The stock market is in a sugar high so expect another sell off

The Thinker by Rodin

Retirement leaves me with a lot of surplus time, time I manage to fill reasonably well with consulting and other activities. But there is still plenty of time for leisure. Instead of watching Netflix, I tend to watch YouTube.

Since the pandemic, recession and the election are in, I watch a lot of videos with these themes. But I’ve been mostly concentrating on watching videos on the stock market. Against all odds it has made a spectacular recovery in just a couple of months. I’ve delved into some of the reasons in previous posts, but it mostly amounts to the Fed not letting the economy fail. It is injecting trillions of dollars into the economy into what are arguably junk bonds to push up stock prices. No major publicly traded company in the USA has become too big to fail, in the Fed’s eyes.

In doing so though the Fed is walking into a trap. It’s the trap that the Japanese government walked into in the 1990s and still hasn’t gotten out of. The basic issue is that by not letting businesses fail, you generate a lot of zombie companies that hang around and provide some benefits like keeping people employed but no real value. Their survival is predicated on an endless supply of cash bailouts, right now indirectly provided through the Fed. In other words, they would have failed without these payments, and arguably should have failed. The Fed is essentially not allowing capitalism to work. This means that trillions of dollars are going toward companies that deserve to die so something that useful and productive that meets our new economy can grow in its place.

There are some companies that are very cash rich where this isn’t a problem: Apple, Google and Walmart to name a few. They are thriving and have the resources to emerge more profitably in our new age, mainly because they offer goods and services for these challenging new times that are likely to persist and thrive. Many of the rest though acted stupidly over the last decade, facilitated by the Fed. The Fed kept interest rates artificially low, making it inexpensive to acquire debt. These companies used cheap debt mostly to back their own stock, which further overvalued these companies. Now the Fed is doing essentially the same thing.

As I noted in my last post, new investors are doing a lot to pump up prices too, doing arguably insane investments like buying stock in bankrupt companies. You know this can’t last. At some point, reality will catch up with stocks again. We got a taste of it on June 11 when the DJIA nose-dived 1800 points. Calm and rising share prices quickly returned when Big Daddy Fed came to the market’s financial rescue again.

Some analysts have noticed a pattern of false market rallies that occurred after similar past financial crises. This has happened in every recession since at least 1992. Stocks drop dramatically, but within a few months there is a rally, only until investors realize they were buying based on hope, not reality. So it’s not hard to see that we’re in for another of these soon. Another correction is going to happen. The Fed can delay it for a while, but it’s coming.

Since like February’s crash I can see this one coming, you might want to do what I am doing: selling when it is high again and husbanding the cash, not necessarily to get by, but to await a time when stocks are fairly valued again. Right now the market is on a sugar high, propped up by the Fed throwing trillions at the market. The market has the unwarranted belief that a vaccine for COVID-19 is nigh, and things will magically go back to normal.

An effective vaccine later this year is possible, but unlikely. There are a few reasons for this. First, typically it takes at least a year to find and field an effective vaccine. It’s generally more like four years. Second, any vaccine for COVID-19 is likely to take longer than one year to develop, because it is more complex than typical new viral diseases. Third, even if one is found, you can’t manufacture 300 million doses instantly; it will take months at best. Fourth, the USA is shooting itself in the foot, by not properly mitigating the spread of the disease. To the surprise of no one paying attention to the issue, it’s spreading in the USA and gaining strength. Moreover, it’s likely to generate a second wave of the disease later this year, which will need to be managed along with the seasonal flu. It’s not hard to infer that we’ll be wearing masks for years. From that inference you can figure out in 2021 and 2022 things will look a lot like they do today. You still probably won’t be taking vacations, going to movies or eating out. Which means the real economy is going to keep sucking.

An unemployment rate of 14.6% that is unlikely to get below ten percent by the end of the year, and with both businesses plus state and local governments running out of money, means that a V-shaped recovery amounts to a Hail Mary, which means it’s unlikely to happen. At some point Wall Street is going to figure out its exuberance is irrational and that predictable bear market is going to return.

Even if the Fed continues its strategy of printing money, eventually investors are going to realize that since assets are valued in dollars, and there are so many new dollars in circulation, that effectively their stocks are overvalued because the dollar is overvalued.

To me, it makes sense to sell while the market is irrationally high again and husband the cash. I’m not suggesting dumping all stocks for bonds or cash, but to change the balance of your portfolio to be much more weighted toward bonds and cash. If you selectively hold onto stocks, hold onto those with big cash balance sheets and who are optimized to thrive in this changed economy.

The 2008 recession was largely due to people buying homes for little or nothing down on adjustable rate mortgages. This house of cards came tumbling down predictably when it was placed under stress. The Fed is shimmying up our new house of cards as best it can, but that doesn’t change the underlying dynamic that our current financial system is yet another house of cards, is fundamentally unstable, and needs reengineering so money can go toward more productive uses.

The Fed’s actions are keeping this from happening. In the long run, this could make us the next Japan as we fruitlessly try to keep companies we think are too big to fail from the failure they so richly deserve.

Note: you way want to watch these two videos, two of the more convincing ones of the ones I’ve watched on YouTube.

The Fed is doing some very alarming stuff

The Thinker by Rodin

Should you care about the Federal Reserve? Sometimes called the Federal Reserve Bank (it’s not a real bank), but generally just “The Fed”, the Fed basically controls our money supply. It does this with virtually no oversight by those who ultimately hold the bag when it makes mistakes: us taxpayers.

