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As you read this, the markets will have taken a recent pummeling, with values of both stocks and bonds sharply down as we approach mid-quarter. Neither surprises me. US stocks are trading at heady valuations, and overdue for a serious “correction.” By the way, downdrafts in US stocks are bound in the short term to affect non-US stocks – call it a bit of the American Flu – but I don’t think that will last as most foreign stocks are still screaming cheap. Regular readers will know that for many reasons I still think US stocks have lots of upside, but the ride will become bumpier as volatility returns and interest rates rise. The steady upward march of stocks for nearly a year and a half is most unusual, really a unicorn market, and one you best not get used to! (Sadly, many newer investors, buying into Bitcoin and even Amazon with PE’s over 350, have known no other market – let’s hope, like young Luke Skywalker, they learn fear before it’s too late!).
For bonds, the tea leaves are much more foreboding. Longtime readers will remember that bonds have been in a super-bull market for some 35 years, as rates dropped from the ‘70s stagflation days. We’ve been warning about this for years, and lately it seems a week does not go by without several articles bemoaning the trend of bond price drops and the likely dismal fate of those that hang onto them. Unlike our outlook for stocks, we don’t think bonds will be higher down the road. Massive forces are lining up to hammer bond prices: a tighter-money Fed, a Fed reversion market impact by dumping bonds (quantitative tightening) instead of buying them (quant easing), a big increase in new US bonds to cover infrastructure and other projects at the same time as tax revenues are dropping from tax reform, dwindling foreign demand for US bonds, and others. The Fed wants higher rates – maybe even higher than the market expects as employment and probably inflation rise – and higher rates mean dropping bond prices. Add onto that big increases in bond supply and shrinking demand, and it looks like a perfect storm is building to batter bonds. It will be a slow, frog-in-the-pot storm, but massive none-the-less. If you have bonds, get out of the pot! And share this with those you care about, who may not have heard my alarms ringing!
So the short of it is pretty much the same song I’ve been singing for a long time now. Bonds are a trap, and won’t be a buy until rates go up a lot and bonds are cheap again. US stocks are richly valued, but have a strong tailwind in a vibrant worldwide economy, and the huge steroid injection of tax reform. Non-US stocks are much better buys, and should be a big part – over 50% – of your equity portfolio allocation.
