Is Extreme Market Volatility Here To Stay With Jeff Small And Hoste Langeraar

What Does This Mean To Buy And Hold Investors

David Scranton: And yes, after a long stretch of smooth sailing the seas have indeed gotten rough again on Wall Street. In fact, the week of February fifth saw the Dow suffered two single day thousand-point drops and the markets thereby officially entering correction territory. We’ve seen a partial rebound since then, but many analysts believe extreme volatility is here to stay. So, the question becomes, what exactly does that mean for committed buy and hold investors, and what might it mean for fixed income investors who’ve already got off the stormy seas? It’s time once again to tune out the hype and focus on the facts that matter to you, the Income Generation.

David Scranton: Hello everyone and welcome to the Income Generation. I am David Scranton your host. Yes, the recent weeks early February has come as kind of sort of a wakeup call for a lot of so-called stock market experts, the Dow and the S&P 500 both set records for rapid decline. By Friday the market overall ended up down by ten percent a big enough drop to officially be classified as a market correction, but the story within that story was about volatility which many experts believe is here to stay, but the question is why? And is volatility always a bad thing or can it trigger opportunities across all the financial markets? We’ll talk about all of that and much, much, more with today’s guests. But first, let’s take a closer look at what’s making all the waves on Wall Street right now. You know we mentioned that the Dow started the week of February fifth with steepest point decline on record. Then ended the week having traveled more than twenty-two hundred points over five sessions. At the same time, the S&P saw its biggest ten-day decline ever from a record high. Now as you might recall my market forecast showed just a few weeks ago I said that I believe the markets would have another double-digit year this year, but I didn’t know whether they’re going to be on the upside or the downside. Yes, I know the year is early and we still have ten months to go we’ve already had a six percent climb in January followed by a double-digit drop in February.

Wherever we end up it’s already shaping up to be a very, very, bumpy year. In fact last week the VIX, the volatility index which measures market volatility, spiked to over fifty. That was its highest level in nearly two and a half years and all this came as a shock to many investors as analysts because big drops in volatility have been so infrequent over the last year, year and a half or so. In fact, the VIX reached an all-time closing low on November third and was still in the single digits in early January. Low volatility has paved the way for all those record market highs that we saw in 2017 you know the Dow closed at seventy-one all-time highs last year surpassing its previous record of sixty-nine achieved in 1995. So, what all changed, and is extreme volatility really the new norm for the stock market going forward as some experts are saying? Well, we discussed some of the reasons for the initial plunge on last week’s show fear over the possible effects of rising long-term and short-term interest rates, especially with the new Fed Reserve chairman now in charge. That fear had been building for quite a while now it was enhanced by a new Department of Labor report this report showed that wages are increasing at their fastest pace in eight years. More jobs and higher wages yes, they’re a good thing of course but they also carry a potential threat of inflation increased inflation is indeed one of the benchmarks that the Fed is watching to determine when it’s going to make its next short-term interest rate hikes. Together rising interest rates and rising inflation could stall economic growth in Wall Street desperately needs that growth, because as I pointed out before investors have already priced it into the market.

Yes, it’s true that we’re seeing some corporate growth at this point. In fact, corporate earnings for the fourth quarter of last year were better than we’ve seen in a long, long, time but if you think about it over 8% of best in peak or peroration it’s have reported in the fourth quarter by February ninth that is seventy-four percent of them had beaten bottom line fourth quarter estimates earnings overall top analyst expectations by an average of 4.8%. Yet, even as all these positive reports are coming in the markets were tanking and volatility was spiking. the reason I believe is because stock prices are indication of what investors are willing to pay for the future value of the markets and for future earnings growth not present and certainly not past. last year’s rally was anticipation of the kind of growth that we’re only beginning to see now.

But the reality is we need to see a lot more of it before the stock market makes fundamental sense again. The stock market must grow into the prices that we saw as of the end of last year and beginning of this year so if something should occur to slow that down or to sabotage it altogether, then the only way for the markets to make fundamental sense again is to have a significant pullback. And that, is why the markets are suddenly showing all this volatility and yes may continue to do so. Investors understand that a factor like inflation and rising interest rates undermine continued G.D.P. growth before the Republican tax cuts have a chance to really kick-in. Well then, the Wall Street Party could end but there are other factors that could kill the party also; the delicate socio-political situations all-round the globe and in fact right here at home. No matter what you think about the Russian investigation or President Trump’s handling of North Korea or Israel or NAFTA for that matter there is no denying that they are all potentially issues that could evolve into something big something that could, at least if it’s not big could still spook investors on Wall Street. We’ll talk a bit more about some of that later our show with today’s guests.