I am most alarmed by what the Federal Reserve has been up to lately. It looks both completely sane and completely crazy. To start, the Fed cut interest rates banks can charge to borrow from each other, or the Fed itself, to zero. This happened in 2008 too and it’s their way of stimulating the economy. I noted in an earlier post that this seemed to be the last trick in their toolbox. Since both consumers and companies were already in hoc to the maximum, this wasn’t a viable way to stimulate growth anymore. But it was what they knew how to do, so they did it.

But the Fed has invented some new tricks they haven’t done before. The Fed has basically decided to bail out any business, at least those that are publicly traded. In the last recession, a lot of large businesses were too big to fail. Now it looks like most businesses in the United States that are publicly traded are too big to fail, in the eyes of the Fed.

Most of these businesses got in trouble because of the cheap money the Fed has promulgated since the previous recession. With no rules, businesses borrowed instead of investing and saving. Mostly they used borrowed money to buy back their own stock. When the stock price invariably went up due to supply and demand, its executives (whose pay is largely based on stock prices, which they get at a discount) sell them and profit. In short, the Fed’s policies of making money so cheap in many ways made this new depression so much worse.

During the Great Recession the Fed also bought a lot of corporate stock too, to show faith in the market. It helped stabilize things and turned the market around, although it took a very long time. Now the Fed is buying corporate debt in unlimited quantities. Basically a business tells the Fed gets to say how much their debt is worth as a share of their company, and the Fed will buy it, no questions asked. Essentially the Fed is paying inflated prices for very shaky corporate debt that no one else wants to buy.

In exchange, companies get some ready cash to help them tie things over. Maybe the Fed will recoup its investment and eventually even make a profit for us taxpayers. But this money was created and doled out with essentially no oversight. The Fed is not accountable to anyone. While there are certain things the Fed cannot do, anything not specifically prohibited is in theory legal.

If I were to load up my family’s portfolio with junk bonds, my spouse would likely divorce me. But when the Fed does the same, there’s no spouse to object, and no oversight to worry. You have to hope the Fed knows what it’s doing, and Donald Trump appointed many of them. God help us.

I don’t have much trust in the Fed. These tactics strike me as desperate. Moreover, they are letting the rich reap a huge windfall. Many of them were like me: smart enough to sell at peak market when we knew it wouldn’t last due to COVID-19. They bought more stock at low market, toward the middle of March. And now with the stock market reaching their pre-crash highs again — due to the Fed buying so much stock that supply and demand is inflating their prices artificially again, despite the ruined economy — they are cashing in again. It appears that the Fed is exacerbating income inequality in the name of keeping the economy from collapsing even more. The Fed is becoming a wealth distribution mechanism that seems to favor the rich.

A rational government should not tolerate this. The Fed is basically trying to keep American capitalism, as we have known it, going. It’s just that it looks like American capitalism is in its death throes. A model of capitalism that is inured from the consequences its actions like the environment costs it inflicts on the rest of us deserves to die. If it is to be replaced at all, it should be with a version of capitalism that works in the interests of the people, not against it.

In short, the Fed’s actions strike me overall as desperate and very chancy. It needs oversight and reigning in. Consumer advocates, and not Wall Street insiders should oversee it. It needs to be accountable.

It’s time for a jubilee

The Thinker by Rodin

Seems like our world is going to hell in a corona basket.

I remember at the end of 2019 all my friends were saying they were never so glad to see a year end. 2019 was a miserable year. Now, most of us would prefer to be back to 2019. A recession that looks like it will become a depression and COVID-19, which may kill a million or more of us, seems like the beginning of the Armageddon that so many so-called Christians are looking forward to. Perhaps that’s why many of them were cheering Trump’s suggestion that everything go back to normal on Easter Sunday.

On that last point, I was going to make a blog post just on that, but I can’t possibly restate any better what so many others have already said about Trump’s unbelievable narcissism. Trump wants us to die so he can get reelected. The smart ones though are going to take a pass and will keep sheltering in place and obsessively washing hands and surfaces. I know we are. Evolution is not called “survival of the fittest” for nothing. For those happy to place emotion or devotion to an insane leader over rational behavior, well, you’ll be one of hundreds of thousands of candidates for the 2020 Darwin Awards. Clearly you weren’t reading my blog, but don’t say I didn’t warn you.

So rather than restate what so many others have already said, let me talk about something that isn’t being much talked about: the way our economy works appears to be crumbling. What do I mean by that? I mean the way we have been running an economy where the rich continue to get richer, the poor more desperate and in debt, and our government more dysfunctional is ripe. It’s not only not working, it’s not working badly for us. We are ripe for revolutionary changes. This upcoming depression (which it looks likely to be) should make us anxious for another New Deal.

It won’t look quite the same as the New Deal and hopefully any depression will be short lived. But our economy is loaded to the maximum with debt. Pretty much everyone, except the rich, holds it. That’s individuals and corporations, made possible by low interest rates since the Great Recession. The Federal Reserve’s recovery plan is to cut interest rates to zero or even lower, trying to coax us to take on even more debt. That’s because they don’t have any other tools to use. Trying to grow out of a depression based on taking on more debt that we already couldn’t afford doesn’t sound very sound to me. It feels desperate, as if we are desperately trying to keep the rules of our old sinking economy alive. The so-called $2T recovery bill signed into law today is an attempt to keep this hamster wheel turning.

I don’t think this will work. First, look how long it took us to emerge from the Great Recession. When we did emerge, our growth rate was always anemic. You’d be hard-pressed to find any quarter where our GDP increased by more than three percent annually. Our economy was like an overloaded subcompact running on three cylinders trying to merge onto the Interstate. It took a long time to get up to highway speeds. And while we technically recovered, we never really felt we recovered because we never fundamentally solved the problems that got us into it in the first place. The half-hearted attempts by Democrats in 2009 and 2010 were not nearly enough.

