Oh, how a couple days can change everything.
There really are no winners when the market drops, unless you are into the insane world of shorting stocks in a reckless bull market that loves to find shorts to squeeze.
Yet, I have to admit I got quite a kick out of watching the market collectively freak out two weeks ago.
I wish I could say that there isn’t a smug component to it, but part of it is the vindication of what we have been discussing all year while the “pros” mocked caution and bearish sentiment.
It is encouraging to see exactly what we’ve been talking about all year suddenly find space in the editorials and articles of Reuters, Bloomberg, and The Wall St. Journal.
Headlines like “The Easy-Money Stock Market is Over,” and “The Fed’s Risky Bet on Growth” by heavy hitters Barry Ritholtz and Mohamed El-Erian respectively, were all but unimaginable back in January.
Another reason I got a kick out of it was watching the market march to a drum that isn’t played by the Fed, if just for a couple days.
Sure, it still dominates market behavior, but it seems like investors are realizing this is less of a parade and more like a game of musical chairs.
We’re not all marching together. Investing is a zero-sum game and when the music stops, people lose. Sometimes it is a lot of people.
A six-year bull market made a lot of people forget the rules of this game, and a little uncertainty really rustled their jimmies.
Though we may have an advantage of being ahead of the curve on the big picture in these regards, all of this doesn’t really do much for us unless we find an application for our knowledge.
We need our money in something, and one sector stands out right now…
The Fundamentals
People like to look to macro events to explain things, but their influence is normally overestimated.
ISIS, the Ukraine, Ebola, slowing growth in Europe and China, they are all factors in some way, but the real problem is fundamental mismatches in the domestic stock market.
Market gains are dramatically outpacing economic growth. The S&P 500 has seen an average increase of 4.7% per quarter from the pits of March 2009 to June 2014. That is around five times faster than the economy.
Buybacks have painted a rosier picture in quarterly financial statements and headline metrics, all while unsustainable cheap debt has swallowed more and more corporate cash flow at the expense of capital expenditures.
As the market dropped, a massive push into U.S. Treasuries shoved the yield on 10-year bonds to less than 2%, basically on par with official inflation figures.
Institutional investors can only hide in fixed income for so long though, and many of us are stuck with holding cash or dumping funds into money markets in our self-directed accounts.
Even if the Fed decides to push that back yet again, the market is sobering up and realizing that long-term growth isn’t going to catch up for quite some time.
This isn’t even a “new normal” thing. It has been going on for half a century.
Take a look at this chart built from historical data from economists at Fulcrum Asset Management:
So equities investors are reassessing the risk baked into years of front running the economy, all while discovering that the economy can’t grow much beyond inflation rates.
Bonds are for treading water and will likely lose real value in the next couple years, and cash does nothing as always.
That leaves one strong contender for driving down overall risk of your portfolio, and there are two ways to play it that can suit your investment style.
Gains Return to Gold
Gold is in a pretty unique position right now. In essence, it decoupled from Fed interventions last year, even as the bond and stock markets kept charging ahead in spite of their glaringly obvious flaws to this day.
The gold market has shed speculators that helped fuel massive price rises through 2011, then fled to equities to chase gains.
Since then, the physical price of gold has tested $1,200 per ounce three times since July 2013, and has held strong. Prices today are near this level, in spite of investor neglect and manipulative paper trading.
Demand is strong, especially in Asia. Chinese gold demand rose sharply once the price fell under $1,200 an ounce this month.
India, with its obscene restrictions on gold imports and purchases, saw a one-third increase in demand for the important Diwali festival year-to-year.
Even central banks are in on the game. Year-to-year purchases are up 28% for Q2 2014.
As compared to the market, prices are very appealing as well. Take a look at the Dow to Gold Ratio since the market bottomed in March 2009:
After all the deficit spending, adding over $4 trillion to the Fed’s balance sheet and overall increase in gold prices over the same time period, gold is looking cheaper than it has in five years compared to blue chips.
Then there are the bullish trends that the stock market cannot match these days:
- Long-term demand growth, while equity inflows dry up and people sit on the sidelines
- Vastly improved balance sheets for gold miners after the sector correction
- Reduced miner exploration constricting long-term supply, except for a few key companies
- The start of a new 40-year gold cycle
In a stock market that has outpaced economic growth five times over and hasn’t seen a real correction in almost six years, even sideways movement comes with a lot of risk these days.
To keep that risk in check while potentially outperforming stocks, gold is the way to go.
