During this report, I will be discussing my outlook for the financial markets in 2013 and the years ahead. Note that this report is my personal opinion and not in fact an investment strategy. I will be basing my opinion on facts, past events and making an educated guess. Let me remind you that I am only 15 years old. Everything I am about to write are my results after extensive research.
The year started off with a huge bang. The S&P 500, which is a collection of the stocks of the top fortune 500 companies, rallied over 5%, the Dow Jones Industrial Average and NASDAQ also gained around 6% in the month of January alone. The air was filled with hope and euphoria. I myself, was also very excited, excited for a new year full of hope and of huge gains for the financial markets. Like all the other financial analysts and professionals, I was very optimistic. I was prepared for a full on recovery. I was expecting a recovery of the financial, automobile, real estate and various other sectors that had lost big during the 2008 crisis. But I was mainly focused on the real estate recovery. Let’s face it, the real estate market is huge. I even created a quote which says, “the bigger the drop, the bigger the gain”. Of Course, this quote cannot be applied to everything, but it can be applied to many things in the financial world. An example would be a person who bought the S&P 500 at its low of around 683 during the peak of the crisis in 2009. That person would have made a return of about 120%. Or another example could be a person who had gone long on the NASDAQ during its low of around 1200 would have received an impressive 180% return if they had held their position until now, nearly tripling their initial investment. Therefore it is historically proven that strong declines have led to strong gains.
Unfortunately, it is not that easy to pinpoint the perfect time to get in or out of a security. If it were, all investors would be in retirement! When you are face to face with a bull market, it is easier to get in than it is to get out. If someone had invested their money in the NASDAQ during the tremendous rally before the dotcom bubble burst, they would have gained an outstanding 540 % in just under 5 years. Which would have turned a 10,000 dollar investment into 540,000 dollars. The only problem was that only a few were able to resist the greed, and continued holding on to their much beloved stocks. But before you knew it, the market turned against those investors and shed over half its value in under a year. Like the company Amazon ($AMZN), that had gone from 107 $ to 7$ per share. The ultimate winners though, were the ones who actually went there and dared to pick up those stocks that had lost most of their value. in the case of Amazon, its stock soon surged back to 200$.
“The Great Rotation”
In my opinion, we are face to face with an upcoming rally. This rally, will be mainly focused on the equity markets and the return back to risky investments. Many investors believe that there will also be a “great rotation” going on. A huge reallocation of money from bonds to stocks. From safe investments to riskier ones. During a period of financial crisis, investors will always rush to ‘safer’ investments to protect their money. In this case, they move into bonds. Of course, there are many different types of bonds, ranging from corporate, to government bonds. During the 2008 crisis, many individuals and investors flocked to US treasury bonds, as they are considered one of the safest investments possible, since they are backed by the “full faith and credit of the US government”. When people buy bonds, the price goes up, which consequently causes the yield to go lower, and vice-versa. It’s basic supply and demand.
On the 27th of October 2008, before the 2008 financial crisis, the 10- year treasury yield stood at 3.97%. It then took a nose dive to finish at 2.1% on December 22nd 2008. While the equity markets were falling, the bond market was soaring. For that reason now, many investors are thinking that the opposite will happen. And this move was named ‘the great rotation’.
I on the other hand, am very skeptical about the great rotation. I used to be a believer in it, but now, I have changed my opinion after looking at what’s happening. After the flow data was released for January, we saw decade high mutual fund and ETF (Exchange Traded Fund) inflows. Investors got very excited and used it as proof that the ‘great rotation’ was in full swing. Unfortunately, the numbers didn’t prove anything. Yes, people are back into equities, but no, its not coming from bonds. The thing is that bonds also had inflows of $30 billion. In reality, the money to equities came from savings and money market accounts. Now, enough talk and let me just show you a chart so you can see for yourself.
Above is a chart of the Barclays iShares 20 year Treasury. I’m not a technical analyst myself but this chart looks pretty bullish to me.
Even though I do believe that money will flow into the equity market, it seems hard to believe that we will see a massive reallocation. For example, pension funds are heading for bond-heavy portfolios as they reduce risk and aim for income. Let’s not forget that the baby boomers are also growing, and they are trying to find safe investments. The same thing will happen with ageing savers all around the developed world. in my opinion a minor-rotation is more likely to happen.
Onto the second part of my market outlook. This is going to focus on after the rally we are going to see in the financial markets. Because as I say, ‘what’s the point of getting in, when you don’t know when to get out’.