In fact, we went back and made the same stupid mistakes all over again, such as getting rid of much of Dodd-Frank banking regulation that was supposed to prevent it from happening again. The fundamentals of our recovering economy were never sound, but were propped up by low interest rates which had the side effect of causing markets to rise. Companies used cheap credit to buy back their own stocks, inflating their stock prices to surreal levels. The bubble would have burst anyhow; the coronavirus thing just made the hole gaping instead of possibly manageable.

What would really make the economy roar back when this pandemic is contained is a big haircut to a lot of creditors. Because an economy can’t roar back if overleveraged people have no cash to buy stuff. What we really need is a jubilee. This is where we force creditors to wipe their debt slates clean.

Take, for example, student loans. Last I checked, there were about a trillion dollars in outstanding student loans, owed by people the least able to pay them back. Desperate for an education instead of flipping burgers for forty years, they didn’t have much choice but to pay usury interest rates for educations whose costs were vastly inflated. Let’s declare all that debt insolvent. The creditors will scream, but a lot of people will have money to spend again on things that matter like food and housing.

It could be done for lots of debts. Write off, say, 25% of mortgage debt on housing purchased for up to $500,000. Wipe out 50% of credit card debt. If you want to encourage thrift, revert the debt if more is incurred over the next five years.

And tax the rich. They’ve been bleeding the rest of us dry for too long, in the process allowing infrastructure and services to degrade. Institute Elizabeth Warren’s proposed 2% wealth tax. Raise rates just to where there were for rich households during the Reagan Administration. Tax dividends the same as ordinary income, or higher. Make work pay again.

Then do what we all know we need to do: make Medicare available to all. Much household debt and personal bankruptcies are due to medical costs that are out of control. Controlling medical costs frees up all sorts of money for more productive use. Institute living wages for everyone with annual increases that keep pace with inflation. Overturn right to work laws.

This is probably beyond a President Biden. But without it, I suspect a President Biden will discover what President Obama discovered: the system will work in counterproductive ways against the needs of the people instead.

Our election, if it can be held fairly, will likely put Democrats in control of government plus give them the margins needed to make real change happen. The question is whether Democrats have learned their lesson, and can institute the changes we need to make the economy work for everyone again.

If not, election 2022 will look a lot like Election 2010, and the crazy cycle will continue to repeat and move us into second world status.

The wizards of Wall Street are no wizards

The Thinker by Rodin

During our recent cruise, we at least got grainy MSNBC satellite TV. When I watched it, I watched the stock market yo-yo back and forth pretty much every day: the DJIA down a thousand one day, and it would often recover it the next day. The general trend though was down, a lot.

In a way, it was good to be on one of the last cruises because I was mostly insulated from this madness unless I sought it out. (Our cruise turned out fine. No passengers developed COVID-19 symptoms, but berthing in Fort Lauderdale we learned that the half dozen ships in port weren’t going anywhere for a month. I felt sorry for the staff, many of who were likely facing unemployment and a one-way ticket home.)

Today though takes the cake, with the DJIA having its worst day since the crash of 1987, down more than 3000 points in just one day. It all feels so predictable by now. I’m just wondering why the wizards of Wall Street are so late to this party. All the signs were there for those with clear eyes. I’m no Wall Street wizard, but I saw it coming. And I took some steps before the crash to mitigate our risk.

Today’s crash was because Wall Street suddenly discovered that the Federal Reserve had essentially used up all its ammunition, which means in effect that there is no steady hand on our financial system anymore. On Sunday, it dropped the Federal Funds Rate to 0%. Soon predictably it will probably go negative, charging banks to temporarily give them money to insulate them from even graver financial calamity. It probably won’t calm markets.

These same wizards of course were cheering companies that bought back their own stock with borrowed money. It gave the market a sugar rush and made stock prices worth way more than they were actually worth. Now many of these same companies, in debt to the max, are discovering the downside: they don’t have a whole lot of liquidity to ride out an economic downturn. In short, expect a lot of these companies, including some of the biggest of the blue chips, to go into bankruptcy.

The coronavirus is going to cause a recession, if not a depression. The virus though is just the trigger that revealed the larger problem, which has been sinking markets. Margins are gone. Businesses are in hoc up to their eyeballs, as are most consumers. Layoffs have already started and are inevitable. When public gatherings of fifty or more are not allowed, restaurants and many public-facing businesses like theaters close down for the interim. This takes money out of the economy and with predictable results. People living on the margins won’t be able to pay rent, or afford to see a doctor, and there are plenty of them thanks to a gig economy that Wall Street just loved but which added immensely to our overall financial fragility.

Stock market declines show that people are sobering up. Donald Trump of course is making things much, much worse by his lack of leadership and counterproductive strategies. He’s also making it worse for himself by continuing to shake hands with people. Most of his supporters still haven’t figured out what a fraud the guy is and are doing really stupid stuff like licking toilet seats to “prove” coronavirus is a myth. Sadly, it is likely that in a few weeks they need to only go to their local hospital’s morgue to see how wrong they are, if they are not victims themselves.

Children are out of school, day care centers will probably just pass on the virus, so parents predictably will stay home with their kids and fret. For many of them, this will collapse their house of cards. Social distancing should help reduce the number of cases, but it’s likely that there will be far more patients in need of critical care than our hospitals can handle. Our wonderful private health care system will prove unable to handle the coming crush of cases, which will kill lots of people needlessly as well as probably feed a mostly downward economic spiral.