A more pressing issue though, that may help keep the market see stormy for a while, is Donald Trump’s new proposed $4 trillion budget, which some experts say could sharply increase the federal deficit. Supporters of President Trump’s economic policies have downplayed these fears because they say that corporate growth triggered by the tax cuts will offset any potential debt increase. Now that may prove to be true but in the meantime the budget has plenty of critics and a long drawn out budget battle with ongoing threats of more government shutdowns is not likely to help lessen the volatility in the financial markets in fact quite the opposite. Ironically the kind of volatility we’re seeing now in I believe we possibly could continue to see throughout the year is more normal than what we experienced throughout all of last year. That was growth based purely on what we call irrational exuberance, and almost entirely separate from reality. It’s reassuring in many ways to see the markets that they’re at least starting to acknowledge reality again and it could even be an upside to it for certain types of investors. We’ll talk about that a lot later in our show and especially with our guests today. But there’s also a big potential downside if the volatility worsens and segues into something more sustained. Stock market history tells us that it’s not only possible but it’s likely considering what the markets have done since the turn of the century. I’ll talk about that a lot more on the show as well and with that let’s welcome today’s guest Hoste Langeraar. Hoste is an international commodities trader, an investment banker with over thirty years of experience. He’s also the author of the novel entitled “Federal”. It’s a financial thriller about a bond trader finds himself thrown into a maze of political and fiscal deceits surrounding, yeah you might have guessed it, the Federal Reserve System. Hoste, welcome to the show.

Hoste Langeraar: David, thank you very much for having me, I appreciate it.

David Scranton: What are the major takeaways that you’d like to see our viewers be able to get from reading your book?

Hoste Langeraar: I would like them to learn about the Federal Reserve. The main thing is that the public thinks that the Federal Reserve is a government agency and it is not. It’s a private company who we do not know to shareholders, of that cannot be audited that doesn’t pay taxes, nonetheless it runs our money it decides what our interest rates are and decides how much money is in the system it controls the velocity of our money, it controls and want M1, M2 and M3, those are money figures.

David Scranton: Should the money supply, right?

Hoste Langeraar: They control our money supply, they control our financial system and they’re a private company. I believe we are the only country in the world where that’s the case and it’s unbelievable that it was able to happen in 1913 which is, when the Federal Reserve was created.

David Scranton: So, the question that is you know how you feel that really affects their policy maybe in recent years what things have been done differently because of that. Let’s talk about what’s been happening is the Federal Reserve seems to be taking, a more and more active role it seems than ever before you know we hear about them on the news virtually every day.

Hoste Langeraar: They have tried after Greenspan to become more open, to become more transparent but it hasn’t happened. They say they are but they’re not doing it. We don’t know who they’re dealing with, we don’t know who their counterparties are, we do not know how much money is outstanding to foreign entities, nor do we know who those foreign entities are. We have no idea, nor do they want to tell us. They are very much secret in terms of what their balance sheet really is and who the shareholders are. We don’t know who owns the Federal Reserve. We don’t know. We do know that probably 60% is not American.

David Scranton: It sounds like something a situation that’s potentially you know ripe for conspiracy theory.

Hoste Langeraar: Right!

David Scranton: Now I must confess I haven’t had a chance to read your book yet. I am going to read it though. Anything about the Federal Reserve is interesting to me and if you could make it fun by putting in a fictional format that makes it even better. But is that part of it, is a little bit of it the flavor of that there’s a little chance or risk of conspiracy going on behind the scenes?

Hoste Langeraar: Yeah, I mean it’s a novel it’s a fictional it’s a fictional story about what happens to a bond trader which is what I was, going through some fluke or some error in a settlement was able to get hold of twenty-five thousand dollars’ worth of federal reserve stock, did the Act itself allows for that. It is possible, it’s just has never been done, and because he becomes an owner and he is invited into a meeting in Zurich and learns things that is not designed for the public.

