Exuberant wealth managers expect another phenomenally good year for stocks in 2014, followed by more great years. They see bonds and bond funds as a juicy investment that belongs in every diversified portfolio, damn the torpedoes. They’re the vast majority of wealth managers.
But there are some fretters scattered around, still, and they’re having a hard time, and they’re losing clients, and they’re pushed to the margins. No one wants to listen to them.
“I cannot imagine how we’ll explain a third crash in 15 years to our clients,” one of these fretters told me. He is no perma-bear. But he looks at corporate revenues and earnings, at risks piling up in the junk bond market, at IPO valuations, at a million things. And he is gently passing some of his thoughts on to his clients – which doesn’t go over very well.
The tricky undertaking of what to tell clients during these crazy times made it into the Wall Street Journal. Richard Saperstein, chief investment officer of Treasury Partners and an occasional guest on CNBC, sorts through the various aspects of the only thing that really matters these days: when the Fed might actually taper its $85-billion-a-month money-printing binge, rather than just talk about it.
“In 2013, the Fed purchased 70% of all new Treasuries that were issued,” he wrote nervously. This couldn’t go on forever. So the Fed would “likely” begin to taper in 2014, in compliance with prevailing if not mandatory market consensus. He didn’t say March. That would have fit nicely. But the fretters worry about December.
“Last summer, the Fed simply talked about tapering, causing the bond market to have one of the most dramatic declines in prices in 30 years,” he wrote. But the stock market continued to ratchet higher. This time, if the Fed actually tapers, rather than just talk about it, “there will logically be some disruption in the stock market.”
So the big question: “The challenge is how to advise clients during this pending change. It’s like you’re at a party and the keg is beginning to float. When do you leave the party? Where do you go?”
Central banks have created a unique, let’s say, situation. The Fed has printed over $3 trillion in five years – amounting to about 20% of GDP – and plowed it into Treasuries and Mortgage Backed Securities. This enormous artificial demand drove up prices and repressed yields. It spread from there. Other central banks have engaged in similar infinitely wise strategies. Consequence: the largest credit bubble in history. Junk bonds yielded at their peak less than an FDIC insured 5-year CD did before the financial crisis. Risk, any risk, and its costs, have been wrung out of the system.
Other asset classes ballooned in parallel: stocks, farmland, housing, art. Oh my, a 1969 Francis Bacon triptych changed hands at $142 million in November, the highest price ever paid at an art auction. Then there’s Bitcoin…. Wait, that’s not an asset class. We haven’t decided yet what it is, but whatever it is, it’s ballooning – and deflating – to the tune of 20% to 50%, sometimes on a daily basis.
The Fed has created an investment environment that no longer has much in common with investments per se, but has turned into a vast, high-stakes gambling den with only one bet: what is the Fed going to do next?
There are complications. The Fed might not do anything. It might just get lost in its own cacophony and confuse the gamblers and itself, as it had done over the summer. Whatever it’s going to do, at whatever pace – and even if it does nothing – the markets will react. Betting on the Fed, that’s what we’ve been reduced to over the past five years.
So, what does a wealth manager or a financial advisor tell clients? That a well-diversified portfolio full of inflated bonds, even more inflated stocks, bubbly real estate, outrageously expensive farmland, a Van Gough, and perhaps an early Francis Bacon will get them through the taper, and its aftermath, without hearing the hot air hissing out of these assets?
But it’s hard to find a place to hide. Are you going to sell one inflated asset, pay taxes on the gains, take the remaining proceeds and plow them into another inflated asset, hoping to escape the tornado forming on the horizon? Like rotate out of bond funds now that they’ve become unpalatable and dump that money into stocks, which are at all-time highs, just when corporate earnings growth is minuscule, and when revenue growth has trouble keeping up with inflation?
Or leave the proceeds in cash and gnash your teeth as the bank takes your money for free and lends it out at 5% or 8% or gambles with it and takes risks that, if they blow up, would force you later to bail out that very bank? In return, the bank pays you next to nothing for your money?
Cash in the bank is a despicable investment. The Fed has done everything so that you hate it. The Fed is giving banks all the cash they need for free. It is competing directly with you to make your life miserable if you want to hold cash. So suffer through this after you sell your bond funds? Or switch your money from one inflated asset into another – and remain exposed to the turbulence you see coming your way when the big taper hits the markets. That’s the choice the Fed has left us.