Everything seems to be moving in the right direction for investors these days. The global economy is doing great, with strong growth in Asia and robust recovery signs from the US economy. Even in Europe we can see the first indications of a revival. As a consequence, investors are buying stocks with renewed confidence and the most important stock markets across the globe are listed at historical record levels.
‘It’s party time on the trading floor’ is a phrase you would hear in professional circles, but all of a sudden the party was abruptly ended by the organization that started it: the Fed. Janet Yellen, chair of the board at the Federal Reserve, openly expressed her dissatisfaction with the party atmosphere on the financial markets. According to Yellen, the valuations on the stock market are ‘very high’ and this could potentially 'lead to trouble'. The statement surprised many investors and Yellen’s words quickly sparked a sell-off.
Investors should not be so shocked, however, since Janet Yellen had already raised this issue of valuations in the past. She specifically referred to excessive valuations in certain segments of the market last summer. At that time, Yellen had her sights set on the biotechnology sector and rightly so. All of this underlines that Yellen is a different type of chair than her predecessor, Ben Bernanke, who never saw danger coming. Not even when the real estate bubble burst in 2006/2007.
What Yellen is doing, in fact, is preparing the markets for the inevitable: a rate hike. The short term rate of the Fed (officially, the Federal Funds Rate) has been listed at 0% since the financial crisis. Never before in history it happened that the Fed lowered its short-term interest rate to zero percent, let alone for more than 6 years. The long-term consequences of this policy are anybody’s guess, which is why Yellen wants to normalize rates as soon as possible.
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In short, we are looking at a new rate cycle, which is something we already wrote about last year and something that is of major importance to investors. A new rate cycle often goes hand in hand with higher highs in the market, but at the same time it also the last signals the start of the final stretch of this bullish phase. The first phase of a rate cycle is a great time to safeguard your profits and decrease your exposure to stocks. Selling at a profit is something you do in a market that is (strongly) on the up, not when prices are going down. Nevertheless, we see the opposite happening in the market today.
What we are seeing is that, after years of being on the sidelines, the masses are starting to see the benefits of the stock market. Investing in stocks is mainstream again and, even more, if you are not investing in stocks you are not cool. Frequent updates and commentary regarding the financial markets are back in mainstream media and the underlying message is clear: there is no other choice than investing in stocks. Savings accounts are worthless, bonds are bad, and in the long term you ‘always win’. That is the voice of the media.
Let’s be clear here: as an investor you always have a choice. There is always a segment that no one is looking at or that no one wants anything to do with. Even more, there are often multiple segments that are interesting. Today these ‘secret’ or unwanted segments are gold and silver mining stocks, Chinese stocks, and different commodities… Unfortunately many investors are not interested in these segments at all. The reason, however, is simple: these assets are not going through the roof today while the rest of the market is in ‘great shape’. Let this be a lesson: this is the mistake the masses make time and time again. Buying into hot market segments and following the herd is not the way to financial freedom, to the contrary. This is what causes drama in many families time and time again.
Our analysis indicates that we are slowly – but surely – turning onto the last stretch of this bullish phase, most likely followed by a fierce correction. Of course, the last phase is often the most powerful, but not always the most profitable. Even more, when the correction strikes, those final quick gains will swiftly vanish. At that time many investors will wake up to yet another stock market hangover. Unfortunately, the fault is their own. The right time for going all-out on stocks was 2009 / 2010, when the market just broke out to the upside. Today, with new market highs almost every week and the Fed sounding the alarm, is not a great time. Never forget the most basic rule of investing: buy low, sell high.
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