David Scranton: And unfortunately, because you weren’t that person you weren’t invited into that meeting you can never know for sure whether those things really happen. It’s like you said, nobody knows so there’s very little transparency

Hoste Langeraar: Very little.

David Scranton: Let’s talk about this. You’re a bond trader and obviously a lot of people who watch your show know that we talk a lot about bonds and bond like instruments. What do you think about how the Fed’s reacted over the last several years? What do you think about all the unprecedented levels of quantitative easing that occurred?

Hoste Langeraar: There is no defense against deflation. There isn’t. Once deflation takes hold it has to run its course. It’s what happened in Japan, thirty-eight thousand nine hundred was the top of their market. In 1989, it went down to eight thousand and they’re still struggling along the bottom because they experienced deflation. The Federal Reserve created a financial system based on inflation and they can manage inflation and it’s a system that we are familiar with the money becomes worthless over time and but if it goes the other way then debt stays the same but as it drops, and this is disaster. So, what they’ve done over the last ten years is to infuse incredible amounts of funds into the economy by keeping rates down.

David Scranton: And the problem that happens of course is every reason economics textbooks which say that when you print money you create inflation but all those textbooks assume one thing they assume that all the printed money in circulation will be used to buy goods and services the stomach economy that is not used for goods and services if instead it saves or used to pay off debt then you’re right you get deflation instead of inflation. We have taken a quick commercial break stay with us we’ll be right back with more from my new friend Hoste.

At the top of the show I use the wave analogy to describe stock market volatility, and you know it’s a very fitting analogy because just like the ocean, the stock market’s waves come in all sizes. They can be small and scary but manageable like the waves the surface right or they can be huge and lethal. The problem is that most stock market analysts as well as advisors focus only on the small waves. Now there are reasons for that which I’ve discussed on the previous shows many, many, times as well as in my books. In short, the system is skewed to a large extent to make optimism a necessary part of the financial industry. It’s not anyone’s fault it’s just how the system works that being the case it only makes sense that most of the financial media and most advisors would focus on the smaller short duration ways why because they want to speak optimistically about the markets more often they’re not going to call attention those giant long-lasting a potentially dangerous waves, but it doesn’t mean that these large waves don’t exist to get a better understanding of these big waves.

Let’s leave the ocean for a moment and let’s head to the mountains back to 1990s. Before the internet many brokers show customers a graph of carefully pick data points called the Mountain chart. Now this chart covered almost seventy years of stock market history from 1926into the mid ninety’s and was meant to show the impressive growth of the stock market over that time and yes it did exactly that but also showed something else. If you bother to take a closer look it showed that during all that growth there were many steep and long-lasting dips affect many flat periods in the middle of the large periods of climb you saw that the long-lasting tips came in on the heels of slightly long-lasting climbs and that together these ups and downs unfolded in a repeating, pattern of approximately thirty-five years. These are what I call stock market by rhythms that are contained within them, are those big waves that few analyst or advisers ever talk about and they go back a lot further than one nine hundred twenty-six even though the mountain chart only goes back to one 1926.

In fact they go back these waves go back to the very beginning of the stock market now our regular viewers know that I’ve talked quite a bit about stock market history on this show in the past and the reason is that the closer you get to retirement the more important it becomes to understand those larger ways as larger cycles get to know where the market stands within these current cycles so here’s a quick refresher course from eight hundred ninety nine and now the stock market has experienced extended periods of ten to fifteen percent growth followed by slightly longer periods of zero net growth. These long-term secular bull and bear market cycles respectively, the long-term growth or bull markets have lasted ten to fifteen years on average while the zero growth secular bear markets have lasted in many cases in most cases more than twenty years. What’s interesting though is within each secular bear market cycle historically speaking, the markets experienced at least three major drops and recoveries within it. that’s why these cycles yield zero net growth for buy and hold investors who ride all those big waves from the top to the bottom each time the major drops end up washing up again.

So, where are we today? Well, the last long-term secular bull market cycle was the longest ever running from 1982 to the year 2000. That was when the markets crashed from 2000 to 2003 and that signaled the start of our current long-term secular bear market cycle. Then the market recovered from 2003 to 2017 in historic form the second major drop occurred starting in 2007, bottoming out in 2009 and again the market then recovered by 2013. But that’s when something happened to interrupt the normal flow of history. I’m talking about of course the Federal Reserve unprecedented overuse of government stimulus known as quantitative easing. Its influence has helped keep the third drop at bay since 2013 and it’s still playing a huge role in influencing the markets as the Fed starts to unwind quantitative easing, by selling back all the bonds that it purchased in previous years. We’ll talk about that a lot more in today’s show.