It’s Republican government that will prove bankrupt once again, as it did in 2008, in 1987 and of course during the Great Depression. We never learn. The fall in the stock market proves these stocks were wildly overvalued and did not factor in the risks that are now obviously manifest. Having come off a cruise ship on Saturday and now home, I got to experience it first hand at our local supermarket where the meat counter and frozen food aisles were mostly empty. So far people seem to be soldiering on, but there is the pervasive undercurrent of social disorder. Things could get ugly not just medically, but civilly. We may be seeing the partial collapse of civilized behavior.

So we’re doing what we did before: hunkering down. We can’t count on our medical establishment, so we have to look out for ourselves. We wash our hands regularly. We take calculated risks going to the store. We wipe surfaces. We reflexively do social distancing. We also try to handle things soberly, mindful of the risks but realizing that we’ll likely survive this; it’s not really the big one. Lots of people won’t though, mostly the elderly and infirmed, and we are approaching our elderly years.

We can’t stop all pandemics and likely we could not stop this one either. But it could have been managed much better. Similarly, the collapse on Wall Street was entirely predictable. We just chose not to keep in place the regulations we needed to cushion this fall. And in search of short-term profits we refused to provide sick leave for workers, raise wages, invest in our public health or do the sensible stuff that government is supposed to do. It’s all so pointless and unnecessary.

We can control only what we can control. We can hunker down. Our pensions should provide a steady income in good times and bad. Moving to bonds at peak market insulated our losses. We are fortunate. We will also likely thrive in this challenging time because we didn’t do the stupid stuff. Unlike Wall Street, we acted logically as best we could best on a sober assessment of the world as it actually is. It was smart of us to do it, but it didn’t have to be this way for the rest of us. As a society we chose to ignore the obvious risks right in front of us.

Am I a financial genius?

The Thinker by Rodin

My recent post I’m betting on a recession didn’t get a lot of reads. There was no reason it should because I was just some nobody opining that a recession was imminent who decided to make a six-figure decision to lessen the impact if it happened.

We won’t know officially if we’re in a recession for about six months, but based on four days of major stock market declines and increasing numbers coronavirus cases, it’s looking like it will arrive sooner rather than later. In fact, it may be here already, we just can’t measure it yet.

Anyhow, yes, on February 14, I moved $106,144 in my retirement account from stocks to bonds. Before it was 60% stocks, 40% bonds. After it was 40% stocks, 60% bonds. My timing was just about perfect, as markets crested about a week later.

Mind you that all this didn’t make me any money. I am still invested 40% in stocks and those took a hit. We lost money overall. But if I hadn’t, we would have lost $89,439. Instead we lost $19,249, as of the close of markets today.

Perhaps I could get lucky twice. Just maybe when stock prices reach their nadir, I’ll move back to 60% stocks, 40% bonds and reap the rewards some years later. But who knows? Growth has been mediocre across the world for years. The main reason stocks were going up at all is because of the cheap credit the Federal Reserve made available. This caused a lot of stock buybacks, which due to supply and demand pushed up stock prices to artificial highs. Perhaps we’ll never go back to peak market again.

To answer my question: no, I’m not a financial genius. No one can time the market. What I did was likely very well timed but mostly luck. I shouldn’t count on luck twice in a row.

But I can watch the fundamentals of the overall economy, and periodically make decisions like this based on my analysis. If my assumptions are sound and I buy into categories of stocks, it could work again, this time on the way up.

With markets now officially entering correction territory due principally to coronavirus scares, a recession looks a whole lot more likely. It’s the supply chain disruption caused by the virus, not to mention its impact on the travel industry that is likely to take big hits that should make it official.

I did notice that someone recently read my Riding the recession’s wave post from January 2008, before stocks really tanked that fall. Back then I explained that a recession could be perversely good for those with steady incomes and significant savings. This definitely proved true for us. During a recession, prices come down, including inflated stock prices that can often be snatched at bargain prices, providing you hold onto them until markets recover. When money gets tight, you can get all sorts of deals. Already, home mortgage rates are dropping. That, with some decline in real estate prices, might make it a good time to buy a home.

If you are retired like we are, recessions make you appreciate the value of a pension, if you are fortunate enough to have them. This makes us recession immune. The portion of our income that comes from selling retirement assets though takes a hit while the recession lasts. You just have to hope that when markets recover your portfolio won’t be too severely impacted.

They say not to put all your eggs in one basket. By moving more of our assets to bonds, I can get a predictable rate of return, albeit half or less compared to what stocks have returned recently. To supplement our income, we sell some of these bonds periodically, husbanding the declining value of the stocks in the portfolio for a better day.

Meanwhile, while I hate the suffering a recession brings, I’m glad I bet on a recession. Let’s see if it actually arrives. We won’t know officially for about six months, but if we see the unemployment rate creep up, that will be a sign. Recent high stock prices have been signaling a false economy, but that appears to be changing.

I’m betting on a recession

The Thinker by Rodin

In a recent post, I suggested leading a logical life. It’s logically the logical thing to do.

Of course, it’s hard to say what is logical, as there is a lot of murkiness in the world. To deal with the murkiness, sometime toward my late forties I hired a financial adviser who gave me all sorts of logical advice about how to manage our finances. It was good advice. He must practice his own advice because after he retired I found another financial adviser so the good times could keep coming.

His advice costs me a few thousand bucks a year, but I figure it’s worth it. I likely wouldn’t be as successful financially on my own, as the ins and outs of markets leave me bewildered. Markets really don’t make a whole lot of sense. One sensible piece of advice that investors will hear from reputable advisers is not to time the market. Find a sound financial strategy and stick to it. Ride the ups and downs in the market. Always think long term.

It’s been good advice. As I noted in previous posts, our wealth is a result of investing regularly, but it was greatly assisted by the collapse of markets in the Great Recession. By accident instead of design, I ended up buying lots of funds when they were grossly undervalued and watched them steadily appreciate over the last decade.

