Investors Need to Take On Less Risk

You might have seen my call for reader responses yesterday. Of all things, I asked you to write in with your thoughts on my signoff: ‘Your friend’.

The only reason I asked is because we had one reader tell me he thought it was extremely presumptuous on my part.

And I could see how he might think that. I haven’t met any of you. The only communication we have is via email.

Before we go any further, I just want to point out that the first reader didn’t have bad intentions when writing in. I genuinely believe he was just expressing his opinions, and I’m grateful he did.

Anyway…I was ecstatic to read all your responses. And we’ll take a look at those right after we hear from an investing legend himself: Howard Marks.

Why you should start taking on less risk

We’re in the eighth inning, according to Marks.

The conservative investor points to mounting uncertainty, saying investors should start taking on less risk.

To many, this means jumping out of the market entirely. A fuzzy future is their kryptonite. They don’t know what will happen next and they don’t want to stick around to find out.

I’m of course talking about monetary policy, and what it could do to stocks globally.

What do higher interest rates mean? Usually they mean higher bond yields.

If interest rates are higher, then investors assume inflation will be higher. And if inflation is higher, then fixed income investors want a return to compensate for that.

It’s why you’ve seen US 10-year government bond yields rise steadily since mid-2016.

MoneyMorning 25-10-18

Source: CNBC
[Click to open new window]

As the US Federal Reserve raises interest rates and offloads assets, fixed income investors are taking this as signals to sell US bonds — which increases yields — rather than buy them.

The European Central Bank (ECB) is thinking of doing the same thing. They want to get back to ‘normal’ interest rates. To do that, they’re going to have to put a hard break on money creation.

But isn’t this good news? Higher interest rates generally mean a stronger economy as well…so why are stocks falling globally?

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What you had to say

OK, back to you guys.

As I expected, we received the full spectrum of responses. Some of you agreed with the initial criticism, like reader Graeme who wrote:

Hi Harje,

While I think your pen pal came on a bit heavy I think he may have a point. Even so I have found everybody at PPP your self-included to be friendly and enjoyable company, after all most of us do not have that many real or close friends.

Friendly cheers, keep up the good work!

Others disagreed, like reader Colin who said:

Hi Harje

I don’t agree with the email you received about signing off as “Your Friend”.

I look at it as a meaningful signoff saying that you are our friend in the market. Maybe he just had a bad day and gave you a bit because he could

My thought is to maybe change it to “Your Friend in Market Strategy and Information”

Anyway there is no problem from my end in you signing off the way you have been

Thx and Regards from an appreciating subscriber

Colin…

And some of you were on the fence, like reader Christine who wrote:

Hi Harje,

Personally I don’t have a problem with the ‘friend’ signoff, but then I’m not a professional.  Whenever I’m emailing a business I usually signoff with “Cheers”.  Especially if it’s an organization where I have business dealings on either a regular or semi-regular basis.

I feel it to be informal without it being familiar.

Have a great day…

I think reader Spiro said it best when he quoted Lincoln:

You can please some of the people all of the time, all of the people some of the time, but you can’t please all the people all of the time.

But I think the initial reader who wrote in to me is on to something. Rather than just copy and paste the same phrase day after day, why not change it up? Why not use different signoffs from time to time, or suit them to the topic we discuss.

It’s why I also liked reading your suggestions. This one was from reader John:

I have not been offended by the sign-off but would suggest “Happy hunting” as more appropriate. Many thanks for your work to date.

John.

Reader Surinder suggested a pretty safe bet:

Suggest “Best Wishes”. Retains individuality of both reader and sender. Conveys image of a brighter future ahead.

Tks/Surinder.

And reader Lloyd had an interesting one:

Why do you not try  CATCH YA LATTER PEOPLE   mate you can’t upset anyone with that mouthful, you see it is essentially Australian, the CATCH YA means you will catch up with them, not in person but by correspondence, and PEOPLE covers all sexes etc. So it is not intimidating and it would be very hard for someone to complain about it.

Anyway you think about it ok?

Be good now…’

Anyway…I was so grateful that so many of you chose to write in. Friend or not, you are the reason we work so tirelessly at Money Morning to share new ideas, however outlandish they may be.

Back to bond yields…

Don’t rely on a pattern for profit

A 3.2% yield is pretty juicy…that’s if you compare it to yields of 1.32% in mid-2016. On an absolute basis, however, it’s still terrible!

If we assume inflation is 2% annually, you’re making a real return of just over 1%. And for that reason, I don’t believe hordes of investors are jumping out of stocks and into bonds.

We’re not in the midst of the great rotation just yet.

OK, so why are stocks dropping? Are investors selling out just to hold cash? Maybe. But I think recent selling and heightened fears has a lot more to do with what Howard Marks said.

People don’t know what’s going to happen. Yes, we know money creation is slowing down. But what will a world of higher interest rates look like?

In an effort to show you, let’s go back to the 80s. It was a time of blue eye shadow, bright neon clothes and huge hair.

It was also a time of extremely high yielding bonds. In 1980, you could have picked up a risk free 10% yield on a 10-year US bond.

If that wasn’t high enough for you, bond yields would go on to rise to 16% in the third quarter of 1981.

The S&P 500, at least initially, rose with bond yields, until yields hit their high. Then, as yields dropped, the S&P 500 rose higher than ever.

You can see the relationship in the chart below.

MoneyMorning 25-10-18

Source: Bloomberg
[Click to open new window]

Rather than try and pick the obvious pattern, notice that stocks can rise along with bond yields. As I mentioned before, higher interest rates, and thus higher bond yields, symbolise a stronger economy. And within that economy are businesses that are always finding new ways to increase earnings.

Yet I doubt we’ll see the same pattern repeat today.

2018 is just too different. There is so much more debt in the system. We also have a power struggle playing out in the open between the US and China.

Lifting rates won’t take you back to the 80s. It will be a completely different financial world.

And I believe it’s this uncertainty encouraging stock market players to quit. They might have lost a bit already and don’t want to lose anymore.

So should you follow them out? If this is only the beginning, wont things get much, much worse?

How to take less risk

The more I read about it, the more I’m convinced a huge jump out of stocks hasn’t happened yet. I mean, why would investors jump into a 3.2% yield?

While US bond yields have more than doubled, yields on Aussie 10-year bonds can’t say the same. Aussie 10-year yields are at 2.66%, up from a low of 1.85% in 2016.

If this was to rapidly rise, expect to see bigger declines ahead. But I don’t suggest you sell everything and hold nothing but cash.

Instead, do what Marks suggests. Take less risk. Don’t buy the company laden with debt. Don’t put all your money into the stocks with a PE of 50.

Make calculated bets on companies you understand and they could pay off over time.

Play it safe,

Harje Ronngard,
Editor, Money Morning

PS: Three speculative lithium punts could make you a small fortune as battery demand reaches fever pitch. Find out more.


Harje Ronngard is the lead Editor at Money Morning. With an academic background in finance and investments, Harje knows how simple, yet difficult investing can be. He has worked with a range of assets classes, from futures to equities. But he’s found his niche in equity valuation. There are two questions Harje likes to ask of any investment. What is it worth? And how much does it cost? These two questions alone open up a world of investment opportunities which Harje shares with Money Morning readers 5 days a week.. Harje also contributes his insights in Total Income, headed by income specialist Matt Hibbard. Harje loves cash-rich businesses, so he feels right at home among Matt’s incredibly exciting income plays.


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