Month: December 2014

Last post I explained why bonds fall in value when interest rates rise. What I neglected to add was that with interest rates having declined so much over the past few years since the 2008 debacle, a lot of people who invested in bonds saw their bonds increase   in value. Many of these people will likely flee their bonds if (when?) rates start to reverse up.   People who became accustomed to merely holding bonds and watching them rise in value may be in for a large shock when they plummet. After the turn when rates rise enough to be attractive, people will exit risky stocks in favor of more conservative bonds or CDs, precipitating a bear market in stocks. For example, if the day ever returns that   I could nail down 6% annual interest in insured CDs, I and many other boomers would presumably be happy to get out of stocks and park our money in interest bearing instruments after retirement.   It is for this reason that I need to be very vigilant for the first signs that interest rates are reversing up….

Mr Market tends to seduce people into the stock market so that the most persons get hurt at some point. I am noticing more and more articles by the media pundits saying that people should just buy   index ETF’s. Why try to beat the market when most professionals fail? Along with this advice is the idea not to try to time the market. Just buy the index ETF and don’t even peek at it.   What could happen to make this advice hurt the most people?   What if the entire market as reflected in these index ETFs or mutual funds declined 30% or more in a short   period of time?   Would these investors who swore off market timing throw in the towel and panic at the exact bottom? I think so.   The boomers who put their faith in index funds will look at the impact of a declining market on their retirement finances and run for the exits. I think we fail to acknowledge the huge negative reaction that boomers will have to the next large stock market decline.

Using many of the components I put into the GMI, and my experience in the markets since the 1960’s, I exited the markets during the major 2000-2002 and 2008 market declines. I then reinvested after the dust had settled. Today I am that much closer to retirement and refuse to hold an index fund through the next big market decline.   I cannot afford (emotionally or financially) to wait even 3   years for the market and my account balances to recover. So I disagree with all of these “buy and hold   index funds (or ETFs)” adherents. Maybe they do not depend mainly on their 401(k)s and IRAs to fund their retirements (hint: that is why they sell their advice)….

I do not know when the market will turn down (no one does). I do know that when it turns it will be quick and massive as the boomers head for the exits. I will monitor my GMI for the early signs and remain a chicken, willing to exit early rather than late.

Over my 40+ years of trading I have learned that the one thing that can kill a bull market is the Fed’s raising interest rates.

When interest rates rise the price of bonds decreases.   This is because   the dividend paid by   bonds is usually fixed. This is why the media often say that a bond moves inversely to interest rates. Most people find this difficult to understand. So here is how I teach my students. Say a bond is issued a $100 and it pays the holder $3 per year. That $3 is fixed for the life of the bond that might extend for many years. If the $100 bond pays $3, its yield= 3% each year (3/100). Now say that interest rates rise over a few years to 6%.   Then new $100 bonds issued will pay $6 per year (=6%). Someone holding the older bonds (that pay $3 per year) if he wanted to sell his bond early and get his money back would likely be offered only about $50 for his bond which he had bought for $100.   Remember the annual payment was fixed at $3 per year.   Thus $3/X (price of bond)=6%.   By solving this equation with rudimentary high school algebra, one realizes that x=50.   Thus a person selling his original   bond in the environment where new bonds now pay 6% would be offered only about $50 in the resale market.   The new buyer will only be willing to pay half of what the bond was originally issued at in order to get the prevailing 6% return. Thus when interest rates double, a person’s bond loses one half of its value, if it is being sold long before maturity. None of this applies if one holds the bond until maturity because the person will get his $3 each year and then the full $100 back when the bond matures and the person is repaid his principal.

All of the above is to explain why the trend in bonds may be worth watching. If bonds start to decline, it means that investors see rising interest rates ahead. It is for this reason that I am a little concerned by this chart of TLT, the 20 year treasury bond ETF. It looks to me like we may have put in a double top, indicating that interest rates may have bottomed out. Note the big decline on Tuesday.   (Click on chart to enlarge.)

If the economy is heating up, the Fed better raise rates so that it has ammunition to fight the next economic downturn. Here we go again…….

Meanwhile, Happy Holidays to all!

The GMI and GMI-2 are both a their maximum values. IBD still sees the market in a correction………

There is a new ETF that focuses on cyber-security. I thought you might like to investigate HACK. It does look like it is a little over extended though, trading above its top BB. Here is its entire daily chart.