Go With The Flow

     To every thing there is a season and a time to every purpose unto heaven. These words were written two thousand years ago but they are still relevant today. Just like farmers follow the seasons for planting and harvesting their crops, stocks follow predictable cycles also. Just like the tides in the ocean, money flows from one asset class to another based on the political, monetary, and fiscal climate. For example, right now we are entering a phase where the Federal Reserve is increasing interest rates. What does this mean to the investor? A lot of things! First understand that when rates go up, bond prices go down. Why is this? Imagine you own a bond that pays a coupon of 3% Suddenly new issue bonds of the same quality are paying 4% Who would want your bond that pays less? How do you get rid of it? The buyer of your bond will pay you less than par for your bond, creating a capital loss for you. The lower price that he paid you boosts his yield to the going rate of 4%. Increasing rates creates a toxic climate for bond investors. That is why the stock market is experiencing large inflows of cash. Even though Donald Trump is taking credit for the market's rise, there is more to the story than he is letting on. Stocks can only go so far on political rhetoric. The tidal wave of money flowing into stocks is a natural occurrence. Valuations are near record highs. Money is desperately looking for a home. One thing that works near the end of long bull markets is stocks of small companies. These small and mid cap names can go long periods without much investor interest but now they are red hot. How long can they outperform? The easy answer is until money stops chasing their performance. My experience is that these trends usually last longer than you would think. Once people invest their money into the small and mid cap mutual funds, they tend to hold for too long. This is not an asset class to buy and forget about. At the first sign of trouble, reduce your exposure. When interest rates near a top, safer investments like cd's start to attract the tidal flow of money. My next post will talk about why every portfolio should have some "core" holdings of  large cap stocks.