Buy low, sell high is great advice too, but you never really know when a stock or a fund is a good value. Currently the cost of buying into the market is quite high, by historical measures. I don’t trade in individual stocks. Like most Americans, I trade in funds: mutual funds and ETFs for the most part, along with various commercial and government bonds. It makes sense: any individual stock can have huge fluctuations. I find safety in market baskets of similar funds instead.

Every year when I think stock prices can’t get higher, I seem to be proven wrong. 2018 turned out to be a no-growth year because of a selloff in December 2018, but 2019 was phenomenal, with funds up more than twenty percent. It’s crazy but looking at our investments, since we retired in 2014 we’ve nearly doubled the value of our portfolio mostly by doing nothing but periodic rebalancing.

Given all this, it would seem foolish to start cashing in our chips. And yet today, that’s exactly what I did. I didn’t do it with our entire portfolio, just with the part I control. Our financial adviser oversees our assets in TD Ameritrade, but I oversee the funds in my Thrift Saving Plan (TSP), the federal government’s 401K system for its employees when I was one of them. Until now I’ve been mirroring in that fund the plan our adviser has been recommending in our TD Ameritrade account: 60% stocks, 40% bonds. Today I issued an order to the TSP to rebalance these funds to 40% stocks and 60% bonds.

Crazy? It might be. While no one can time the market, for a long time I’ve been queasy about being so highly invested in stocks. Our financial adviser said not to worry because my pension means that we can assume more risk, and thus reap greater rewards. And he’s been right. I keep waiting for this house of financial cards to collapse, but it doesn’t seem to be doing that.

While not an active investor, I do watch a fair amount of financial news and look at trends. Certain mega-trends that have me worried. What I keep seeing is that we’re doing the same stupid stuff that led to the Great Recession. It really looks like we have a credit bubble underway. If this bubble pops pretty soon, I’m going to look smart. If it doesn’t, I’ll look kind of silly. But consider these statistics:

  • Corporate debt is now higher than it was before the Great Recession: 46.5% of GDP in 2019
  • Credit card debt is at an all time high of $930B, which is $60B more than at its peak before the Great Recession
  • Auto loan delinquencies are at an all time high too, past the Great Recession rate. Some 7 million Americans are 90-days or more behind on their payments
  • Overall household debt is at a new high of $14.15T, as of the end of 2019
  • Student loan debt is at $1.4T at the end of 2019, and no one realistically expects most of these loans will be fully repaid
  • Wage growth has been mediocre. One percent real wage growth per year is certainly better than no wage growth, but it’s hardly a shot in the arm to the economy, which is probably why debt is up so much. The real cost of living is much higher than this mediocre wage growth which means most Americans are treading water financially. To the extent lower wage workers are doing better, it’s largely due to raising the minimum wage in more progressive states and localities.

The Fed is keeping the economy primed by injecting cheap money into the economy, which is encouraging the record high debt statistics. Because Trump’s tax cuts benefited largely only the rich, who can’t spend much of this new wealth, the Fed has to prime the economy instead.

On the plus side, mortgage default rates are half what they were before the Great Recession, which is probably because it’s still harder to get a mortgage than it was before the Great Recession, when pretty much anyone could get one with no money down.

All of this strikes me as showing that our economy is fragile and built on large amounts of unsustainable cheap credit. Certain sectors of our economy are in recession. Many nations are already in recession. Then there is the fallout from trade wars and now a coronavirus to worry about. Given all these risks and the huge credit bubble, my gut tells me that things are overdue to fall, perhaps spectacularly again. And when they do, the Fed will have few tools to use.

In general, stock prices strike me as crazily overvalued, pumped up by cheap credit and stock buybacks financed by cheap credit. All this cheap credit is encouraging unhealthy levels of debt by all sectors.

Obviously, I could be wrong on all of this, but reallocating about $100K in our portfolio from stocks and toward bonds lets us reap these inflated stock prices before most catch on that these assets are wildly overvalued. Also, when stocks return to more reasonable prices, we could buy them cheap again.

We’ll see what happens but I’m betting I made a smart move today.

A soaring stock market means little

The Thinker by Rodin

Donald Trump is hoping to win reelection based on the soaring stock market.

Good luck with that. A soaring stock market doesn’t hurt, but these days a soaring stock market amounts to more evidence that more income is being redistributed toward the wealthy. Why is that? It’s because you have to be relatively wealthy to own stocks in the first place.

To the extent most of us own stocks, it’s probably through mutual funds we own as part of a 401-K and/or IRA. We do this because these investments are typically tax-advantaged. Unless you choose a Roth IRA, you defer taxes on the gains of these funds until retirement, plus these investments are typically pre-tax dollars, meaning you subtract the cost of buying these funds from your adjusted gross income, which means you pay less tax.

The bottom line, according to a 2016 study by NYU economist Edward N. Wolff is that the richest 10% of households control 84% of the total value of stocks. About half of U.S household own some stocks, generally through retirement funds. The other half doesn’t own any stocks.

When markets rise, wealth rises proportionately toward those who own them. Since about half of households don’t own any stocks, there is no stock appreciation to reap, so the rich simply get richer, increasing income inequality.

Our household is definitely not in the top 10% but we do hold onto a lot of retirement assets, principally in bonds and mutual funds. Markets are up about twenty percent this year, but the rise is not as big as it looks. As you may recall, in December 2018 markets gave up their gains for the year, effectively making 2018 a wash on the stock market. Over two years then stocks have gained about ten percent annually, which is definitely good but by no means amazing. Stock market gains during Trump’s tenure so far do not equal Obama’s. Of course, in Obama’s case there was no way for them to go but up, as stocks were severely underpriced after the Great Recession.

