If you haven’t noticed, there is a lot of banter about the future continuation of the bull market with a little volatility. What they are saying is they have no idea what is going to happen in the next 6 months. Here are a couple of clues. The Chinese have $35 billion in government securities that have matured and not repurchased them in the current auctions. Out of $785 billion they are reducing their holdings while the dollar is strong. Then they spend those dollars to get the most value out of it. The rest of the world is buying U.S. Govt. securties to take up the slack due to every one else wanting to exit the Euro and buy U.S. securities. VERY SMART!… Reduce your exposure to securities that are defined in a currency that is sure to lose value. Other sovereign funds (or foreign countries investable assets) are buying U.S. securities do reduce their currency risk. European countries are expecially interested to hedge the risk of the Euro which has been dropping lately. With Greece and the rest of the PIIGS experiencing higher risk of default on their bond obligations, the value of the dollar has been climbing. Ultimately, though as the U.S. government deficit becomes increasingly less likely that it will be paid back, buyers of treasuries and bonds are going to be demanding a higher return for the increased interest rate risk. As the offering rates increase the existing bonds will decline in value. The increase in rates is going to also have the effect of increasing the cost of borrowing for businesses which in turn will slow their growth rates and profitability.
There are going to be two results of the above condition. First, all of those holding U.S. treasuries and bonds will have to continue buying if they don’t want to lose substantial amounts in their current holdings. This makes for a slow and gradual migration into higher yields as older securities are redeemed and new ones bought. Second, as the global economy experiences the slowdown in growth, we will also see another leg down in valuations of most stock markets around the world. There will be few places to hide other than short term cash and Treasury Inflation Protected Securities or TIPS. There is already a growing interest in these types of investments. Unfortunately, there are not enough being offered to meet the growing demand.
I have to point out that since October 19th, the U.S. stock market has only briefly advanced and then has been trading in a range of plus or minus 3%. It is proving to be a good call to eliminate market risk, stay in cash, and wait until the current crises play themselves out.
