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Stick With Bond Funds in Your Sig Plans

The Kelly Letter’s first-quarter rebalance demonstrated anew why we do not get caught up in endless discussions about bond market fluctuation.

During the quarter, small-cap stock funds stole the show:

Q1 2021 Price Change (%)
– – – – – – – – – – – – – – –

+18.1 S&P SmallCap 600 (IJR)
+12.7 Russell 2000 (IWM)

General bond funds lagged:

Q1 2021 Price Change (%)
– – – – – – – – – – – – – – –

-3.7 iShares Aggregate Bond (AGG)
-3.9 Vanguard Total Bond (BND)
-3.7 Schwab Aggregate Bond (SCHZ)

Even as their prices dipped during the quarter, all three bond funds paid distributions:

Q1 2021 Distributions ($/Share)
– – – – – – – – – – – – – – –

0.382 AGG
0.268 BND
0.206 SCHZ

Our 3Sig plan signaled selling excess IJR profit and moving the proceeds into BND’s lower price. We paid 3.9% less for BND on Monday ($84.67) than we paid on January 4 ($88.07).

This dynamic offsets short-term price changes, making them a wash over the long term. Our plans enjoy generally rising lines on both sides of our fund pairings, thanks to:

<> Rising earnings in the stock market
<> Steady distributions from the bond market

Conclusion: Stick with bond funds in your Sig plans.

Posted in Bonds | 4 Responses

Do Not Fear Archegos

In this year’s Note 7 of The Kelly Letter, sent February 14, I wrote:

“The Reddit/Robinhood combo looks like a passing media obsession. Soaring and crashing stocks are not new. Day trading, coordinated action, short squeezes, option plays, insider information, and all manner of influence have pressured the market from its inception. The only shiny object here is that some people discuss stocks on Reddit and trade them on Robinhood. This provides a veneer of newness over what is actually timeless trading activity.”

This week, analysts switched from blaming small traders to blaming big ones.

The guilty party is hedge fund Archegos, supposedly responsible for recent volatility. CNBC said the fund “sent shockwaves through Wall Street,” and The Wall Street Journal said it “set off a storm in the stock market.”

The fund liquidated some $20B worth of holdings last Friday after Morgan Stanley and Goldman Sachs, lenders to the fund, demanded that it sell shares to cover losses in Viacom stock. In a typical ripple effect, other institutions connected to Archegos, including Credit Suisse and Nomura, warned that they would suffer losses.

This, too, is as as old as the market itself. We could write up the story with blanks in place of company names and reuse it every couple of years.

Yet, analysts say the Archegos incident represents a threat to stocks.

Steen Jakobsen at Saxo Bank wrote in an email: “Billions of dollars in block trades went through on Friday. And there is uncertainty over how much more of the hedge fund’s holdings remain and could hit the market this week.”

Paul Donovan at UBS Wealth Management wrote in an email that “investors are looking with some concern at the prospect of further large sales hitting financial markets.”

Maybe so, but we could say as much every week. It should come as no surprise to market participants that stock traders trade stocks, whether from small individual accounts at Robinhood or big institutional accounts like Archegos. Neither represents anything new to the market, nor at face value any reason to be any more concerned than in any other week.

As usual, we don’t need the story.

Prices are fluctuating due to a number of known and unknown factors, as always. The fluctuation is all that matters, not the stories to explain it. There is never a systemic threat. Great price declines are met with rescue efforts, which spur recoveries, and our plans take advantage of such cycles—automatically, using price-change reaction alone.

Nobody is breaking the market.

To his credit, Donovan wrote as much later in his email, noting that Archegos sales have been relatively minor. “Does this have any economic implications? Probably not. Some parts of the financial system may experience losses, but it seems unlikely that this will threaten the financial system’s stability.”

Conclusion: Do not fear Archegos.

Posted in Stock Market Narratives | Leave a comment

Message to America From Japan: Your Guns Are Not The Problem

The pandemic kept Americans home for a year. Now that they’re venturing out again, the mass shootings have resumed. Last week a gunman killed eight people in Atlanta, Georgia. This week another killed 10 in Boulder, Colorado.

Each of America’s mass shootings sparks a gun rights debate that misses the root of the problem: a culture of violence.

