That screens out 98 of 100 opportunities. All that remains are plays that offer a legitimate chance to earn five, 10, even 20 times the money you risk.
Bottom Line
So Marion, I hope this answers your question. The bottom line is all investors must rig their portfolio for maximum defense today. That means practicing intelligent asset allocation, first and foremost.
Then—for those investors who have 100% locked down their risk—some appropriate speculative plays can help to diversify your risk profile… as we all hang on to wherever the central banks take us next.