Did anyone not see this coming? Apparently the market understood the preliminary estimate for the Q1, US-GDP growth would be bad. This morning’s price-action in the market suggests the market understood what was coming, as the wheels are still on the cart as I write. The S&P is in the green and the Dow is vacillating between green and red. Given this, it seems it is business as usual in the market – bulls and bears play fighting.
Yet, there is one activity going on with the market and the US economy that we should consider, or at least address for no other reason than the breathless media has latched onto it as a negative.
- In a phenomenon that has surprised many on Wall Street this year, money is rushing into Treasury bonds even as stocks hover near multi-year or all-time highs.
Maybe the strong movement into bonds is a problem, but, as always, let’s look at it and decide for ourselves. Keep in mind, US GDP growth declined 1% in Q1, according to the government’s first estimate.
- Some market watchers are reading the rally in the bond market as a sign the economy is about to take a turn for the worse.
True, money has been flying into bonds recently. Witness the sharp drop in the 10-year yield for US treasuries. Currently, it stands at 2.41%. That is the lowest it has been in since June of last year, but is that low rate reflecting investors’ belief that the US economy is “going off the rails?
- Pension managers had a 30% up year in stocks last year. They’re fully-funded and – guess what – they now have to rotate out of stocks into bonds.
Pension funds are a different breed of investor. They are highly regulated, as most belong to government entities, large and small, and even those that are private are more regulated than mutual funds, for example. All tend to be conservative, which means they could move money into bonds, if they felt the US economy was headed south. Yet, the above rotation information suggests their recent conservatism is not about the US economy, rather it is about the rules, regulations that force them to be conservative.
If a pension fund is “fully funded,” it means it can meet its obligations for pay out, which then means it no longer needs to take on risk, which means it moves money into the safest vehicle around – US Treasury bonds. This, then, drives the price of treasuries down, which means the naysayers can then claim money is flowing into bonds because investors believe the US economy is falling apart.
As to the government report that GDP contracted in Q1, well, let me just say two things. First, don’t be surprised if the government revises that number up sharply, as not all the data is in. Two, of the data that is in, one piece of it is that consumer spending rose, yes I said “rose” 3.1%.
Okay, so maybe saying just two things sells me short. Here is a third and fourth. The problem with the GDP report is that exports declined and imports rose, which then caused the trade deficit to increase, which then subtracted 1% from the GDP rate, according to the US government bean counters. As well, inventory accumulation slowed dramatically from the exceptionally harsh winter, which reduced output numbers, which means productivity dropped.
Finally, (okay, five things to say about GDP), the problems with the GDP report will be corrected in Q2 and the market seems to get this today. Both the Dow and the S&P are in the green as I write, as is the Russell 2000 and all the other big indices. Looking at the VIX, one can assume investors who hedge are not afraid thirty days out. It remains in the mid-11 range. Okay, enough about that. Let me move on. Hedging is a good segue.
I only trade stocks. I don’t short stocks. I don’t leverage or get complex in any way. I keep it simple and it works. I make money and that is the name of the game. Like the pension funds, I am conservative when it comes to my money – I like to stay full funded – but many folks are not. While this is my strategy, it is not so for many others. Others like to gamble for the big pay off, which means taking big risks in options, futures, and other derivatives.
- Not only is your return going to be magnified, so are your losses.
Here are two things to consider about complexity and leverage if you are just starting out.
- Complexity is expensive for at least two reasons. Every bit of fancy footwork, be it a derivative bet or a complex hedging technique, costs money, money which is a sure thing while the supposed benefits are only speculative. Complexity is also the great friend of the intermediary, making it easier to load up unsuspecting investors with costs.
- Leverage can never turn a bad investment into a good one, but it can turn a good investment into a bad one by transforming the temporary impairment of capital into the permanent impairment of capital by forcing you to sell at just the wrong time.
I like choice when I play the market. Leverage reduces choice. I like cheap trades. Complexity makes trading expensive. Simple enough.
Trade in the day; invest in your life …