The bottom line though is that volatility like what we’re experiencing now, and we’ve experienced that volatility off and on ever since the 2000 and every secular bear market before that, is your typical cyclical volatility. You can think of it as the smaller waves within a bigger wave. And here’s why it’s so incredibly important for investors over the age of fifty, Income Generation members, to understand and be aware of these bigger waves even though most advisors want to focus on the smaller ones you know as I pointed out last week. Consider that since the turn of the century buy and hold stock market investors have experienced an average return of a little bit over five percent. Why? Because of those two giant crashing waves those two major stock market corrections the one that started the beginning of the year 2000 when the tech bubble burst and the one that started 2007 with the financial crisis. They washed out all the previous gains and forced investors start building again from square one and you know that process takes time that rebuilding. Remember, it took seven years for the market recover from to its previous peak after the 2000 drop in six years after the 2008- 2009 drop six and seven years just to break even again and start building. Now obviously, if you’re within ten years of retirement that’s not a position that you want to find yourself in financially.

Time just isn’t on your side after a certain age as we all know, so the question becomes could the return to volatility we’re seeing in the markets now be a sign that the third major market drop is on the way? It could be. Smaller waves usher in the bigger way if well no one knows for sure of course but keep in mind that we’re still less than twenty years in the secular bear market cycle and that third major drop still has plenty of time to get here and the odds are that it won’t get here are mathematically very slim. I’ll talk about that a lot more later in the show now it’s time to welcome back Hoste Langeraar. So, we know what the Federal Reserve has done. The Federal Reserve just printed more money trying to get the economy stimulated. They say they got us out of the financial crisis, but it didn’t stimulate to the extent that they wanted and now they’re trying to reverse it all. What effect do you think that’s had on what’s happened over the stock market over the last couple weeks and was happy with interest rates like interest rates on the ten-year Treasury?

Hoste Langeraar: First you must raise rates. I believe the G.D.P. will come out of five plus. If that happens to have to raise rates.

David Scranton: The G.D.P will come out of five plus!

Hoste Langeraar: It’s numbers that I’m hearing.

David Scranton: Wow I mean I I’m a fan of President Trump and most of our viewers are fans of President Trump, but his goal was four percent G.D.P.

Hoste Langeraar: We’ll see, even if it’s four percent or more.

David Scranton: You have more confidence in him that he even does it himself. That’s impressive must be difficult.

Hoste Langeraar: That could be difficult for this man but-but whatever happens they’ll have to raise rates to slow down the economy. they will have to do this. We have already seen the slide over the last couple of weeks. The Dow was down a couple of thousand and it’s on its own. That’s not a significant number percentage wise but that’s what they’re going to have to do the cost of money is going to have to go up.

David Scranton: And it’s interesting because what’s helping push the cost of money go up longer term you know is the fact that you know last year the Federal Reserve, I think we talked about this last week or the week before on the show, last year the government issued over five hundred billion of government bonds they bore over five hundred billion this year they’re talking about bearing almost a trillion. It’s not clear where that includes enough money to replace those rolling off the Fed’s balance sheets but that increases supply. It should raise long-term rates and we’ve finally seen it.

Hoste Langeraar: Right and you know whatever the Fed will do, it’s what people don’t take into consideration if there’s another balance sheet at the Fed is one with which is to reserve currency. So, we have what’s our debt sixteen seventeen trillion something or maybe twenty trillion.

David Scranton: Twenty trillion on the books a book about the part that’s off the books will be funded [cross chatter 22:28- 22:30] right

Hste Langeraar: Correct. So, it’s what’s on the book, but what we don’t count with this is what is a real but what is our real dollar exposure including the reserve currency and it’s over a hundred trillion. Yeah that’s why it is so important that oil stays in dollars, that gold, not only commodities, stays quoted in dollars. I mean the countries that have stopped selling their commodities in dollars was Iraq, and we know what happened there. Yeah, it was Libya. Guess what happened there? So, it’s not a clever idea to do this.

