Perhaps at no other time in modern history has there been so much confusion and uncertainty for the typical investor. In just the last 10 years there have been bubbles, crashes, recoveries, and run-ups in a number of markets. We have created billions of dollars via Quantitative Easing, kept interest rates at all-time lows, and managed to stave off inflation.
Make no mistake, we are in an all-new economic and investing environment where the stakes are high and there are no sure paths to victory. There is a clear abundance of risk across almost all conventional assets right now with very little room for maneuvering. Even the so-called experts can't seem to make sense of it. So if there's ever been a time to seriously explore new assets and non-correlated alternatives… this is it.
Let's explore some of the risks and uncertainties facing traditional investments. Take a look at the Fed Funds rate:
Rates are at all time lows. Putting your money in a CD or savings account may be low risk in the sense that your principal is protected, but your gains are minimal at best assuming inflation stays around 1.5%. If inflation runs higher than expected, or is actually higher than the CPI-based data suggests, you are guaranteeing yourself a small loss with zero upside opportunity.
Rates this low also present a significant risk to owning precious metals and bonds. As we all know, an increase in rates spells trouble for bonds. When yields (interest rates) go up, prices go down. Assuming The Fed begins to raise rates later this year as Janet Yellen indicated in last week's Congressional testimony, you can expect to take a hit on bonds. Granted, you can minimize your losses by moving from longer to shorter dated bonds, but they are still losses. The only way to avoid this would be to hold the bonds to maturity, but does that make the most sense with the returns being offered?
Less obvious is the risk to owning metals. However, the risk is very real, real enough that I do not feel comfortable recommending gold or silver to any of my clients as an investment right now. I broke this process down in my previous entry: Gold and Interest Rates ... What's the Big Deal?
Whether you believe Janet Yellen and The Fed or not, is irrelevant. There is only one direction rates can go from here – and that is up. Do not buy into the argument that the United States government will not be able to service the national debt at an increased rate. One of the key stipulations of The Fed raising rates will be continued GDP growth. Growing the size of the economy increases the government's tax revenue and will offset any increased debt payments.
This happened once before as the United States had massive debt after World War II, over 100% of GPD, not too different from today. Rates were around 1% in 1945 and gradually rose over time. Because the economy was growing right alongside rising interest rates, (and interest payments on debt), those increased costs were easily managed.
So we see the dangers with owning bonds and precious metals because of the low-rate environment we're in. We also see the lack of performance in CDs, savings, etc. What about equities though?
The answer isn't so straightforward. One of the main arguments right now is that monetary policy was designed from the ground up to support the market. It has been the only game in town as returns in other traditional assets were simply not strong enough to warrant investment. This money has flowed to the stock market – and what goes up must come down.
On the other hand, we see the debt problems in Greece – and basically the entirety of southern Europe. China has massive debt issues and a troubled market. There are good reasons for investment capital to leave other currencies and come running to the U.S. markets – but with how interconnected economies are and the prevalence of multinational companies there may be more risk in the U.S. markets than history would suggest.
Furthermore, investors are panic-prone. Take the Ebola crisis for example. Was it really that big of a deal? No, but we can see how it affected the market!
What will happen if Greece defaults and leaves the Euro? What if Spain, Cypress, Portugal, and Ireland want the next round of handouts? What if Germany bails on the Eurozone and currency collapses? Sure these are “ifs” – but really, how unlikely is it that any of those can't happen? What about the impact to the U.S. markets? Would the reaction be positive or negative?
I can't answer that question, but I can say that it has me nervous. I don't even know many people that aren't nervous about their positions in the market and when you take that and combine it with the risks in precious metals and bonds… it doesn't leave you with a lot of options. When you're in a position of uncertainty about where and how you can avoid these risks to find a positive return.
Wise investors understand these risks and uncertainties, and they can make adjustments based on that understanding to best position their family for the future. Right now is the perfect time to begin incorporating alternative strategies and non-correlated assets into your mix of investments as the outlook for so many traditional markets is very murky.
And while I am not an expert in every alternative, I do have a deep understanding in how many of these markets work – and I am a strong believer in being creative and coloring outside the lines, so-to-speak, with your portfolio. I am happy to share any thoughts or insight I may have on using various alternatives as a means of diversification. Please feel free to reach out to me with your questions.