It May Be Early - Weekly Blog # 898

 

 

 

Mike Lipper’s Monday Morning Musings

 

It May Be Early

 

Editors: Frank Harrison 1997-2018, Hylton Phillips-Page 2018

 

 

 

A Usual Trap

A classic mistake in making future plans is focusing mainly on the present. In search of an investment policy for the next few years or longer, one should look at the causes of the main trends, not the size of the tariffs that have been announced.

 

The key force behind the announcements on tariffs is Donald Trump. His background is one of complex negotiations evolved from materially different views of how he sees the present and the future. I believe The President saw a critical problem of unfair trading terms facing the U.S. and saw a way to change the terms in favor of the country. He saw a way to solve the problem through meaningful discussion with the powers on the other side. The key was getting the right people around the table.

 

The core elements of unfairness are to be found in non-tariff trade barriers (NTB) erected by commercial interests with official or unofficial government support. (A number of examples were listed in last week’s blog, copy available.) While there is no published total of each country’s NTB effects, some experts believe their impact is twice the level of tariffs applied.

 

Mr. Trump’s way of dealing with foreign countries is to make the host nation an ally by using the size of US tariffs as a hammer. This is the reason behind the high announced tariffs, which is where President Trump expects the real bargaining to begin. I expect negotiations with major trading partners to take most of the summer. We may never fully understand the various changes to NTB’s, but a good clue will be changes to US tariffs.

 

Clearly there is another element to the aggregate size of the final US tariffs, the amount of cash expected to be paid to the US Treasury. This needs to be meaningful enough to keep the growth of the annual deficit acceptable to an unknown number of Republican Senators.

 

Most of these should be settled in the fall and early winter, so they do not unduly impact the mid-term elections. The economic background to the elections may be influenced by layoffs and the administration’s attempt to expand the economy. Additionally, further international actions may be the cause of how some state elections turn out.

 

The current crosswinds shown below may also impact the level of markets during this period:

1. After a period of outflows, T. Rowe Price is cutting staff.
2. Freight railroads are growing from China to Iran and Spain, for US continental trains, and other trains from Canada to Mexico.
3. Tariffs may encourage smuggling.
4. The latest weekly American Association of Individual Investors (AAII) sample survey showed a 39% positive and negative 6-month outlook.
5. A study of structural bear markets shows the average breakeven to be about 9 years.
6. The critical operating problems facing the US government is no different than those facing commercial and non-profit activities, a focus on effectiveness, not efficiency.
7. Jaimie Dimon has shared the following thoughts:

• Tariffs will be inflationary
• US reserve currency status rests on military superiority
• Markets are not low
• Lessons can be learned from the turnaround of Detroit and problems created (and elongated) during the 1929 crash
• Dollar weakness helps US multinationals 

As usual, I hope you will share your insights on the various thoughts expressed.

 

 

 

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Mike Lipper's Blog: Misperceptions: Contrarian & Other Viewpoints: Majority vs Minority - Weekly Blog # 897

Mike Lipper's Blog: Expectations: 3rd 20%+ Gain - Stagflation - Weekly Blog # 896

Mike Lipper's Blog: Analyst Calendar: Preparation for 2026 - Weekly Blog # 895

 

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Comfort Concerns - Weekly Blog # 672

 

Mike Lipper’s Monday Morning Musings

Comfort Concerns

Editors: Frank Harrison 1997-2018, Hylton Phillips-Page 2018 –

Good Numbers

This week’s US stock market performance numbers are great: Dow Jones Industrial Average (DJIA) +4.07%, NASDAQ +3.09%, and S&P 500 +2.74%. (Cannot expect to keep up this rate.) Individual investors apparently believe these bullish results can continue for at least six months. The American Association of Individual Investor’s (AAII) weekly sample survey indicates that 49.4% are bullish, up from 40.3% the week before. (Market analysts treat the AAII numbers as a contrarian indicator.)

One of the underlying supports for this bullish attitude is the average per person wealth in the US surpassing its former peak, which occurred just prior to the Coronavirus hitting. This is true, according to the Federal Reserve, even excluding the net worth of the 2100 US billionaires, who produced an average per household net worth of $330,000. (In view of these numbers, one wonders if the various stimulus measures passed, and other discussed, are going to unleash high inflation, with too many dollars chasing too few dollar-earning assets.)