David Scranton:  So, we all know Bitcoin of course is going to be the new reserve currency and save the world. We could talk about that if you like as soon as we come back from our commercial break. Stay with us please. We have a lot more from my new friend Hoste Langeraar. We’ll be right back. If you’re in retirement head over to and download your special report which is specifically for the needs of the Income Generation. I’m David Scranton and you’ve been watching the Income Generation.

Randy Conn: Hello I’m Randy Conn Let’s go ahead and look at some of the stories that move the markets this week Warren Buffett’s investment firm, Berkshire Hathaway bought more shares from the generic drug maker TIVA pharmaceutical industries and more shares of Apple. The company filed its stock holdings from the end of last year it shows that it owns nearly nineteen million shares of TIVA which is worth more than $350 billion last month. The Berkshire said it would work with Amazon and J.P. Morgan to create their own health care company. Meanwhile Amazon could be gearing up to become the go-to source for basic combative supplies such as latex gloves, bandages and sutures. The online marketplace wants to focus on outpatient clinics which includes everything from doctors’ offices to surgery centers. Big hospital systems have been rapidly buying up medical practices as they move into the outpatient care market. And President Trump supports a twenty-five-cent gas raise tax to fund his infrastructure plan a White House official tells Axios that it’s one option he’s considering but everything is on the table to fund his one and a half trillion-dollar proposal. That could result in $350 billion more in tax revenue over the next decade. For more of these stories visit Now let’s get back to the Income Generation with David.

David Scranton: We’re going to have a bear market again and it will be the worse in our lifetime. That’s what a noted market analyst Jim Rogers of Rogers Holdings incorporated told Bloomberg News not too long ago and if he’s right it means the stock market would have to take even a steeper drop than the fifty-four percent correction that occurred from 2007 to 2009. Now that may sound somewhat alarmist, but it can make sense when you understand the history of the stock market in addition to every long-term secular bear market cycle experiencing at least three major drops. It’s also not uncommon for each successive drop to be bigger than the one before it even seen that already within our current cycle and which a second drop was yes indeed steeper than the first and this occurs oftentimes through a process we call waves of capitulation. You see with each successive drop bigger investors start to capitulate and join in the sell off and investor for example might be able to afford to hang on there for one major downturn but might decide that he is a real want to or can’t hang in there for two and a investor who could ride out to decide he can’t afford to afford to endure three. The result obviously is a bigger selloff and a steeper market plunge each time as wealthier investors are selling off a greater dollar amount of investments into each market drop. Of course, neither I nor Jim Rogers nor anyone can say that this is the third major drop in that started now or pinpoint for that matter when it will start but with five to seven years still left in the secular bear market cycle odds are that it will not occur within that time are well I believe slim to none.

Apart of my rationale for believing that the third market drop of this secular bear market cycle is imminent asked to do with the Guinness Book of World Records let me ask how many of you know someone personally who set a world record has a place in that book I certainly don’t and I’m guessing that probably not many of you do either now how many of you know someone who set two world records probably even fewer. How about somebody who set three world records now I’m going to go out on a limb and guess that probably none of you know someone who set three world records. Why? Because the odds of doing that for anyone or anything are extremely minute.

Now please keep that in mind when I talk about this third major market drop which has yet to occur because if in fact it does not occur then our current secular bear market cycle will yes hold three places in the Book of World Records. First it will hold the record for the shortest secular bear cycle ever recorded at just thirteen years this is based of course when the market recovered to its previous peak in 2013 after its second major drop. It would be the first secular bear market cycle to finish without experiencing three or more major drops within it and last it would be the first time in recorded history a secular cycle secular bear market cycle ended before P. E. Ratios had shrunk and back down into the single digits. Average P. E. Ratios right now are still in the high teens or low twenty’s depending upon which method you use to calculate them so could all of this occur could this current long-term bear market cycle make history three times over. Of course, anything’s possible but the question according to history is, is, it probable or is it a real long shot and if it’s the latter then do you want to gamble your life savings on a long shot?

