Thoughts from Jim Puplava's recent Big Picture podcast, "End Game – Tactics for the Final Phase of the Bull Market," which can be listened to in full on the Newshour podcast page here or on iTunes here.
Jim Puplava, the founder of Financial Sense and Chief Investment Strategist at PFS Group, laid out his case on Saturday that we are entering the final stages of the bull market in US stocks and offered seven strategies investors should consider.
First, why are we entering the final phase? Puplava contends that, in most cases, bull markets do not simply die of old age, but are typically killed off by a particular set of circumstances—one of the most obvious being a tightening in monetary policy.
As Puplava noted at the onset of the current bull market (see here), monetary expansions can have a very powerful influence in driving markets higher; then, at a certain point, central banks begin to tighten and withdraw liquidity until something in the market or economy finally breaks. After seven years of near zero interest rates, it appears that the Fed is ready to move towards tightening, albeit at a very slow pace.
This does not mean that investors should automatically move to cash however, since stocks can do well in the beginning phase of tightening in recognition that economic conditions are improving (for proof that economic conditions have indeed improved see the most recent December Macro Update: Balance of Data Remains Positive).
Though some commentators claim that the US is in or on the verge of recession, particularly when looking at the weakness in manufacturing, such claims are not supported by many historically reliable leading indicators. As a case in point, here is the Federal Reserve Bank of Philadelphia State Leading Index (in red, S&P 500 in black), which has pinpointed market tops and recessions (red bars) in the past. Not only has it maintained a positive reading since 2009, but it is still in positive territory currently.
Source: Bloomberg, PFS Group
When you consider that the balance of US economic data and leading indicators are still positive (see also Jobless Claims, Leading Economic Indicators Still Not Warning of Recession), what is the risk? Jim outlined three possible scenarios for investors: a base case, a best case, and a worst case.
The worst case is that global economic growth continues to suffer as the Fed hikes rates, eventually precipitating a financial crisis. In this case, both economic growth rates and central banking monetary policies between the US and the rest of the world diverge even further, with an associated spike in the dollar, collapse in commodities, and contraction in the emerging market and junk bond space.
Though our PFS Group Recession Model (see chart below) has yet to warn of a major economic downturn in the US and turn us bearish, a worst-case scenario could be the catalyst for one ahead. For that reason, monitoring a wide range of historically reliable leading indicators is extremely important.
Source: Bloomberg, PFS Group
A best case scenario would be that global stimulus begins to take hold and prevents a further contraction in the global economy (see Is a Major Global Economic Recession on our Doorstep?), which in turn helps to support oil, commodities, and resource-related sectors. In such a scenario, Jim contends that we could see a very strong finish to the final stages of the bull market, similar to 1998-2000 and 2005-2007.
One other possible scenario outlined by Puplava, a financial planner and strategist for many high net worth clients, is a large rotation by investors out of bonds funds, which could suffer greater losses with a rise in interest rates, into blue-chip dividend paying stocks.
A major concern of Puplava’s and others, including the SEC, is on the types of illiquid investments held by many large bond funds, which have tripled in size over the past decade, and the potential problems this may cause if investors are forced to sell all at once (see WSJ article: The New Bond Market: Some Funds Are Not as Liquid as They Appear).
In order to mitigate this risk and the losses that could result, Puplava recommends bond investors consider using a laddered bond portfolio of individual bonds broken out to different maturities of shorter length. Another option is to use bonds that have interest rate floaters, which will adjust to market rates if interest rates begin to rise.
Though Puplava outlined seven different strategies to consider in his recent podcast, including a focus on dividend paying blue chip stocks with high levels of free cash flow, with the future inherently uncertain he reminds investors to diversify and not simply join the herd by piling into high priced momentum stocks.
Listen to this full broadcast with Jim Puplava, President and Chief Investment Strategist at PFS Group, by clicking here. For a complete archive of our broadcasts and podcast interviews on finance, economics, and the market, visit our Newshour page here or iTunes page here. Subscribe to our weekly premium podcast by clicking here.