People who don’t own stocks mostly don’t own them because they can’t afford to own them. Their money is going toward more important priorities: keeping a roof over their head and food, most likely. Rental costs generally exceed inflation, and food usually does as well. So they are being stretched more. Lower income people aren’t stupid. If they could afford life’s basic necessities, they probably would be investing in the stock markets. It’s simply not an option for them.

As we learned, investing takes perseverance. If you want to fully reap the market’s gains, you have to keep at it persistently, relentlessly, in good times and bad. As a federal employee, I rarely missed a paycheck. When I did, it was because the government was shut down. I never lost money when the government was shut down. Plus, I earned enough money to allow us to invest.

And that’s pretty much how we built wealth: through steady paychecks and doggedness. As I noted, we profited from the Great Recession. In retrospect, this was the biggest factor between retiring okay and retiring comfortably. We bought a lot of mutual funds when they were priced artificially low and kept them while market values increased. I’ve done the math. Were it not for the Great Recession, I expect that our investment portfolio would now be worth about 25% less than it is.

While many of my friends have and continue to struggle with this economy, today’s economy feels to me like an unearned gift. While hardly in the top 1%, I sometimes feel like we should pay a wealth tax too. A lot of our gains seem unnatural and surreal.

This increase in wealth is having me rethink how I want to use it. It still doesn’t mean I will buy a bigger house, a fancier car or a second home somewhere. It’s not quite that large. But as someone nearly age 63 with hopefully twenty-five more good years ahead of him, it does expand the possibilities.

For example, a year ago we were visiting Ecuador and the Galapagos. It was not a cheap vacation. The two weeks cost us at least $15,000, probably closer to $20,000 when you add in all the airfare and extras. It was amazing and incredible but we probably wouldn’t have done it without all this unexpected extra wealth. And it didn’t impact our bottom line at all. It seemed surreal.

Consequently, we are setting our sites further. We could have afforded two Hawaiian vacations for what we spent in Ecuador and the Galapagos. Now we are thinking: why not sail the South Seas? I hesitate to be away from home for too long, as we have two cats. But when they are gone, why not take a round-the-world cruise? Why not a month long train tour around Australia?

But if I were one of those in the fifty percent of households without any stocks, I’d feel resentful. They might want to visit the Galapagos too, or at least Hawaii, but it’s probably not an option. I would feel, rightly, like my pocket had been picked. That’s because it has. Their productivity has been swept up and placed in my pocket instead, but much more disproportionately into the pockets of the very wealthy who can’t begin to spend all of this new wealth. The difference is that I think I can use it to make the rest of my life much more meaningful. Rest assured a fair amount of it is going to help others too, roughly $400 a month or so.

To change this, we need that political revolution that Bernie Sanders keeps talking about. This comfortable retiree will be voting to bring it about.

The negatives of negative interest rates

The Thinker by Rodin

Donald Trump wants the Federal Reserve to drop interest rates to zero or to even allow them to go negative. It’s pretty obvious why: so he can avoid being at the wheel if a recession inconveniently hits before Election Day. He’s clearly freaking out about the election still more than a year away, as also evidenced by his decision to suspend some tariffs on Chinese goods.

Why should negative interest rates matter to you? It’s not like you can set up a Federal Reserve bank account. The Fed Funds Rate is currently 2.25%. This is the interest rate the Fed requires that one bank charges another bank to park its funds in their bank. It usually parked there only overnight. Any excess reserve a bank has on hand is money they cannot earn interest on. So parking it overnight at another bank allows them to make some money on it.

So what does this mean if the reserve rate is set to 0%? It effectively means there is no reason for a bank to park its excess reserves because it will not earn the bank any money. They might as well lend it. What happens if it’s a negative number, say -1%? Then effectively a bank takes a hit to park its money elsewhere. It would be stupid not to lend it.

A bank could pass its lower profitability from these lower rates onto its depositors. This happens routinely when the Fed Funds Rate changes. We bank at Ally Bank. When the Fed cut its rate by .25%, my savings and money market interest rates were cut by this amount too. Anticipating a rate cut, we at least did one thing smart: we took out a certificate of deposit for one year, which locked in our rate. We’ll earn 2.47% on it after one year, but not before. In general though most people don’t like to tie up their cash like this, so when the Fed Funds Rate drops, they will lose interest income. Better to take that money and risk it on investments is the hope.

Banks could in theory charge depositors’ negative interest rates, i.e. charge them for holding their money. (Considering all the bank fees we pay, some of us in effect already are!) They probably won’t, but accounts that effectively draw little to no interest at least one advantage: safety. Or do they?

Most accounts are fully insured because they don’t pass the threshold of $250,000 per depositor per bank. So yes, if a bank goes under you are likely to get your money back. But since the Glass-Steagall law (passed as a result of the Great Depression) was repealed in 1999, things have loosened. Banks can now invest in speculative investment with depositors’ money. This resulted in the Great Recession when banks loaded up on toxic assets to chase their bottom line. For them, the worst thing that can happen is they declare bankruptcy, which is what happened to so many banks in the Great Recession. The government got to clean up the mess and shoulder any financial losses, i.e. you and me assumed the risk.

Now, as the economy improved and Republicans controlled government again, these financial rules were loosened even further. In 2018, Trump signed into law new regulations that eased oversight on the largest banks, by raising the criteria for what comprises a very large bank. This results in less regulator oversight.

Add in low or negative interest rates though and we add a lot more risk to our financial system. Trump of course is hoping these low rates will incentivize banks to loan money, pumping up the economy. (It might also save him boatloads of money, if he can renegotiate interest rates on his loans.) But by incentivizing banks, we are in effect incentivizing risky loans. In short, we risk another Great Recession, or possibly another Great Depression by doing this.

