A high risk of gas pump explosion

First of all, HAPPY CHRISTMAS

Have you ever remembered a time when stocks were suffering a steep decline? Conditions were oversold. The Volatility Index (VIX) was spiking higher. Investor sentiment (a contrary indicator) was overwhelmingly bearish. And stocks were falling nearly every-single-day. I don't think many people, if any, can think about such a time but it was just two months ago, in October. At the time, the world seemed to be ending with SPX crashing down towards 4100. That was the time nearly no one was thinking the market could go up again! But the Market God did fiercely fight back and we are close to all-time highs now.  

Now we are just in an opposite situation where conditions are overbought. The VIX is trading at its lowest level in three years. Investor sentiment is off-the-charts bullish. And, stocks are rallying every-single-day.  This is the time when no one believes the market will ever go down again. But it will, probably in an epic way surprising most folks out there. So it is the time to be extremely cautious!

Watching the stock market right now is like watching a trash can fire next to a gas pump.

The fire itself is contained, manageable, and doesn't pose any serious threat. But one small change, an errant spark, or a shift in wind direction, can create an explosion.

The moment is dangerous and is coming……

I just wish the explosion won't happen during the holiday season to scare away Santa Claus!

Wall Street Wants You To Compare

Comparison is the root cause of more unhappiness than anything else. Perhaps it is inevitable that human beings, as social animals, have an urge to compare themselves with one another. Maybe it is because we are all terminally insecure in some cosmic sense.

Let me give you an example I discussed with Adam Taggart at Thoughtful Money last week.

Assume your boss gave you a new Mercedes as a yearly bonus. You would be thrilled until you learned everyone in the office got two. Now, you are upset because you got less than everyone else on a "relative" basis. However, are you deprived on an absolute basis of getting a Mercedes?

Comparison-created unhappiness and insecurity are pervasive. Social media is full of images of people showing off their lavish lifestyles, giving you something to compare to. No wonder social media users are terminally unhappy.

The flaw of human nature is that whatever we have is enough until we see someone else who has more.

Comparison in financial markets can lead to awful decisions. For example, investors have trouble being patient and letting whatever process they have work for them.

For example, you should be pleased if you made 12% on your investments but only needed 6%. However, you feel disappointed when you find out everyone else made 14%. But why? Does it make any difference?

Here is an ugly truth. Comparison-related unhappiness is for Wall Street's benefit.

The financial services industry is predicated on upsetting people so that they will move money around in a frenzy. Money in motion creates fees and commissions. The creation of more and more benchmarks, products, and style boxes is nothing more than the creation of more things to COMPARE with. The result is investors remain in a perpetual state of outrage.

The lesson we want to drive home here is the danger of following Wall Street's advice of beating some arbitrary index from one year to the next. What most investors are taught to do is to measure portfolio performance over a twelve-month period. However, that is the worst thing you can do. It is the same as being on a diet and weighing yourself every day. 

If you could see the whole future before you, making an investment decision knowing your eventual outcome would be effortless. However, we don't have that luxury. Instead, Wall Street suggests that if your fund manager lags in one year, you should move your money elsewhere. This forces you to chase performance, creating fees and commissions for Wall Street.

We chase performance because we all suffer from the 7th deadly sin – Greed. 

Most of us want all of the rewards without regard for the consequences. However, instead, we should learn to "love what is enough. "

In a year like 2023, where primarily seven companies drove the S&P 500 index, many individuals, thinking they "missed out," will want to change their strategy for next year.

As is often the case, such will likely be a mistake.

How We Are Trading It

Remember, our job as investors is pretty simple – protect our investment capital from short-term destruction so we can play the long-term investment game. Here are our thoughts on this.

• Capital preservation is always the primary objective. If you lose your capital, you are out of the game.
• Seek a rate of return sufficient to keep pace with the inflation rate. Don't focus on beating the market.
• Keep expectations based on realistic objectives.  (The market does not compound at 8%, 6% or 4%)
• Higher rates of return require an exponential increase in the underlying risk profile. This tends to never work out well.
• You can replace lost capital – but you can't replace lost time. Time is a precious commodity that you cannot afford to waste.
• Portfolios are time-frame specific. If you have a 5-year retirement horizon but build a portfolio with a 20-year time horizon (taking on more risk), the results will likely be disastrous.

