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Opinion: The rise and fall of bonds, stocks and commodities

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The caution flag is out for bonds, stocks and commodities. Here’s why.

Bonds
Be careful. The less-than-enthusiastic reception for the recent Treasury offerings may indicate an early trend of reluctance to hold the low-interest-rate issues that have been the norm this year. Of concern to many is the fact that PIMCO, the largest bond managers, has been selling a portion of its Treasury holdings. We have recommended for more than a year that bond investors either hold only short maturity issues or use a laddered maturity technique.

For the aggressive investor anticipating that a rising interest rate trend is starting, shorting the longer term treasuries is an alternative. Because few have the asset size or necessary acumen to do this, an exchange-traded fund (NYSE: TBT) is available.

We also suggest looking outside the U.S. to corporate and sovereign debt issued in emerging markets, where economic growth is projected to be greater than domestically. A more difficult area, rife with political and currency considerations, it requires expertise most individuals do not have. PIMCO, as well as other funds (mutual, open-ended or ETFs) are preferred to trying to do it on your own.

Stocks
The sale is over, at least in terms of the markdown levels we referred to earlier this year when we wrote that the stock market is about the only place that individuals refuse to shop when prices are drastically reduced. At today’s level, the market is in a fair value range. The average price per earnings multiple for the market as measured by the Standard & Poor’s 500 is 15.
Consensus estimates for that index’s earnings are in the neighborhood of $85. Applying the average multiple of 15x to that number produces a target of 1,275, a level that is about 70 points above current value.

We are not implying that the 1,275 number is a top, but it is merely consistent with an average level at which the market has traded historically. This is not a finite exercise, as markets have traded in the 20x area at extreme highs and at 7x to 8x at extreme lows. Look at the 1,275 level as a point at which you evaluate your holdings on the basis of the historic multiples at which they have traded. Don’t be afraid to eliminate or scale back those issues that are higher than their historic P/E range. And don’t let a distaste of taxes on gains cloud your judgment.

We are heavily invested in the dividend-paying, dividend-growing issues written about during the past year. As we have stated before, we like to own investments that pay us to own them.

Commodities – especially gold
Whether soft or hard commodities, i.e. grains versus metals or petroleum, the value of the dollar coupled with demand and speculation dictates prices. Should the dollar continue its move downward, that will raise the cost of the commodities. That may be offset by the price increase lowering demand. If the dollar strengthens against the euro, yen, pound, etc., then commodity prices will decline.

Then there is gold. The commodity is priced in dollars and has a limited industrial or jewelry demand, but an incredible fear factor, resulting in as much a psychological factor as fundamental ones. If investors or speculators sense that the dollar is going to strengthen and move considerably higher against foreign currencies, it could fall very far very fast. This one is a tricky area, loaded with the risk of a rapidly changing psychology – one of the reasons we are not acquiring it in our portfolios.

Clark Davis is a 37-year investment veteran and CEO of St. Louis Investment Advisors, a specialized money-management company. He can be reached at cdavis@slia.com.[[In-content Ad]]

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