Some countries are trying negative interest rates to stem deflation or deflation fears. Deflation occurs when money you have today is worth more tomorrow. In that case, there is no incentive to invest the money. Rather, you want to hold onto it, which means it’s not available for others to use. By making savers pay negative interest, it encourages them to loan out the money to stimulate the economy instead.

As a tactic for stopping deflation, maybe it has some merit. It’s working marginally in Japan, which has experienced years of deflation. But the United States is not in a deflationary environment. Hopefully though the Fed is instead trying to prevent deflation from happening in the first place.

Negative interest rates don’t have to lead to financial calamity, at least if they are properly overseen and regulated. But in this country it would be a very nervy thing to do at present. The Fed’s toolset though is very limited and well tried. The Fed’s policy of quantitative easing (imitated by lots of central banks) was one tactic of desperation after the Great Recession when the economy was still a mess even after virtually zero interest rates. Quantitative easing is essentially the Fed buying up investments others don’t want to buy with money the Fed creates out of thin air. They control the money supply, and can create money willy-nilly. That and low interest rates are about all the tools they have left.

A negative interest rate policy looks like the next and more desperate step to keep an economy from sinking into depression. It is basically a tool to use for deflation, which is what happened in the Great Depression. It’s like a fire extinguisher alarm: break glass only in case of emergency.

If investors though figure deflation is going to happen, they have an option: take the money out of the banking system and figuratively put it in the mattress. That way no one can use it but at least it’s safe, unless someone looks in the mattress. It’s more likely though they will move it to currencies and economies that are not deflating.

So hopefully the Fed will take a pass on Trump’s idea. In reality, the problems of our economy are structural and these tactics of the last ten years are basically stopgap measures. The Fed should have been doing more modest increasing of interest rates instead, as our economy, at least if it’s not in a recession, should be able to handle it. Mostly our economy is showing every sign of being over-leveraged and fragile again. If your economy is truly strong, you don’t need to even think about using these tools.

If this house of cards collapses again, it will be felt the way it was last time: soaring unemployment, wiped out savings. A lot of it will be due to risky investments, just like the Great Recession. If you are looking for a true revolution, another Great Recession or Great Depression is a good way to start one.

Here’s why the improved economy means so little

The Thinker by Rodin

The stock market is reaching record highs again, which make us moneyed people woozy. I’m modestly including myself here although I’m not that well moneyed. But I am retired on a nice pension with plenty of assets to draw on should things go south. The Dow Jones Industrial Average passed 27,000 yesterday and closed for the week at 27,322. Not bad for an index that dropped to 6547 on March 6, 2009, a little over ten years ago.

Happy days are here again? It might help to wonder why the market indexes are so high. The most recent surges are almost surely due to the Fed’s strong hinting that it’s going to reduce interest rates soon. Maybe Donald Trump’s bullying is getting to the Fed, but much more likely the Fed has read the tealeaves and suspects a recession is getting started and is trying to prevent one. And it’s enough to calm Wall Street and make them think happy days will keep on coming.

You don’t have to look hard though to find worrying signs: tariffs are slowing trade, commodity prices are dropping, and the percentage of people in the workforce keeps dropping. This is artificially keeping the unemployment statistics low. Consumers are taking on the same levels of record debt they took on before the Great Recession and Republicans have managed to repeal many of the key safeguards put in place to keep it from happening again. Student loans passed the $1T mark, sucking money from these former students’ wallets that they can’t spend on actual goods and services like houses. Perhaps in response, mortgage rates are dropping again, which is actually not a good sign. Banks are trying to entice people to buy houses, so the lower the rates go the harder time they are having finding people who can afford to take out a mortgage.

Still, many of us including me have been expecting calamity and have been wondering why we have been proven wrong. There are a few positive signs. With unemployment low, workers can bargain for higher wages and it’s working, sort of. They are beating the cost of living by .5 to 1% annually. That doesn’t translate into a whole lot of money, but it beats the decades of wage stagnation we’ve been experiencing. This is hardly the end of wage stagnation, but it is at least a hopeful sign.

Donald Trump is wondering why he isn’t getting more traction on the economy. That’s actually his one bright spot, with a slim majority approving of his handling of it, while his overall approval ratings seem mired in the low 40s. 40% of Americans still cannot find $500 to draw from in an emergency. It could be they are all inept at financial management, which is what Republicans would like you to believe.

The real reasons are much simpler. Much of today’s work requires people with fewer valuable skills, which mean they can’t command as much in wages. That’s why they are working two or three jobs to pay the bills. Even this is not enough, which is the real reason they can’t find $500 and are living paycheck to paycheck.

But there’s one other important factor that is often overlooked. Certain things cost a lot more than they used to (housing is a prime example) and there are other things that cost dramatically more than they used to. The most likely reason you will get thrown into poverty is if you need more medical care than you can afford. The Affordable Care Act was a good first step, but it wasn’t nearly affordable enough, despite the subsidies. You still needed enough income to pay for the bronze plans. And since they came with high deductibles, they mostly only bought catastrophic protection. All those deductibles, copayments and coinsurance payments cost a heap of money and all of it needs to be in the form of disposable cash, which for the most part these people don’t have. They still can’t afford to be sick. Of course, a lot of states won’t offer health care under Medicaid to these people, which they probably could afford if it were offered because copays are minimal when they exist at all. Medical price inflation is still insane and there are fewer mechanisms to check it. The magic of the free market has proven largely illusory with health care costs.

