Ignore Pundits’ Predictions – Interest Rates Will Forecast Markets’ Future

As the year begins, it’s customary for most market pundits and commentators to look into their crystal balls and provide their forecasts for the year ahead. But I am not going to do that. To do so this year would, in my opinion, be a fool’s errand.

Why?

That’s because to make a financial prediction with any degree of accuracy about what the markets are going to do, or not do, requires a basic level of certainty in the assumptions underlying the economic forecast. And currently, all I see is UNCERTAINTY everywhere I look.

As a professional investor, I know that UNCERTAINTY means risk as well as opportunity. But with U.S. stock valuations already sky high —  refer to my article last week in Money and Markets in which I reveal how pricey these markets really are — the risk of loss is certainly higher than the potential for gain … at least in the short run.

That’s why, in this article, I am going to briefly review what is behind all the UNCERTAINTY and what is the one key market measure you should currently be watching so you’ll know what to do next with your nest egg. What’s more, I’ll show you a chart that points out how a certain group of Wall Street insiders are placing their bets with their own money on this crucial market metric.

Looking back, 2016 was a year of political surprises. From the growing support for fringe nationalist parties across Europe, to the U.K. Brexit referendum, to Donald Trump’s presidential election victory in the U.S., it’s obvious that a major populist shift is underway, with the electorates in the major Western economies all demanding change.

It’s unknown what new government policies, trading arrangements and geopolitical fault lines will emerge. However, the primary overarching risk going into 2017 is the UNCERTAINTY associated with more inward-looking, rather than outward-facing, political leadership across the developed world.

How did we get here?

The anemic and uneven economic recovery from the recession caused by the 2009 global financial crisis is challenging the broader trend toward global integration. The ongoing immigration crisis in the eurozone, low labor-force participation rates, strong resistance to new trans-Pacific and trans-Atlantic trade agreements, the rise of extremist parties across Europe, and particularly the major political shocks of 2016 in the U.K. and U.S., all reflect growing resentment toward globalization in the Western world.

Don’t bet the farm on what may be the fleeting euphoria of the stock market – but make sure you have a quality portfolio.

It’s become clear that government activism is the preferred approach in the developed world. Indeed, two of the main economic pillars for President-elect Trump’s incoming administration are increased government-provided fiscal support and the rollback of regulation in areas such as energy and banking.

On the spending side, President-elect Trump’s transition team has proposed tax credits with the aim of funding up to $1 trillion of investments in airports, roads and bridges. At the same time, lower tax rates for corporations and households across all income brackets have been proposed. As I discussed in previous Money and Markets articles, whether or not these proposals gain Congressional approval or what affect they may have on long-terms economic growth is UNCERTAIN.

But with the U.K. and Japan also planning to increase spending on transportation and communications infrastructure, the clear bias in the developed world is toward pro-growth fiscal policy.

There’s no doubt that regulatory changes in the U.S. will have a mixed-but-important impact across a number of business sectors as specific policies are enacted and old regulations are repealed or trimmed. For example, it’s anticipated that banks will be helped by the easing of some Dodd-Frank rules, while large portions of the healthcare sector will feel the pressure of UNCERTAINTY of the efforts to repeal Obamacare and reduce drug prices.

As you can see for yourself, the common theme of this brief narrative is that the developed world is awash in UNCERTAINTY.

That’s why I am watching interest rates like a hawk — especially the 10-year U.S. Treasury Yield — because it’s going to provide me a signal about which way the stock market is headed. Currently, the yield stands at 2.45%, which is up dramatically since its U.S. Election Day-level of 1.88%. However, to put this move in context, it stood at 2.24% as we entered 2016 so the change is not as dramatic as the mainstream media would lead you to believe.

Nevertheless, the rise in the 10-year has been significant, and it correlates with the upward move in the U.S. stock market as investors see the president-elect’s policies as good for business, growth and future corporate profitability.

Is this move in interest rates and stock prices sustainable?

If you’ve read my December Money and Markets articles, you’ll know that I am skeptical. And it’s not because I am a pessimist or because I want to throw a wet blanket over all the euphoria. The reason I remain skeptical is because the big factors influencing the world economy —  a huge debt overhang and poor demographics —  haven’t changed. Yes, a shift in government policies can make changes around the edges but the big core problem remains: Slow global economic growth. And that hasn’t changed.

Here’s a chart that you’ll rarely see. It shows that there are some other Wall Street insiders who agree with me. In fact, they are so convinced that they’ve even put their own pocketbooks on the line.

This chart reports that the number of net long positions in 10-Year U.S. Treasury bonds held by institutional U.S.-government-bond traders — the so-called “smart bond money” — has moved sharply higher in recent weeks. In fact, ignoring the 2005 spike, the number stands at a two-decade high.

Without getting into all the intricacies of bond trading, this simply means that these professional traders, whose only job is to know the U.S. Treasury bond market inside and out, think that interest rates are going to reverse and head back down, which I think will mean a decline in U.S. stock prices.

Similar levels of net-long positions in 2012, 2013, and 2014 all coincided with a fall in interest rates. Will they be right again this time? I think they will — and they do too — or they wouldn’t be putting their precious investment capital and, in some instances, their own jobs at risk.

What should you do?

Well, here’s where you — the everyday investor — can turn the tables on the big boys. That’s because by owning some of the highest-quality companies in the world, you can get the best of both worlds: A dividend that’s comparable to the yield on the 10-year U.S. Treasury and a growing earnings stream to hedge against market pullbacks. But as I’ve said previously, you have to be highly selective because these companies are rare and you have to buy them at the right price.

To win in this UNCERTAIN and HIGH-PRICED environment, it’s crucial for you to keep your portfolio of the highest-quality and emphasize liquidity.

It’s obviously early in the new year and there’s a new sheriff in Washington, D.C., which means lots of change and UNCERTAINTY. That’s why you should be on the lookout for my future articles, where I will keep you on the inside track of what it all means for you and your money.

Best wishes,

Bill Hall

Bill Hall is the editor of the Safe Money Report. He is a Certified Public Accountant (CPA), Chartered Financial Analyst (CFA) and Certified Financial Planner (CFP). Besides his editorial duties with Weiss Research, Bill is the managing director of Plimsoll Mark Capital, a firm that provides financial, tax and investment advice to wealthy families all over the world.