I grew up in Colorado’s Rocky Mountains, an hour’s drive from the King Soopers where this week’s shooting took place. My childhood was steeped in America’s rural gun culture. As a boy I shot my own Marlin .22 rifle, mostly at targets but occasionally aiming hollow-point bullets into streams and ponds for the fun of seeing big splashes. I helped my father reload ammunition for other firearms, including .223 rounds for his collection of AR-15 rifles. I attended the University of Colorado at Boulder for four years, one of them while living in its Kittredge dormitories on the south edge of campus, two miles from this week’s shooting.

It was taken as gospel in my family that the solution to a bad guy with a gun is a good guy with a gun. The question, “What if nobody had guns?” never came up. Nationally, it probably can’t. Even advocates of gun control push only marginal measures, such as banning assault weapons, but any gun can be used in an assault and so can other weapons.

The problem lurks farther down the chain of events that produces an active shooter. If the only change we made in America was getting rid of guns, would the violence end? If the ingredients that made an active shooter were altered so that he did not want to kill people, would it matter that guns were available? No and no, are my guesses.

From within America, it’s hard to notice the country’s obsession with militaristic conflict, but from a culture that does not share that obsession it becomes blindingly obvious. It pervades every corner of America, hardening into contentiousness and fierce tribalism so ubiquitous that we become accustomed to them and don’t realize that they’re not the default for human society. I didn’t notice the constant conflict in America until moving to Japan almost 19 years ago. Seething gave way to safety. Few people even gesture angrily at other motorists, much less want to kill for killing’s sake.

The ones who do, however, manage to get it done, and this is instructive. American commentators sometimes say that mass shooters would not do as much damage without guns, but Japan’s rare killers have found ways.

In July 2019 an arsonist walked in the front doors of a Kyoto Animation building carrying 11 gallons of gasoline and set the place on fire, killing 36 people and injuring 33 more. The massacre reached a level more horrifying than most of America’s mass shootings, including the August 2019 attack at a Wal-Mart in El Paso, Texas (23 killed, 23 injured); the February 2018 shooting at Stoneman Douglas High School in Parkland, Florida (17 killed, 17 injured); and the April 1999 Columbine High School rampage in Columbine, Colorado (15 killed, 24 injured).

The primary driver of mass violence is not the means, but the desire, and the United States produces this desire in great quantities.

Founded by war and engaged in war for much of its history, America has reached the ironic state of needing the right to own guns to protect against the right to own guns. The country lives under a cloud of mutually assured destruction, affirmed by the Supreme Court in its 2010 Heller decision stating that the right to own guns isn’t for national defense but guarding against gun-toting neighbors.

Japan’s massacres by other means suggest that Japanese people could kill each other more frequently and on an American scale if they wanted to, but they don’t. They’re taught in school that maintaining society’s harmony, called wa, is paramount. Children remind their classmates to avoid meiwaku (annoying others) and jama (hindering others).

In America, by contrast, kids are taught an us-and-them worldview. The two primary tribes—let’s call them left and right—are pitted against one another and resort to violence when unhappy. We get riots from the left and riots from the right, each side excusing theirs and condemning the other’s. Small wonder, then, that when I asked a Japanese friend who once lived in California if he was surprised by the many shootings in America, he replied, “No, I’m surprised there aren’t more.”

Maybe this time, in the wake of the Atlanta and Boulder tragedies, we can set aside the Second Amendment impasse to focus elsewhere. The best time to stop a shooter is before he becomes one.

Posted in Opinion | 22 Responses

Small Caps Dominate Post-Vaccine Market

Federal Reserve Chairman Jerome Powell and Treasury Secretary Janet Yellen made their first joint appearance before Congress yesterday, delivering remarks to the House Committee on Financial Services.

Questioned yet again about inflation, Powell said: “We’ve been living in a world of strong disinflationary pressures for the past quarter century. We don’t think a one-time surge in spending leading to temporary price increases would disrupt that.”

Nonetheless, expectations for high inflation abound.

This is not necessarily bad for stock investors, particularly small-cap-stock investors. According to CME Group, small caps have been the best place for stock investors during periods of rising inflation expectations:

“Since 2010, small-cap stocks have outperformed large caps during periods of rising inflation expectations and vice versa. 2020 was no exception.”