Of course, neither I nor Jim Rogers nor anyone could predict exactly when the next major market drop will start and I’m not going to say I know for sure it’s going to be steeper than the previous drop even though that is a common pattern throughout history let’s face it for it to be bigger than the previous drop, you know the next one would have to hit about 75% drop from the peak we saw at the end of January and that’s pretty extreme but or to get below that ceiling that that glass ceiling that resistance level that existed from 2000 to 2013 this next drop would have to be at least 45% which I do believe is not only very possible but quite, probable; possible and probable and certainly capable of doing plenty of damage for those members of the Income Generation who end up getting caught in the downdraft. Well, let us welcome back one more time my new friend Hoste Langeraar.

Hoste Langeraar: I was just kidding. I don’t want to talk about Bitcoin really. I, Bitcoin kind of bores me but, but, interest rates

David Scranton: So, it’s interesting you know. Why do you think with five interest rates increased by the Federal Reserve on the short-term side? Why do you think it took until really January for the bond market to come out of a coma and for a long-term yield to increase?

Hoste Langeraar: I think what happened with the tax reform is that a lot of people going to not a lot of money more money it is perceived to drive the economy, and the perception is that are going to be richer better off a year from now to now that will stimulate the economy it will stimulate it was to stimulate demand which is basically seventy 75% of G.D.P. and that’s why all of a sudden we see does increase in movement in interest rates we see is increasing in purchase power big companies are bringing money back to the United States well that is very, very, very positive.

David Scranton: So, the stock market throughout all 2017 arguably was running off half-drunk, optimistic, anticipating that the tax reform was going to go through in the bond market they said the bond market smarter than the stock market I think you probably believe that since you are an expatriate.

Hoste Langeraar: Absolutely.

David Scranton: So, finally the bond market wanted to wait there from Missouri they said OK seeing is believing now that it’s through now we’re going to get growth and that’s why rates start to come up. So, the question becomes not where do they level off do they level off? in the low three days and if so then where do they eventually go and what is your best guess?

Hoste Langeraar: I don’t know, I don’t answer for that, but I do know that markets find its extremes.

David Scranton: Come on you’re the expert you have been trade in bonds longer than I have.

Hoste Langeraar: So, the extreme was going to be wherever ultimately the market says it’s enough. We could very well go to high fives high six high sevens. Who knows? It depends on how well the economy takes off, it depends how well the consumer wants to buy new products, how many new houses are being built is just is the housing market for real or not.

David Scranton: But that’s what you’re talking about is the component of long-term interest rates that have to do with forward-looking growth prospects and I get that. However, there’s another part of this demand for Bonds you know we have an aging population of baby boomers, you and I are right there, who have an increasing demand for income-based investments like bonds, you know, does that have the potential to offset this and maybe cap it off at a lower rate?

Hoste Langeraar: I don’t believe it will offset at a lower rate. I don’t believe that. I don’t believe that that is the big part of the economy. It’s a part but it’s not the one that drives the economy. What drives the economy is big multinationals, it is other nations, other governments or other government agencies. They’re the big buyers to the ones that will look at it and say Is it doesn’t make sense on a geopolitical basis to buy to ten year right now and hold it for five, six, seven years, whatever the duration is.

David Scranton: So, if you really want to know how high the rates are going to go and when it’s going to happen we really must look at what various governmental entities are doing. Go back and look at the Chinese government if they’re still have an appetite for bonds that.

Hoste Langeraar:  The Chinese are not going to sell their bonds. They’re not going to sell their bonds. It’s ludicrous to think so. It would be shooting themselves in the foot. Especially now with what’s going to happen where Trump is going to change the way we do business with them.

David Scranton: You know I agree 100%. Listen, we need to leave it there unfortunately, all good things must come to an end. Thank you for being on the show, it’s been wonderful.

Hoste Langeraar: It was an honor. Thank you very much David.

David Scranton: All right, well stay with us we’ll be right back with a lot more. So, what then, if anything, does the return of stock market volatility mean for the bond market? Well we discussed this on last week’s show and the most important, message to keep in mind is that the bond market, by its very nature simply does not experience the same kind of volatility that the stock market does and never fluctuates as dramatically either on the upside or downside. You know rather than an ocean where the challenges are large and small waves you can think of the bond as a calmer body of water where the challenge is the current which is sometimes moving with you and sometimes moving against you. This is primarily because the inverse relationship between bond values and interest rates.

