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Economy , Finance , Investing

This Investment is Completely Out-of-Whack

October 17, 2016

“Hindsight is 20/20.”

Ever heard of that saying?

It’s the idea that we can look back in time and clearly see what we unfortunately missed at the time. This is especially true for people’s financial decisions.

Time and time again, people make simple mistakes because they are not able to step back and look at the world with a macro-perspective. It’s easy to get ‘lost in the weeds’ and not realize what is going on in the big picture.

The last two times investors got lost in the weeds, in 2000 and 2008, the repercussions were significant.

Investors got burned in 2000 because they were buying stocks that were trading well above a P/E ratio of 100. Internet companies were popping up all over the place and instantly trading for 100 times their earnings.

Looking back, we can obviously see that people didn’t take a step back and say, “Is this realistic? Can all of these companies continue trading for these prices even though their earnings are zero or even negative?”

2008 was almost a carbon copy with investor sentiment, only it was with homes. The idea that home prices would go up forever and never decline was almost an accepted fact. Just like internet stocks, investors got lost in their thinking.

Home buyers neglected the idea that there might be a possibility that they couldn’t repay their loan. They didn’t look at the fact that a declining economy could lower their income and prevent them from paying their mortgage. They also didn’t even think about what rising interest rates would do to their monthly mortgage payments.

Today, looking back at the housing market bust, we can all think, “How did so many people miss this?”

Of course, if you remember living through that time, it was easy to get lost in the excitement of making money with homes – everyone was doing it!

Today we have the same scenario unfolding in a market that is twice the size of the stock market.

The global bond market has nearly tripled in size over the past 15 years at well over $100 trillion dollars.

This bond buying frenzy has begun to eclipse investor’s rationality. Just like the dot-com bust and the housing crash, if today’s investors were able to take a step back, they’d see how dangerous the bond market is today.

Bond yields have been decreasing which means bond prices have been increasing (bond price and yield move in opposite directions). But in some countries and even some corporations, bond yields have turned negative, which ensures that the investor will get less money returned than what they initially invested.

Does that confuse you?

It should. It makes absolutely no sense. Investors are willing to purchase expensive bonds that yield nearly zero (or in some cases negative) with the assumption that these bonds are 100% safe.

The risk/reward ratio in this investment is completely out-of-whack. When this bond market corrects, it will drag down the rest of the market with it.

10 years from now, people will look back at this time and say, “What the heck were people thinking?!”

Fortunately, for you and I, we can ask that now before it’s too late.