Beware of Too Much “Risk Aversion”

08/23/2010 1:00 pm EST


John Bollinger

President and Founder, Bollinger Capital Management

John Bollinger, editor of Capital Growth Letter, says the flight from risk is becoming “the new normal,” and Baby Boomers may be hit hard when the bond market corrects.

Risk aversion seems to be the name of the game these days, as fear does seem to be the meme at present, whether it is fear of leverage, fear of lack of growth, fear of fear.

The risk-aversion trade is being sold by the cognoscenti as part of the “new normal” package. The “new-normal” rap is one of an aging population, deflation, deleveraging, low or no growth—it is, in short, a grim view of the future, the sort of view that suits the bond vigilantes perfectly.

While we do have problems, they do not spell an end to life as we have known it. In fact, the new normal is an entirely logical expectation that one would expect to see at this time as we are well into, and perhaps nearing the end of, a long-term consolidation.

We believe that the stock market entered a sideways consolidation phase in the middle of 1998. The expected length of this consolidation is 16 years, with potentially a lot of slippage either way. We have just finished year 12 and are now three-quarters of the way through the nominal expectation for the consolidation.

The overall sense of gloom is spreading as people now accept the fact of the consolidation and the “new normal” that comes with it. [So,] many now expect the consolidation to last into the foreseeable future. Of course, they are wrong, but they cannot be convinced that they ought to rethink their position.

The nearer we get to the end of the consolidation, the nearer we get to a growth phase that they will deny completely until the new phase becomes so obvious that it can no longer be gainsaid. Even then, some will not capitulate as they are simply stopped clocks.

In short, the “new normal” is exactly what we should expect in this phase of the market cycle, and this meme will likely become stronger before it crashes.

Bond yields continue to plummet as the Federal Reserve seeks to stimulate the economy through low interest rates. This is possibly the greatest case of long-term compression I have ever seen. It will almost certainly end in a massive bear market for bonds, one of the prime beneficiaries of the risk-aversion trade. By the time everybody is out of risky stocks and other risky assets and into “safe” bonds, it’ll be time for another massive shellacking.

The boomers will really be annihilated by the time this cycle gets done with them: First, they get beaten up in stocks; next, they get beaten up in real estate, and finally they get beaten up in bonds. (Interestingly enough, all three disasters are due, at least in part, to low rates used to stimulate the economy.)

The final irony is that having finally been completely crushed, they will ignore salvation—a new bull market in stocks—when it arrives.

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