Managing Assets When Markets Become Irrationally Effervescent
Pacific Park Financial Inc. | Nov 30, 2017 12:03AM ET
When I co-hosted a national talk radio show in 2000, tech stock inquiries came furious and fast. JDSU or Sun Micro? Powerwave or Cisco? Webvan or theGlobe.com?
Few expressed concern about a recession. Few wondered if they might lose money by investing in the New Economy’s Internet favorites. Even fewer callers believed that they might want to take less risk rather than more.
Granted, tech stocks may not be as wildly overvalued as they were in 2000. That said, the U.S. stock market as a whole is beginning to look a lot like it did in previous bubbles.
Speculative excess is certainly not confined to the equity arena. Consider the crypto craze. Bitcoin began the year at roughly $950. At last check, it chimed in at $10,950. Wait, $10,600. Hold on, $11,200.
“You don’t understand cryptocurrency potential,” supporters tell me. “Bitcoin and blockchain technology must be viewed through a different prism entirely.” Really?
Real estate prices in a number of major metro areas are getting way ahead of themselves as well. The 3.75%-4% 30-year fixed here in the 2010s may justify higher home prices than previous decades, since home buyers are essentially buying a monthly payment. But how much more? Portland, Dallas, Denver, Seattle and San Francisco Bay Area homes all carry price tags that are 20%-45% higher than they were during the housing bubble peak in 2007.
Keep in mind, the incredibly easy access to 5.75%-6% mortgages in the mid-2000s was a major component in 2007’s housing bubble and eventual bursting. With existing home sales turning negative on a year-over-year basis, here in 2017 and the masses expressing little worry about their property values, might one be wise to approach the asset class with a bit of caution going forward?
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Perhaps mortgage obligations and the overall expenses associated with home ownership are less onerous than they were in 2007. On the flip side, households are saddled with more debt than ever. Should asset prices from stocks to real estate depreciate in the future (and they will), those entrenched obligations would weigh heavily.
Even with asset prices rocketing to all-time highs on a monthly basis since the election, cracks in the ability to pay back debts are emerging. The delinquency rate for subprime auto loans originated by auto-finance lenders has reached a seven-year high. And U.S. credit card spending has outstripped incomes for more than two years already.
Business lending is also declining, down to 2.48% from 2.79% the prior quarter and down 7.67% from the prior year. The fact that nonfinancial companies in the S&P 500 have a debt-to-adjusted earnings ratio of more than 1.5, as opposed to 0.7 to 0.8 for the majority of the post-recession period, suggests that banks may be fearful of lending even more money to corporations.
Meanwhile, U.S debt-to-GDP has remained elevated at more than 100% for five years. That’s far greater than it was before the financial crisis; it is far greater than at any point since World War II, when there was a brief spike beyond the 100% level.
The current debt might be “sustainable” from a theoretical standpoint, should interest rates never move meaningfully higher. Yet the Federal Reserve continues to push shorter term maturities higher even as intermediate and longer-term maturities barely budge. That has been pushing the yield curve toward an undesirable and precarious flattening.
Sure, the yield curve may not invert, signaling the probability of recession. However, it is troubling to recognize that tax cut enthusiasm originally sent the spread from 1% up to 1.3%, only to see it drop down to less than 0.6%. In other words, expectations for economic growth are rather subdued, in spite of the Federal Reserve’s confidence.
From the start of the current bull cycle in the first quarter of 2009 through the end of 2014, we placed many of our near-retiree and retiree client base near the top of their risk profiles; that is, many had a tactical allocation of 70% widely diversified stock and 30% widely diversified income. Exchange-traded trackers such as iShares S&P 500 (NYSE:IVV) and iShares ACWI All-World ACWI Index (NASDAQ:ACWI) have been mainstays.
For nearly three years now, however, we have advocated for 50% higher quality stock, 25% higher quality income and 20%-25% cash equivalents. The allocation proved beneficial in the 22 months prior to the election when stocks move sideways for nearly two years; it proved less rewarding since the election more than 12 months ago.
While we have seen slightly less reward by taking slightly less risk in the latter stages of the current bull cycle, we will remain on hold. As it stands, price appreciation alone has taken stocks up to 57%-60%. And we do not intend to incorporate additional risk into retiree and near-retiree accounts until bearish price depreciation allows us to snatch up bargains.
There’s more. If the monthly close on the 10-month SMA finishes below its trendline, we would reduce our exposure to risk assets substantially. This is the technical trigger that helped me sidestep the bulk of bear market losses in the tech wreck (2000-2002) and the financial crisis (2008-2009).
Disclosure Statement: ETF Expert is a web log (“blog”) that makes the world of ETFs easier to understand. Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc., and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert website. ETF Expert content is created independently of any advertising relationship.
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