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My Investment Advice “Top 10”

October 12, 2012

With the US stock market making new highs of late (though falling off over this past week) and long-term bull market in bonds apparently not quite over yet, many market pundits are talking about the continuing gains in these investment sectors as if it were “business as usual”. But those who have read my blog know that I have a far less sanguine, long-run economic view than the conventional wisdom which is driving today’s markets. And what I see does not give me much comfort with the standard philosophy of “buy and hold” for US stocks and bonds in the future.

Though my father was an investment counselor on Wall Street and I spent a couple of years early in my career as an investment analyst at a bank, I will readily confess that I am not a “professional’ investment analyst. However, I do spend a lot of my evening and weekend hours following the markets and reading about investments and have always managed my family’s own money.  Several books have most recently influenced my thinking including “This Time Is Different: Eight Centuries of Financial Folly” by Reinhart, Robert Schiller”s “Irrational Exuberance” and most importantly “Aftershock: Protect Yourself and Profit…” by Robert Weidemer et al. which I have referred to in previous posts.  

Nonetheless, the usual cautions apply and I offer NO guarantees that I will be right. While my opinions are shared by some others in the economics and investment fields, this is not the usual advice you will typically receive from investment banks and analysts. However, my advice at least is not biased by incentives to get you to buy stocks and bonds, which of course IS the bias of most investment professionals. Instead, my focus is simply to present the facts and tell you how I am trying to protect my own investments.

As I have outlined in a previous blog, there are several decidedly inconvenient truths which make investing totally different from the past 30 years, but which mainstream investment advisers generally ignore or downplay. To review:

(1) A Huge and Dangerous $16 Trillion US Federal Debt  which is up 50% in just the last four years and continues to grow rapidly. Though a Romney election “might” force more rapid cuts in Federal spending than an Obama second term, the prospects for a significant change in the current status quo of continuing large deficits seems small. The US debt will continue to grow rapidly and US default risk along with it. This problem will become particularly acute once interest rates start to rise significantly. One scary number to ponder: if the average interest rate on all US treasuries hits 5% in 4-5 years, the US government will face almost $1 trillion in interest payments per year which is more than 30% of the current federal budget. And a 5% average might even be optimistic if we hit double-digit inflation as soon as I think is  possible!  

(2) Enormous US money printing (along with Euro, Yen and Yuan printing)  has artificially kept interest rates extremely low. US money supply has already tripled in the last four years and is likely to grow at least another 20% per year under the open-ended QE-3. Eventually, this will lead to high inflation and much higher interest rates and a falling US dollar. To be clear, it is the money printing which is holding the US economy together for now and preventing another recession, and I don’t totally fault Ben Bernanke who is in a difficult position to say the least. But the short run stimulus will turn into longer run poison with much higher inflation and interest rates that are eventually completely out of the Fed’s control.

(3) Historically high levels of US consumer debt will put a damper on long-term retail spending in the US (currently more than 70% of the US economy). Despite some reports to the contrary, absolute consumer debt levels are now higher than ever, which means “deleveraging” and its negative economic consequences have only just begun.

(4) “Bad” US demographics particularly the retiring of the baby boomers over the next 5-10 years means that this highest consuming part of the economy will be reducing its discretionary spending substantially over the next decade and increasingly living off savings. This will put downward pressure on retail sales, as well as stocks and bonds as pension investments are sold off for retirement needs.

And there are other major headwinds such as the Europe economic recession, China’s growth slowdown and the very high level of US state and municipal future unfunded pension liabilities to name just a few.

So in the context of this rather dim economic future, the bottom line is to protect the principal in your retirement savings and hedge against coming inflation and higher interest rates. Hopefully, you can do better than that, but that is the most important goal.  

So for what its worth, here’s my Top 10 advice:

10. Don’t Own Any Long or Intermediate-Term Bonds- We are at the end of an incredible bull market for long and intermediate bonds of all types–treasuries, corporates and municipals. Corporate long-term bond issuance is at near record high levels which should tell you something ( i.e. corporate CFOs realize this is the best time ever to get high prices and lowest interest rates on new issuance) . For reasons that I have outlined, inflation in the US and interest rates will eventually rise very significantly. When this happens, bond values particularly for long-term bonds will fall dramatically. No one can be sure when this will occur but it is a virtual certainty that it WILL happen. Do you really want to own bonds that earn an extra 1 or 2 percent interest a year today, while risking losing 30-50 percent of your investment sometime in the next 2-4 years?

9. Buy Treasury Inflation-Protected Securities (TIPS)— As the name implies, TIPS provide protection against inflation which is likely to heat up in the next few years in the US. This is a good investment for the next 3-5 years as inflation increases and until the point that default risk on all US treasuries starts to increase substantially. US “default” (or what will no doubt be called “debt restructuring”)  is almost inevitable in my estimation once the Chinese and other foreign investors start to sell their US dollar-denominated investments in droves. If you have read my previous posts, you know the numbers simply aren’t going to work even if the next administration is successful in cutting spending immediately and raising new tax revenues thru tax reform.  (Although the inflation and interest rate outcomes and long run economic outcomes will be better than if we do next to nothing which is our current path!!!). So even with TIPS you will need to eventually sell these investments as long-term interest rates start to rise substantially above even inflation rates to reflect the greater and greater default risk.

