Bubbles make people feel good at first, since they appear to be making money. The trouble is that you often don’t realize a bubble until it’s too late.
Don’t play chicken with the bond market. It’s only a matter of time before rates go up — which will cause some people to have trouble securing loans, or worse, paying the service on their existing debt. This will cause the bond market to spiral quickly in the other direction.
That might not happen this month or even this year. But it will happen eventually. Do you really need more warning signs than the fact that 10-year Treasuries are at record low yields after America nearly defaulted on its debt last year and suffered a credit downgrade?
Not all bonds will crash, of course. AAA-rated debt from more fiscally secure countries like Canada or Australia will fare better, and of course some corporate bonds will remain bulletproof — though admittedly, their poor yields leave much to be desired. However, some high-yield corporate bonds — commonly referred to as “junk” — could be highly risky. And even sovereign debt could give investors a turn for the worse.
That’s to say nothing of debt that eventually is paid back, but at rates so disappointing it serves investors no better than cash. I mean, a 2% annual return on T-notes? While the current rate of inflation is 2.9%? That’s not even treading water.
Be wary of trusting too much in the bond markets. Traders have favored bonds in the past few years, with many related investments doing quite well. But that could all change very soon.
Small-Cap Momentum Stocks
It’s very simple logic: When conditions are favorable, the small, fast-moving companies on Wall Street post the biggest gains. They have the most to benefit as their operations grow quickly, investors jump in and push them higher and higher.
But when conditions go south? These small-cap momentum stocks are the first to sour.
That momentum already has started to wane. The Russell 2000 Index, which tracks companies with an average market value of $738 million, added 2.3% last month, compared with a 4.1% gain in February for the S&P 500, whose members average $25.9 billion in value. That’s a heck of a disparity.
There are, of course, some small-caps that will continue to swim upstream even in a tough environment. The platitude about it being a “stock-picker’s market” is always true if you happen to pick the handful of stocks that perform best. But by and large, most smaller companies are going to have a very hard time weathering a downturn that saps earnings — especially if they have been bid up to nosebleed valuations on investor optimism.
Take Tempur-Pedic (NYSE:TPX), which is up 50% in the first two months of the year. Sure, earnings and sales are going strong … but you think $1,000 mattresses are going to keep selling like hotcakes if oil hits $150 a barrel and macroeconomic fears keep creeping in?
Or the fad stock Crocs (NASDAQ:CROX), which has staged a comeback with a 33% run year-to-date in 2012? Is this the kind of diversified and innovative small-cap that you want to be holding when the music stops?
Small-caps are powerful growth investments in bull markets, but they can hurt you just as badly on the way down. If you’re uncertain about the market, be wary of high-momentum stock with a small market size right now.
Jeff Reeves is the editor of InvestorPlace.com. Write him at email@example.com, follow him on Twitter via @JeffReevesIP and become a fan of InvestorPlace on Facebook. Jeff Reeves holds a position in Alcoa, but no other publicly traded stocks.