Rising interest rates can be an opposing current for bond investors but with actively manage fixed income portfolio you can drop anchor to keep from losing ground in that situation and through active management you can move forward again when the current shifts and is in our favor once again. I bring this up because as I discussed it at the top of the show one of the main reasons for the return of the volatility in the stock market is the fear of rising interest rates. Interest on the ten-year Treasury yield is climbing from 2.4% at the start of the year to 2.9% currently. That gives the Federal Reserve a bit more wiggle room to hike short-term rates without flattening out the yield curve and that, along with inflation, has Wall Street nervous because of what it might mean for the economy. But the more important question for fixed income investors who have already reduced their market risk is, will long-term rates continue to rise, or will they level off? How long will the opposing current last and will it get stronger?

Theoretically, it should get stronger as the Federal Reserve continues the process of unwinding quantitative easing. We’ve discussed this before that will keep the bond supply high keeping prices low and theoretically driving interest rates even higher. But as I said last week I believe that the ten year Treasury might make it up to maybe three and a quarter at this point and then stop and then maybe even pull back for a while why because going to a very strong resistance level at that point in the main reason I believe this is because Americans in our age group income generation members who’ve been burned twice by the crashing stock market are going to remain committed to less risky less volatile investment strategies. In other words, the demand for bonds is rising and I believe that that demand must at least partially offset the increased supply of bonds thus, holding interest rates at a reasonable level. Now will they eventually get up above three in a quarter? Absolutely but in terms of short-term the next several months I think that’s a strong resistance level that’s likely to hold.

I firmly believe that all the so-called bond vigilantes out there that are predicting the bursting of some so-called bond bubble are just another variety of what I like to call stock market cheerleaders. People who are pro stock market like to talk about how great it is and like to put down the bond market whenever they possibly can. Personally, most of them just don’t know what they’re talking about when it comes to fixed income and now it’s time to welcome our next guest to the show. He is a repeat guest whom I’m sure you’ll recognize. My good friend Jeff Small is the president of Arbor Financial Group in Melbourne, Florida, and he’s also the author of the book entitled: Turning Financial Planning Right Side Up. Thanks for being on the show, Jeff.

Jeff Small: Hey Dave it’s great to see you.

David Scranton: Hey so what’s going on with the stock market volatility, you know we’ve talked about there being another drop and some people have said, one of the advisors that I work with said that he thinks it’s like 2008. He’s ready to short the market. I personally think that a bit like we saw maybe in 1998 where there was a short pullback, but we might have another year of growth in the market before we get the big drop. What are your thoughts.

Jeff Small: Who says we can’t have rising interest rates and rising equities? A lot of the fundamentals are sound. What happened the other day, David, with a ten percent correction in theDow and the 5% drop in the S&P really shake the euphoria out of the market and we were due for a pullback after climbing forty percent since President Trump was elected.

David Scranton: You think that the market got ahead of itself. It got up over its skis, instead of building another 10% anticipation of the tax cuts going through, it built on another twenty/thirty percent so now it’s just kind of getting back to normal, digesting that market growth.

Jeff Small: It really is and don’t forget that in January we were up seven and a half percent. So, the short-term market looks strong and bullishness. It is returning as we can see the markets climbing back from the bottom from last week.

David Scranton: Do you agree with me that this isn’t the big one? Yeah, I know you we’ve talked enough to say that I know you believe that down the road we need to have a pretty significant pullback, but do you think this market’s got more legs?

Jeff Small: I think the market has more legs, but I think as we gap up between three and a quarter and three and a half we run the risk of more both volatility and there will be more volatility even though today, rates were spiking on the ten year and the market was just kind of smiling at it didn’t really care at some point I become a factor again.

David Scranton: But I think that eventually interest rates will affect the market. How high do you see interface going on the ten-year before the end of this year, what’s your best guess as to is a number?

Jeff Small: Well I think we’re looking at three to four rate increases in the next twelve months. They’re going to add a quarter percent per rate increase. So, we will see rates twelve months at least one percent higher from here and the Fed’s goal of course is to raise rates another one percent from there which I think ultimately would be devastating to the economy and the markets.

