Investors face a difficult month ahead
Historically, August into the second week of September has been a trying period for the markets. I have been warning readers to buckle their seat belts and grit their teeth because we are now in that period.
The sudden and unexpected downgrade of the nation's credit rating by Fitch, one of the three large credit rating agencies, is being blamed for this week's decline in the stock market and the sharp spike in interest rates. Fitch is the second U.S. agency to reduce the U.S. sovereign debt from AAA to AA+. Standard & Poor's did the same back in 2011. The downgrades on both occasions were caused by the deterioration in standards of governance.
While Wall Street and the U.S. government downplayed the rating change, there is, and will continue to be, a real cost in added interest expense for the nation in the years to come. I had warned readers during the debt crisis that there was a real possibility that this could occur and now it has. Bottom line: the lower a nation's credit rating, the more a country must offer investors to buy their bonds.
Since the debt ceiling passage, I had also explained in several columns that the U.S. Treasury would need to refill its checking account (called the General Account) by selling $1-2 trillion in new bills and bonds in the coming months. I warned this could add upward pressure to interest rates.
That time is now. The U.S. Treasury is planning to raise $102 billion in its quarterly refunding of longer-term Treasuries. The consensus among bond dealers is that the government will auction $42 billion of 3-year notes, $37 billion of 10-year notes, and $23 billion of 30-year bonds in the next two weeks. I believe at least some of the back-ups in yields over the last week are a result of these upcoming auctions.
So overall, rising rates and a rising dollar in an overbought market are a recipe for volatility. In my last few columns, I warned that we could see a 5-7% pullback in the markets this month. But I am looking at this as a pause rather than as a correction in the equity market.
Seasonally, August and September are vacation months for a lot of the hot money players as traders cash out of positions and take off for the beach or mountains. In September, we also have the end-of-quarter window dressing among institutions, and more importantly, the Fiscal Year end for Mutual Funds. All of this results in a large number of stock positions being bought and sold for other reasons besides investments. One should expect pullbacks, and oversold rallies, sandwiched between periods of inactivity.
It is a good time to sit on your hands if you are an investor in the stock market. I did mention in this week's Thursday column, however, that it might be a good time to put some money in what I call a "catch-up" trade if you are a trader. It is worth a read if you get time.
On another subject, after so many straight months of making money, most investors have become accustomed to almost weekly gains in their portfolios. Psychologically, once something becomes that routine, humans can fall prey to several biases that can make your life uncomfortable if not miserable. Next week, I will address the topic with the help of a colleague and friend of mine so stay tuned.
Bill Schmick is a founding partner of Onota Partners, Inc., in the Berkshires. Bill’s forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners, Inc. (OPI). None of his commentary is or should be considered investment advice. Direct your inquiries to Bill at 1-413-347-2401 or e-mail him at bill@schmicksretiredinvestor.com .Investments in securities are not insured, protected or guaranteed and may result in loss of income and/or principal.