As discussed here, there is a wide range of potential outcomes based on valuations in 2024. No one knows with any certainty what next year will hold. However, by focusing on risk controls and the technical underpinnings, we can safely navigate the waters to safety.

We are certainly anxiously anticipating the arrival of "Santa Claus." However, we remain keenly aware of the lessons taught to us in 2018 and 2020 that nothing is guaranteed.

Lance Roberts

This time is not different!

 Share an epic write-up about the history of the rate hike and the consequence. While history may not repeat itself, it often rhymes! 

 

This dismal pattern began a few years after the Forgotten Depression. As a new speculative boom took hold during the second half of the decade, the Fed started raising rates sharply in early 1928, ultimately reaching a peak of 6% in 1929.

But it wasn't until October 1929 – roughly two years from the start of that tightening cycle – that the stock market began its historic plunge (the Dow would go on to drop 89% before bottoming in 1932). And it was still another year after that before the Great Depression went global in early 1931. That's when Austrian bank Creditanstalt – one of the largest and most important banks in Europe – collapsed, setting off a deflationary crisis that quickly spread across the continent.

The 1960s and '70s saw this cycle repeat several times.

In mid-1967, in an effort to fight inflation, Fed Chair William Martin began an aggressive tightening cycle. In just over two years, he more than doubled the federal-funds rate from 3.75% to nearly 10%.

Yet, it still took another 10 months – and three years in total – before trouble began. Economic shockwaves followed the failure of railroad giant Penn Central, at the time the largest corporate bankruptcy in history. Since the railroad controlled a third of the nation's passenger trains and a majority of freight traffic in the Northeast, its collapse created significant economic and financial market fallout.

In addition to the obvious disruption of interstate trade and significant losses among the company's many pensioners, the collapse triggered a liquidity crisis in the short-term corporate-debt market that nearly bankrupted renowned investment bank Goldman Sachs.

Martin's successor – the much-maligned Arthur Burns – presided over a similar tightening cycle a few years later.

Despite his legacy of being "soft" on inflation, the Burns Fed aggressively raised rates from less than 4% in early 1972 to a whopping 13% in July 1974. And it was not until October 1974 – nearly three years into the tightening cycle – that his Fed finally relented.

In that cycle, the central bankers feared the recent collapse of Franklin National Bank, the largest bank failure in U.S. history at that time, could trigger a financial crisis (much like the failure of Lehman Brothers several decades later).

Regulators quickly stepped in – orchestrating the first federal wind down of a major financial institution in history – and Burns cut rates back down to 5% to ease financial conditions, even as inflation remained high.

Even famed inflation fighter Paul Volcker was a victim of this lag.

As many recall, Volcker held rates as high and as long as necessary to defeat inflation – rapidly pumping up the fed-funds rate above 20% by 1981.

But when Volcker finally gave up his fight in 1984 – again, roughly three years after his final tightening cycle began – it was not because inflation had been defeated. Consumer prices would continue to rise between 4% and 6% annually – well above the Fed's target – for much of the next decade.

Rather, Volcker began cutting rates following the near-failure of Continental Illinois National Bank – the country's largest commercial and industrial lender and arguably the first "too big to fail" bank – that threatened to trigger a financial crisis that spring.

Most notably, Volcker's successor, Alan Greenspan, played a role in multiple such cycles in the following decades. Those lags culminated in the "Black Monday" stock market crash in October 1987, the savings-and-loan crisis in the early 1990s, the dot-com boom and bust in the late 1990s, and ultimately, the 2000s housing bubble and the great financial crisis that followed.

And despite all that history could have taught him, former Fed Chair Ben Bernanke – who took over the reins from Greenspan in 2006 – was most famously fooled by the lag.

In a speech in March 2007 – almost three years after the start of the Fed's most recent rate-hike cycle – Bernanke assured Congress that the growing problems in the subprime mortgage market were "contained" and unlikely to impact the "broader economy and financial markets."

Of course, we now know that the worst financial crisis since the Great Depression was already brewing, and the Fed would begin cutting rates in a panic just a few months later.

Bernanke's misplaced confidence is among the biggest blunders in modern financial market history. But as we've seen, virtually every Fed chair – along with most investors and market pundits – has made similar mistakes in every tightening cycle in U.S. history.

P.SB