David Scranton: So now we get back to the commercial break I want to ask you, what you think that’s going to do? How is it going to translate to long-term interest rates? Jeff stay with us. You too, stay with us. We have a lot more from Jeff Small here on the Income Generation. We’ll be right back. Welcome back to Income Generation. It’s time to bring back our guest, Jeff Small author of the book Turning Financial Planning Right Side Up. So, Jeff I know you answer the question before the break on short-term rates, but let’s face it, over the last couple of years short-term rates have gone up a quick one and a quarter percent. Long-term rates haven’t gone up by that much so how do you think those three or four increases throughout the rest of 2018 in the short-term side, how do you think that will translate into increases on a longer-term rate such as the ten-year Treasury?

Jeff Small: Well, the Fed is hoping that the rates between the thirty the ten-year and the two-year gets wider because if we get within an inverted yield curve scenario the last seven times the curve is inverted we’ve had seven for seven recessions.

David Scranton:  this what I love about you just because you just because you’re from the Space Coast nobody could ever accuse you of being a space shot. See, you’re trying not to let me trap you into a number, but Jeff come on play ball with me here.  You heard me. I went out on a limb just a moment ago in front of millions and millions of viewers and I said I think three and a quarter is the highest we’re going to see in the next six months. That’s a strong resistance level, you know, what’s your number, what’s your best guess then short term as to where that will go, maybe by the end of the year?

Jeff Small: I think by the end of the year we’re three and a half.

David Scranton: By the end of the year you going to be up to where?

Jeff Small: Three and a half on the ten-year note.

David Scranton: Yeah okay, so, you and I aren’t too far apart with that. That’s good, but now of course you have the issue as you just said if we only gain another 0.6% on the ten-year but a whole 1% in the short and now you have that fly you incur problem you know the difference right now between the two-year in the thirty year is only 1% and that’s not that much.

Jeff Small: It really isn’t, and investors really need to pay attention to that because if that gap stirs to sure or get closer in nature there’s going to be pullbacks in the market and more volatility and I see pullbacks happening anyway between three and a quarter and three and a half is the ten-year gaps up from three and a quarter.

David Scranton: So, bottom line what can investors expect to earn today? You know the bond vigilantes say well you can only get to three percent in bonds and there to come crashing down when interest rates go up which you know we know is not. Not the way it works the question then becomes, what do you tell investors, if not two-three percent, what can they read easily, get investing in diversified portfolio bonds, and bond-like instruments, investing for income instead of growth?

Jeff Small: Well if you want to stay within the triple B range. I mean, you’re going to be between four/three and a half or one quarter percent. There are good bonds out there to find. If you go one letter below with two B’s in the equation you might be four to have five, five and a quarter, and there’s good companies out there but you’ve got to work with a qualified investment advisor that has access to that marketplace. What the investors really must understand is that interest rates are a cycle and right now they’re going to cycle up, they’re going to peak, probably in twelve to twenty-four months or less, and then they’re going to cycle back down as business starts to calm down right after the trump up.

David Scranton: That’s right. So, you know it’s interesting. I tend to agree with everything you said there is and it’s why you wrote the book: Turning Financial Planning Right Side Up, because you most people think you’d only get two or three percent a bond portfolio and you and I know better. So, Jeff, thanks so much for taking time out of your busy day to be with us.

David Scranton:  I’d like to take this opportunity to thank today’s guests for joining us on another episode of the Income Generation. I’d also like to thank you our new, and yes, especially returning viewers. As the stock market settles into what might be a prolonged, new period of unsettledness and volatility, I hope you keep a few things in mind. First, that what we’re seeing now with the markets focused on real economic developments is really a more normal than what we saw all last year with the markets soared based purely on hope and optimism. Second, that these daily weekly even monthly ups and downs are cyclical market patterns that the small waves contain within the long-term secular market cycles. These longer-term cycles play out over decades. And third, that investors over the age of fifty, members of the Income Generation should understand it and be aware of these long-term secular cycles. If they want to improve their odds of avoiding a major financial loss close to or during retirement. And a fourth, that the odds of our current long-term secular bear market cycle ending without a third or even fourth major market correction is extremely remote and yes, would be considered as three unprecedented world records regarding the stock market. And finally, that you don’t have to endure the dangerous ocean waves to have a successful retirement plan. In fact, there are better and smarter options where the sailing is smoother, safer, and ultimately more pleasant. Thanks for watching. If you’re close to retirement and really want to know how to protect and maximize your money it’s essential let you stay informed, up to date, and right here is where you can do it with us on the Income Generation. I’m David Scranton and thanks again. We’ll see you next week.