It’s no wonder then that surveys show that for most voters it’s not how well the economy is doing that matters, but how well their economy is doing — and it’s not going that great. The good news is that there is work out there for pretty much anyone who wants it. The bad news is that without a lot of high-paying skills, at best you can barely get by on the wages you are earning. Voters have figured out that health insurance really matters, and it’s their number one concern now. Those who had Obamacare realized that at least for a while it cushioned financial shocks. But they also need health care because they can get sick and simply can’t afford to get well. There are people driving hundreds of miles to Canada regularly just to buy insulin at affordable prices.

While it’s true that Donald Trump is widely seen as unlikeable and unpresidential, what voters are really understanding is that government needs to actually govern, and so little of it is happening. A president can be thrown out after four years, which is likely to happen to Trump. But we need a Congress that compromises in the public interest and tackles real problems like immigration reform and the lack of affordable health insurance ten years after Obamacare.

It may be a long wait. The Supreme Court recently decided states were perfectly free to gerrymander based on political party. In short, it’s allowing states to stay in the business of incumbent protection, making it harder and harder for people to actually have a true republican form of government. With our courts now largely in conservative hands, it’s hard to see how this can change.

Which is why Bernie Sanders’ call for a political revolution makes a whole lot of sense. Achieving it without wholesale insurrection though looks incredibly improbable.

Can you profit from a likely coming recession?

The Thinker by Rodin

There are a lot of wags predicting a recession in 2020. There are wonky predictors of recession, like sustained inverted yield curves, which have accurately predicted most recessions in the past. This happens when short-term treasury bonds earn more interest than long-term bonds, which has been the case for a while now. Historically, it’s a great predictor of a recession and gives you about a year of warning.

Much of the world’s investors are already paying for negative yields, basically paying governments to take their money in the form of negative interest bonds. This sounds crazy. They do this as a hedge against currency deflation. During deflation, there is no incentive to spend money because the same dollar will buy more in the future. Fear of deflation often predicts recession too. We saw a little of this in the Great Recession when some money market accounts actually lost money, at least until new rules were created to place the full faith and credit of the U.S. government behind these accounts.

Naturally, Trump is not helping things. By initiating trade wars, principally with China, Mexico and Canada, he is injecting even more uncertainty into the markets, not to mention reducing international trade. Making willy-nilly decisions, like his recent threat to impose new tariffs on Mexico, feeds this pessimistic narrative.

It seems paradoxical that the stock market is rallying. But it’s rallying only because the Federal Reserve is suggesting it will lower interest rates. If it does, it’s only to try on the hopes of stopping a recession from happening, a recession that appears to be likely largely due to Trump’s trade policies. The Fed though doesn’t have a whole lot of flexibility as interest rates were only modestly raised since the last recession, so there’s not much room for them to fall. No wonder that so many investors are scared of the specter of deflation.

It’s been a good stretch of growth – one of the longest ever – ten years pulling out of the Great Recession. Good times never last forever anyhow, but Trump has certainly been pulling the wrong levers. We should be investing in clean technologies because that’s where future growth will come from. We should be improving our infrastructure, which is decaying around us because the economy needs a robust infrastructure to keep humming. We should be promoting higher wages so people have more money to spend, not throwing more money at millionaires and billionaires who can’t spend much of it.

Recession is coming at some point; it’s just a question of when. Most economists think the likelihood of a recession in 2020 is sixty percent. Should you be buckling down for the next recession? Given that personal credit card debt levels are as high as right before the Great Recession, it looks like many of us are not well prepared, a situation made worse by income inequality. Those who could hopefully pared down debt and created an emergency fund. But since 40% of Americans can’t afford an unexpected $400 expense, we can only hope that when the next recession comes it not as severe as the last one. Since many of the factors that got us in trouble last time are back again, largely because Republicans insist on deregulation, that doesn’t seem likely. Most Americans will simply hunker down and pray.

Looking back on my experience from the Great Recession, my takeaway is that it inadvertently made me, if not rich, a lot richer. I was blessed with a steady job that paid well and a 401K I kept contributing toward regularly. I was surprised in 2014 to discover that recovering markets made it not only possible to retire, but to retire comfortably, and I haven’t looked back. Inadvertently, I bought a lot of cheap stocks through my 401K and in just five years this was more than enough time to greatly increase my wealth.

So if you are 10-20 years away from a retirement and in a comfy job that’s unlikely to go away, then perversely you might welcome another recession because you can profit from it the way I did. If you have the nerve (something I don’t have), like a short-seller, you might want to bet against America. By this I mean, count on recession and try to profit from it.

How? If you take the bet that markets are likely at record peaks, then sell. I’m not recommending selling your entire portfolio, but it might make sense to sell a good portion of those stocks, ETFs and mutual funds and park them in U.S. treasuries, which is what a lot of investors are doing. Or you could take them as cash. You can do this with your IRA or 401K without a tax penalty. Then you just have to wait until the inevitable happens. No one can predict how much markets will decline, but if they are down 25% or more, that would be an excellent time to buy some cheap(er) stocks, ETFs and mutual funds. During the Great Recession, there was a huge sale as which discounted Grade A stocks as much as 50% from highs. After all, those who need the money to buy stuff will sell it for any price they can get, which is when bargain hunters like you swoop in. Then, like me, wait for the inevitable appreciation as stocks recover.

Will I take my own advice? Of course not! I’m retired, in my sixties, and although reasonably well off, almost all of our saving are in retirement assets. I could up my percentage of bonds and then later move them back to stocks when the market is at its low. But at my stage of my life, I want to maintain my standard of living, not necessarily gamble on some prospect ten years from now of a much larger net worth which would also be harder to enjoy before I die. Also, I pay a financial adviser to make sure we stay on plan.

But if I were a younger person like I was at the start of the last recession, then I might be taking some joy in the misfortune of others, knowing that when markets recover I would reap substantial rewards.