Welcome to the Liquidation Cycle

Whenever I hear the old adage that ???there???s always a bull market somewhere,??? I tend to think that people feel like they???re missing the boat on stocks. They start thinking to themselves that if only they were allocated to just the right sectors, all would be well.

Now, while this situation may be true in theory, when it comes to actual practice, it???s impossible to be invested in only the right bull sectors at just the right time. Let???s do a little reality check here to see the overall conditions in the equity market to see just how tough it is to find winners right now.

If we look at the chart here of the Vanguard Total World Stock ETF (VT), we see that the broadest measure of all tradable stocks around the world has seen a very sharp pullback since late May.

It is no surprise here that the catalyst for the global sell-off was Fed Chairman Ben Bernanke???s May 22 talk that the U.S. central bank may ???taper??? current easy-money policies. Since then, stocks have plunged below their 50-day moving average. VT also fell to its 200-day moving average. But during the past couple of trading sessions (including today), we???ve seen a rebound off of the long-term trend line.

There???s also been a rebound in the emerging markets sector during the past couple of sessions, but the technical picture in these markets is much different than it is in the broader VT measure.

Take a look at the chart here of the iShares MSCI Emerging Markets (EEM). The volatile segment collapsed after the Fed???s narrative about tapering began. Even with the bounce during the past couple of sessions, EEM remains trading near its 52-week low.

What these two charts (VT and EEM) tell us is that the liquidation cycle for stocks is here. How long will we be in this cycle? Well, that???s always the $64,000 question. Of course, the answer is we won???t know until the cycle is over.

For investors, the pullback in VT, EEM and in the domestic markets is the beginning of the market ???reboot??? that I???ve been predicting to subscribers of my Successful Investing newsletter.

I suspect that this reboot will ultimately be a great buying opportunity for investors, but how you buy, what you buy, and with how much of your portfolio is going to be the key to navigating these waters expertly.

To find out how we are doing that right now, I invite you to check out Successful Investing today.

The Bond Bloodbath and Real Estate

Bonds have gone bust, or at least it seems to be the case by looking at the tremendous spike in bond yields during the past month.

Check out the chart here of the 10-Year Treasury Note yield. As you can see, this metric has gone parabolic since ???Big Ben??? Bernanke suggested the monetary sugar high will come to an end as soon as next year.

The rise in bond yields has caused a bloodbath in bond prices, and that???s made a lot of bond holders, bond fund managers and income investors very, very nervous.

I have been doing a lot of studying on this situation to really determine how much of an effect this rise in bond yields will have. My conclusion for the short term is that bond yields aren???t likely to climb too much more from here. While I do think that long-term interest rates (bond yields) will rise gradually, I do not think the economy is strong enough — domestically or internationally — to warrant much more of an increase in rates.

Indeed, today???s release of the downwardly revised final Gross Domestic Product (GDP) figures for the first quarter indicates in no uncertain terms that while the economy is improving slightly, it???s in no way firing on all cylinders. This reality means the Fed can???t stop its bond buying purchases too quickly. It also means that bond rates aren???t likely to go much higher.

The one danger area here from rising rates on the 10-Year Note is that this metric is tied to mortgage rates. We???ve already seen a big spike higher in rates during the past couple of weeks. Any further move higher in borrowing costs could put a significant damper on the nascent housing recovery.

The rise in rates comes at just the wrong time for housing, as we observed the biggest one-month gain in large city home prices in the history of the S&P/Case-Shiller index.

Will a rise in mortgage rates derail a housing recovery before it really gets going? It definitely could, but if rates only rise gradually the way that I suspect, then housing likely will keep improving.

The proof of this thesis will be seen in the next few S&P/Case-Shiller prints, and that???s what I???ll be watching closely to help determine the fate of the economy and, by extension, the potential fate of equities and bonds.

A Thought on Thinking

???If everyone is thinking alike, then somebody isn???t thinking.???

–George S. Patton

The pitfalls of groupthink are easily seen in a military environment. They also are easily identified in the behavior of the stock market. As an investor, you can???t ignore the herd mentality that drives the markets. You can, however, refrain from succumbing to the worst habits groupthink produces, including chasing stocks when they run up too high, or selling just because everyone else is selling.

Wisdom about money, investing and life can be found anywhere. If you have a good quote you???d like me to share with your fellow Making Money Alert readers, send it to me, along with any comments, questions and suggestions you have about my audio podcast, newsletters, seminars or anything else. Click here to ask Doug.

To read my e-letter from last week???s Eagle Daily Investor, please click here. I also invite you to comment about my column in the space provided below my Eagle Daily Investor commentary.


Doug Fabian