Ho Ho Ho or Ho-Hum?
Stock market investors are looking to have a rollicking Christmas this year, while holders of bonds and precious metals may feel like they are getting a lump of coal. Yet taking a closer look at what has developed in the markets since the U.S. Presidential election reveals that not all may be merry and bright. In short, it is time for rebalancing your portfolio.
What’s driving the stock market
Since November 8, the S&P 500 is up nearly 6%, while the Dow has catapulted 8% and is looking to break 20,000 by year’s end, leading many to call this the Trump Rally.
The first thing to keep in mind is that the stock market typically rallies in an election year, and most new Presidents enjoy a “honeymoon rally” after the election, as chief economist David Rosenberg has noted. Markets hate uncertainty, so a close election that didn’t end in a tie and drag on for months gave the stock market a sigh of relief as the ambiguity ended.
Second, also as Rosenberg has ably pointed out, the S&P is largely being driven by two sectors the market perceives to benefit from the new administration: energy and financials. These two sectors are only 20% of the S&P 500 but they have accounted for nearly all of the gains; the other sectors have remained virtually flat.
Take a step back
There is nothing inherently wrong with this because sectors do go in and out of favor; but it is telling that this is not a broad-based rally. It also adds more political risk because market participants believe these sectors will benefit from deregulation. This probably could not happen due to the political games played in Washington, but even if it does occur, it will take a very long time to work through the political process.
Finally, the S&P 500 is now at the third most expensive valuation level ever, exceeded only by the dot-com bubble and a very brief point right before the Great Depression (as measured by the CAPE ratio). This is not a timing device or even a prediction that markets are set to crash, but it does mean that over the next 10 to 12 years, investors should expect low single-digit annual returns or worse on average.
The Fed is not the cause of bond yields rising
Many have attributed the spike in bond yields and interest rates to the anticipation, and the subsequent action, of the Federal Reserve raising interest rates. This is only partly true.
Remember that the Fed can only set interest rate targets on the rate that banks lend to one another. This certainly influences the attitudes of other bond buyers, but it is a relatively small market. And with the Fed out of the QE game for now, they are not directly intervening in the larger bond market.
What is a much larger force in the bond market is China, which has been furiously dumping U.S. Treasury Bonds. China has gotten rid of so many U.S. bonds that they have now given the title of largest holder of U.S. debt to Japan!
China is likely doing this to try to prop up their falling currency, the yuan, as they battle a credit crisis of their own. Although it hasn’t received a lot of mainstream press, things are getting so bad that China briefly suspended the bond futures market, and has been injecting emergency loans into the banking system.
China’s woes are an article for another day, but the bottom line is – watch out for China!
Low-priced gold and silver – exactly what you want right now
Gold and silver bugs are probably feeling more like the Grinch this season as they have watched gold tumble 11% and silver almost 13% since November 8. Yet this is exactly what you should expect and want.
Remember the purpose of precious metals in a portfolio; not to produce lots of juicy returns or return on capital, but to preserve capital. Indeed, year-to-date, gold is still up 7%.
So if precious metals are expected to hold value or even appreciate in times of inflation or when stocks fall, then they should conversely be expected to fall in times of dollar strength and stock market rallies.
This negative correlation to stocks is exactly what makes gold and silver so valuable and important as a stabilizer and insurance policy in a portfolio. It is also why we consistently recommend a 10% to 15% allocation.
Rebalance your portfolio now
The slump in precious metals combined with the sharp rally in stocks at the end of the year signifies the perfect time for most individual investors to rebalance their portfolios.
Rebalancing to your target weightings automatically allocates money away from expensive assets (like stocks) to assets that are likely undervalued such as gold and silver. So this holiday, take cheer in knowing you can take some money off the table and sleep soundly at night with a well-balanced portfolio that is primed and ready for whatever 2017 may bring….