This happened some 40 years ago as well:

“January 1979 – July 1983: The Russell 2000 outperformed the S&P 500 by 77%. During this time, inflation rose to as high as 13% and the economy suffered a double-dip recession in 1980 and 1981-82 before staging an extremely strong recovery in 1983 with growth rates as high as 8.5%.”

Whether the current outperformance by small caps is due to rising inflation expectations is unclear. CME Group wrote in January:

“While they have risen substantially from their lows in March, inflation expectations at 2.1% over the next 10 years are not especially high by historical standards. That said, a tight labor market might be a prerequisite for durably higher inflation. Now, with the labor market still significantly disrupted by the pandemic, a demand for higher wages in the US or elsewhere would seem unlikely. However, large budget deficits and continued central bank quantitative easing could help to elevate inflation down the road.”

Whether because of inflation expectations, reopening hopes, or something else, small caps have dominated the post-vaccine market. Chart of the Day makes it plain:

Chart of the Day: Small caps dominate post-vaccine market

Posted in Inflation, Small-Cap Stocks | Leave a comment

We Would Exploit a Grantham/Dent Spring Crash

In this year’s Note 3 of The Kelly Letter, sent to subscribers on January 17, I wrote about Jeremy Grantham’s bearish call: At the beginning of the year, he wrote that we’re in a “real humdinger” of a stock bubble that will burst in spring.

The co-founder of Boston-based asset management firm Grantham, Mayo & van Otterloo (GMO) ignored the usual valuation argument and said, “A bubble peaks when you reach almost unbearable levels of ecstasy.” He believes the US stock market swims in froth on froth, and that the only safe place to hide is cheaper foreign markets.

I wrote: “If you and I could vote on this, here’s what we’d request: Another bang-up quarter to nosebleed heights at the beginning of April, followed by Grantham’s crash in late spring or early summer. This would have all three of our plans selling again on April 5, boosting buying power to take advantage of burst-bubble buy signals in July and October.”

Last week, Harry S. Dent Jr. threw in his lot with Grantham.

Dent is an infamous contrarian, almost always dour—and usually wrong. When he’s right it’s generally by repeating wrong calls until eventually they come true, at which point he says he was right. Examples of this include Japan’s 1989 bubble burst and the dot com crash.

His new book is What to Do When the Bubble Pops: Personal and Business Strategies for the Coming Economic Winter. It rails agains Federal Reserve stimulus, claiming that “the Fed cannot keep the bubble from popping much longer…” The Fed wins almost every headbutt with Dent; it repeated the tradition after his book came out last April 21. The S&P 500 has risen 45% since then.

In an interview with ThinkAdvisor published last week, Dent said by phone from his base in San Juan, Puerto Rico that this is “the riskiest market since 1929. The difference is that ’29 wasn’t as global. … This may be the biggest bubble crash ever—stocks, commodities, real estate. The next crash is the initiation of the next big [economic] downturn, which will be much worse than the one in 2008-2009.

“It will likely come by the end of June, probably sooner. The S&P falls to 2,100—lower than the March 2020 low—and that would be a 47% to 48% drop from recent highs, though it may go to 4,000 first.”

You’ve read for most of this year that bonds will crash as interest rates rise. Dent is a rare bear who disagrees. He thinks long-term Treasuries are the place to hide:

“…what’s better than sleeping with 30-year Treasury bonds—the safest investment in the reserve currency of a country that’s in big trouble—but not as much as Europe and Japan are in and nowhere near as much as China is in. We’re in the best house in a bad neighborhood.

“[The 30-year Treasury bond will] fall to half a percent and maybe zero. It will expand your money 30%, 40%, 50%, while stocks are crashing 70%, 80%, 90%, [along with real estate and commodities]. Everything is going to default. Cash will preserve your money. The 30-year Treasury will magnify your money.”

Bears are usually wrong, but if Grantham and Dent got lucky this time it would favor our predefined quarterly trading schedule. Dent’s call also affirms our longstanding policy of keeping buying power in bonds rather than cash.

Conclusion: We would exploit a Grantham/Dent spring crash.

Posted in Stock Market Forecasts | Leave a comment
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