8. Refinance any mortgages you have TODAY if you haven’t done so recently– Interest rates are never going to get much lower so you want to minimize your monthly payments. Make sure you have a fixed rate mortgage as well as this will protect you from inflation and higher interest rates down the road.

7. Don’t own real estate except for your own home ( but only if you plan to live there awhile). While in the near term we will likely see some price recovery from recent lows,  real estate looks to be problematic once interest rates start increasing significantly. Higher interest rates are always bad for real estate, as is “bad” demographics which includes some baby boomers selling their homes in order to live off the proceeds for retirement.  Further, as the government gets more and more desperate for tax revenue, expect to see mortgage interest deductions become more limited (or even eliminated) for upper and upper-middle income taxpayers which will put further downward pressure on home prices.

6. Avoid International Stocks–Most of the countries in the world are heavily reliant on a healthy long-term economy in the US for their economic success. But as I have noted, the US economy will probably not be healthy over the next 5-10 years at least. Many international stocks (most notably EuroZone countries) have taken a beating even as the US stock market has risen. Don’t be tempted by historically low prices however.

5.  Don’t Own US Stocks or At Least Substantially Reduce Your Exposure– If you have held on to your US stocks in your portfolio up to now, I congratulate you for riding the markets to their near record levels. However, this is a good time to pare your stock holdings if not get out altogether. ( I have pared my stock holdings to only about 5 percent and this is almost all in defensive electric utility stocks. ) I will explain in my next blog  post why US stocks are so risky right now, but suffice to say the combination of weak, long-term economic growth prospects for the US and for the world generally, rising inflation and rising interest rates will be deadly for future US stock valuations. When you consider that the US stock market is up approximately 1400% in 30 years at the same time the US GDP is up 500%, it gives you some sense of how overvalued the market is today.  However, the good news is there is probably still time to get out of stocks before we face a major meltdown in the markets (which probably only comes AFTER we see much higher inflation and higher interest rates) which is at least a couple of years down the road. Eventually, though probably not quite yet, you will want to bet on the markets decline thru the use of LEAPS put options. (Email me if you want to discuss this more). 

4.  Buy Foreign Currency to Hedge Against a Declining US Dollar– In the near term, the dollar will likely remain fairly strong or at least not weaken too much, particularly as concerns about the strength of the Euro continue to grow. However, longer term, as US money printing continues at a rapid pace, the dollar’s value will come under pressure as large foreign holders (most notably China) become concerned about the value of the currency and sell more of their dollars. (China has already exited some from US treasuries in the past couple of years but still is the largest holder).  One way to hedge against a falling US dollar is to buy foreign currencies in countries that are fiscally strong (e.g. have relatively low debt levels, and sound economies). My favorite right now is Canada, which is one of the few countries in the world that is fiscally sound and hasn’t turned on its printing presses.

3. Buy Inverse/Short Treasury Bond Funds– With the eventual rise in interest rates, there is one way to directly profit which is to own exchange traded funds (ETF) whose values increase with rising interest rates/falling treasury prices. These funds are so-called “short” treasury funds meaning they go up in value as the price of treasury bonds fall. Please note that these are riskier investments and it may be some time before they start to really increase in value as the Fed will continue to print money to keep rates down. However, there doesn”t appear to be a lot of downside risk in these funds in the near term and lot of upside in the long-term.  One fund I own now is Pro-Shares Short 20+ Year Treasuries an ETF found under the symbol TBF.

2. In the  near to intermediate term, keep a significant amount in Money Market Funds— Remember protecting your principal is paramount, so while you won’t earn anything in the near term, you at least wont lose it when the stock market and bond markets start to fall.

1. Buy Gold—I realize gold has increased over 400% in price over the past decade, and it’s always tough to buy something AFTER it has had good returns. However of late, gold price % increases have been directly correlated with the % increase in the US money supply and we aren’t going to stop printing dollars anytime soon. Further, gold does really well as currencies such as the dollar get devalued, and central banks around the world buy more gold deposits to back their own currencies (often selling dollars to do so) which has happened steadily over the past few years. Further, the price of gold doesn’t just benefit from money printing in the US but also in China, Japan, the UK and in the Euro Zone where similar rapid money printing is continuing. Finally, gold does really well as inflation increases and we will be seeing a lot of that in the near future.  


Hope this helps.



From → Investments

One Comment
  1. William Hildeson permalink

    Don’t disagree. I guess it’s good President Bush’s idea to put Social Security money in the stock market didn’t come to pass.

    Personally I think (hope?) that China will crash first. Not b/c I wish them ill and you’re probably better informed than I. But I figure by the time that happens and the subsequent inflation to the US market, I’ll be old enough or dead and it won’t matter to me. But that of course is short term thinking and has partially resulted in the current mess.

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