So much for the summer vacation. The financial markets sailed through July, only to close the month with a thud. That sinking feeling continues into August. The culprits: a rate cut/trade war double-header. The two current investor obsessions competed for attention as the stock market entered the time of year that often brings the weakest returns. Yet, with the buy-the-dip mentality still dominant in financial markets, the nine lives of the 10-year bull market could continue. Let’s take a closer look.Ray Dalio, founder of the world’s largest hedge fund, Bridgewater Associates, recently wrote in a LinkedIn post that “investors have been pushed into stocks and other assets that have equity-like returns. As a result, too many people are holding these types of securities and likely to face diminishing returns.”Why would he think that? Because after one of the longest economic expansions ever, there is still a big part of Wall Street that wants more. It reminds me of one of my daughters when she was very young. You see, it wasn’t enough to have cake batter-flavored ice cream. No, the dessert was not complete without gummy bears and sprinkles on top. We were all taught as kids that the place where camels roam is the desert with one “s”. And, what you eat after dinner is dessert, with two “s”s. In my daughter’s case, perhaps the word should have been “desssert.”That’s what the market seems to want. More dessert. After all, as I have noted here in recent months, dropping interest rates can only go on for so long. The Fed Funds rate is at 2.25%. Past rate-cut cycles have typically resulted in cumulative reductions in rates of 2-3 times that. So, the Fed will run out of room to maneuver quickly — kind of like how most of us would not maneuver too well after eating the dessert I described above.Meanwhile, my “Eye of the Hurricane” scenario looks more likely all the time. As you may recall, that is my analogy for the current stock market. It was pretty angry late last year and then enjoyed some very nice weather this year. But a hurricane does damage in two phases, with a period of calm in the middle.However, given the laundry list of hurdles to continued high returns, the eye could be running out of time, right on schedule for what is often the worst stretch of the year (August/September/October). And, an intensification of the U.S.-China trade war doesn’t help.And then, there’s bitcoin. I see what many others do in the evolution toward blockchain technology. What I don’t see is a lasting frenzy over the stock prices of one application of blockchain, namely cryptocurrencies. To me, it’s very simple: any asset whose value fluctuates as wildly as bitcoin does should be considered less of an investment, and more of a speculation. I leave it to others to play that game.“Aggressive capital preservation” is still the name of the game. Knowing your risk limits is key. That starts with being realistic about how you will act amid future market turmoil. At this late stage of the market cycle, it is a priority for retirees and those within at least 10 years of retirement.
U.S. Stock Market
The S&P 500 did not spend one second of July in the red. It rose 1.51% for the month, and finished July up over 20% for the year so far. Unfortunately, this is starting to develop like past periods of market turmoil. Specifically, the S&P 500 has outperformed even aggressive portfolio mixes by a wide margin recently. In other words, good old-fashioned diversification techniques are being left in the dust. This creates excitement and herding into index funds that track the S&P 500. When so much money is chasing yesterday’s winners, that’s a red flag to me.Bond Market
Bonds may stink for yield these days. However, for price-appreciation, they are racking up impressive, even historic gains. The 10-year U.S. Treasury yield spent most of July in the 2.00-2.10% area, and then dove below 2.00% as August began.I see bond volatility continuing, since so much of what concerns investors today has a direct relationship to interest rates. The trade war impacts rates because currencies and global growth fluctuate. The Fed rate cut, though it pertains to very short-term interest rates, impacts longer-term bonds as well. And the stock market’s gyrations can create a situation where Treasury bonds are seen as a safe haven investment one week, only to sell off the next when the momentary fear subsides.Most importantly, if history is any guide (Hint: it is), the Fed rate cut on July 31 is more likely to mark a point where investing became more dangerous. This is especially important if you are investing based on some type of very long-term strategy that blows off the threat of major marketturbulence. It’s been a nice 10-year run, and it may well continue for a bit. But don’t wait until the bear is in your face to think about how you will confront it.This chart summarizes today’s U.S. economy as it pertains to work and wages. The unemployment rate is about as low as it can get. But wages have been stagnant for decades. I think this has a lot to do with how the nature of work is changing, and how the employment figures are calculated (no matter who the president is).Many people are working multiple part-time jobs because they can’t find a satisfying full-time job. That creates more Uber drivers and the like, but it doesn’t help people earn and save more. Combine this with the fact that there is a serious skills gap — many high-skilled jobs that go unfilled, and this appears to be a problem. More jobs are being automated as we speak, and that will only intensify the problem.This has been masked by headlines about a strong economy, but with global economic growth starting to slow, the risk is not that this issue will get worse. It likely will. The risk is that investors will be shocked when it becomes more obvious and react harshly.
Key Market Stress Points
The Plan
Perhaps this old bull market has one more run higher in it. We always need to account for that. The churn of the spring has given way to a precarious late summer. So, what’s the action plan?My portfolios have been positioned with above-average caution for much of this year, while still allowing a portion to ride the bull, so to speak. The events of late July into August are a time to examine that balance even more closely, with a willingness to throw the hammer down to protect portfolios as needed. Every move today (whether to add or reduce risk in exchange for more or less potential return) should be part of a multi-move sequence. The next moves will be based on how the reward/risk tradeoff changes next.I am neither bull nor a bear. I am a realist and a devout risk-manager. Be careful, understand what you own, and respect the laws of gravity.My portfolios have been positioned with above-average caution for much of this year, while still allowing a portion to ride the bull, so to speak. The events of late July into August are a time to examine that balance even more closely, with a willingness to throw the hammer down to protect portfolios as needed. Every move today (whether to add or reduce risk in exchange for more or less potential return) should be part of a multi-move sequence. The next moves will be based on how the reward/risk tradeoff changes next.I am neither bull nor a bear. I am a realist and a devout risk-manager. Be careful, understand what you own, and respect the laws of gravity.