In my opinion, crises are never sudden. They usually build under the radar, before popping in people’s faces. In 1996, Alan Greenspan, former chairman of the Federal Reserve coined the term ‘irrational exuberance’. This term is used to define the greed investors get at the top of a bull market. They try to pursue higher and higher returns and overlook the deteriorating fundamentals. Over $ 2.3 trillion was invested during the dot com bubble. The reason I think for that was because the FED (Federal Reserve) was encouraging them. How? by lowering interest rates making it easier to obtain ‘cheap money’. Why? to keep the economy from slipping into a recession in 1990. Banks eventually received a lot of cheap money and were ready to lend. All this cheap money made investors want to take on more risk. Unfortunately, cheap money causes inflation. The availability of all this ‘cheap money’ caused the tremendous rally we saw from 1990 to 2000. Even in his memoir, Alan Greenspan wrote that he knew that lowering interest rates might cause a bubble. Essentially what investors did was that, when they made a good investment, they got the profits, but when the investment turned bad, Greenspan would just lower the interest rates.
After the dotcom bubble burst, the FED started pumping more money into the system during 2001-2002, just to get the economy moving again and to try to stop. By lowering interest rates, they brought investors back into the markets. This time though, it was the real estate market. When all else failed, regular people would turn to homes as they thought it would provide a safe investment, since the value of the home would just continue increasing. The Federal Funds Rate went from 6.5% in 2000, to a low of around 1% in 2004. What then happened is that again, greed took over and that led to more speculation, which in turn, made investors ignore the fundamentals. Thanks to low interest rates, average Americans were buying all sorts of different things they couldn’t afford, like a house, thus leveraging everything up. The one most important thing they had forgotten was that, they couldn’t really afford any of what they were buying. But then in 2006, interest rates came back to normal levels, but people could no longer get new loans to pay off the old ones. People who had been given a mortgage despite their low income, couldn’t afford to stay. From what I have written so far, it seems like to save the economy, the government inflates a new bubble every time.
This next crisis I am talking about, wouldn’t be because of the real estate, or the stock market. After they did the dot com bubble, and that burst, and then inflate it with the real estate and credit crisis bubble and then that burst, they now created the biggest bubble of all, but unlike the other times, when it was the United States that started it, this time the whole world is. After the financial crisis of 2008, banks had lost billions. Some of them failed, like Lehman Brothers. Some others, had to merge together, like Wachovia or Merrill Lynch. To help, the FED decided to yet again, lower interest rates. Except this time, they lowered it even more, to 0.5%. Other Central Banks around the world, did the same.
A big issue, is that the US. government, didn’t actually have the money. During the financial crisis, they decided to give $ 3.3 trillion to bail out its banks. It was the biggest financial bailout in history. Around the world in Germany, Italy, Canada, South Korea and Great Britain, other politicians do the same to save their banks. The United States though, had to borrow it thus adding it to the deficit. Now, you could say that ‘irrational exuberance’ has hit Washington. A way you could look at it is that, Congress is on the bull market of government debt, and like in the other financial bubbles, they are not watching the fundamentals of the nation’s finances. Current Chairman Bernanke said that having such a huge debt, increases the chances of having a sudden financial crisis. He warned and said that the only way to prevent having a ‘Greece-like’ debt crisis in the long term, is by getting the budget deficit under control. He went on to warn that unless things change, the US will go through a situation similar to what Greece has been going through lately. This is caused by a countless amount of promises, but no ways of producing actual results. Therefore investors lose confidence in the country. But to reassure people, you need to make those promises, to get them confident. The United States has made many promises, like healthcare, Social Security, Medicare, pensions, education so on and so forth. The problem is that there are no real solutions, and no one to run to for help. This time though, there is no way around it but through. The government can save banks, but who can save the government?
Another big thing is that the United States is considered the world’s bank. It provides what some people call the ‘reserve currency’. Throughout the world, many things like traded goods, oil, major commodities and even real estate etc. are denominated in dollars. The US provides confidence that the dollar is the ‘safest’ currency in the world. Countries cover their risk by investing in dollars through T-bill auctions which enable us to run budget deficits. Unfortunately though, the world is starting to lose confidence in America. What will make them lose confidence and withdraw their investments would be when the US reached a high level of deficit spending and debt. And unlike the other times, when they could run to another country to cover our deficit, they wouldn’t have anyone to run to this time. Many agree that the budget sequestration won’t work from an economic or political perspective. And to top it off, the FED’s QE, in which it prints money to buy the US’ own bonds in order to improve economic and employment numbers only provides a great recipe for huge inflation.
I truly hope you found this ‘outlook’ interesting and that you enjoyed it. Even if you are hugely bullish on the markets in the long term, its always good to know all sides of the debate after you invest. After all, investing is all just a huge debate between the bulls and the bears. But knowing both sides of the argument only does you more good and provides you a better insight. Even though you cannot predict the future, a lot of research can you give a better insight on it. After all, that’s basically what investors try to do, predict the future.
Written in 2012