By far the largest portion of the average American’s wealth is invested in financial assets (equity and fixed income), followed by real estate. A sample survey of people expected to receive stimulus checks indicates they plan to put half of it into “the market”. This appears to be particularly true of younger or inexperienced investors.

Late Stages

Often, individual and institutional investors who’ve built up their cash reserves, as many currently have, get sucked back into the market. (There is the story of Sir Isaac Newton, the famous scientist and the Master of the English Mint, who withdrew his personal assets from the market in the early stages of “The South Sea Bubble”, only to be sucked back in during the momentum move at the end, losing all his money.) Investors, recognizing the declining value of their money relative to the sharply rising value of tradable assets, often feel the need to quickly catch up and concentrate their purchases on what is moving up the fastest (momentum). 

Interpreting Fund Flows and Yield Curves

The combination of flows into both conventional mutual funds and exchange traded funds (ETFs) has been positive the past few weeks. This represents a change for mutual funds, particularly equity funds, which for many years have been in net redemptions, despite generally good absolute investment performance due to actuarial and job-related issues. 

Investors reaching retirement age often reduce their perceived risks by reducing their equity exposure. Sometimes, this switch comes earlier than expected due to an earlier than planned retirement or a business difficulties. Exchange traded fund products often attract shorter-term investors, who want to capture market volatility and some tax advantages.

The recent change in the aggregate behavior of fund buyers suggests, similar to The South Sea Bubble, that normally conservative investors feel their reserves are losing value relative to equities. This past week, investors put a net $45 billion into funds, with $29 billion going into money market funds and only $15 billion into equity funds. $1.1 billion went into tax exempt funds and $683 million went into taxable bond funds. I suspect a good bit of the money going into money market funds was transitioned from other investments.

The US Treasury yield curve tracks the difference in yield at various maturities. Interest payments are made to investors for delaying the consumption of their wealth, or for investing in more active and speculative securities. It makes sense that the longer investors delay spending their money, the more they should demand from borrowers,  often the US government. Investors traditionally need to guess how much purchasing power will be lost over the period they lend their money out. When they demand higher interest rates, particularly for extended periods, they are gauging their inflation risk. 

Today, there is a major dichotomy between what the US Government thinks long-term inflation will be, through the Fed and Treasury, and what the commercial world thinks. The US Government thinks it’s under 2%, while the JOC-ECRI Industrial Price Index year over year change is now +59.48%! Even if one discounts the index by 90% due to its volatile composition, this suggests future investors dealing with inflation rates in the region of 5%. This 2-5% spread is enough for some investors to change their asset allocations.

In searching for investments to protect against the markets being flooded with cash and materially higher inflation; it is normal to look for an investment with momentum behind it. In many ways momentum is a catch-up move to compensate for prior slow or down periods. Thus, it is not surprising that 16 of the best performing mutual funds for the week were small-cap funds, with the others tied to rising energy prices or financials expected to be flush with earnings from reserves that are too high. 

Warning!!

Four of the worst performing funds for the week were invested in the China Region. This is disturbing, as China is the single largest contributor to both global growth and world trade. The authoritarian government is actively attempting to address a growing debt expansion. While the debt is on the books of various provinces and non-bank financials, it is both a political and economic problem for the central government due to the exposure of the Chinese people. A slower growing China could be a major concern for the rest of the world.

Conclusion:

Each investor should review the concerns raised in this blog and make their own decision as to how to apply these possibilities to their multiple investment responsibilities. Please don’t ignore these possibilities completely. 

Also, if you would like to discuss, I would be happy to have a Socratic discussion with you. 

Did you miss my blog last week? Click here to read.

https://mikelipper.blogspot.com/2021/03/next-race-winner-weekly-blog-671.html

https://mikelipper.blogspot.com/2021/02/did-something-happen-last-week-weekly.html

https://mikelipper.blogspot.com/2021/02/debt-inflation-and-markets-weekly-blog.html

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Next Race Winner - Weekly Blog # 671

 

Mike Lipper’s Monday Morning Musings

Next Race Winner

Editors: Frank Harrison 1997-2018, Hylton Phillips-Page 2018 –

My best education in picking my next winning investment was not taking the graduate course in Security Analysis as an undergraduate under Professor David Dodd, co-author with Benjamin Graham of the seminal textbook. While the course was very valuable in helping me understand markets, it was not particularly useful in helping me pick future winners, particularly if the future was different than the past.

My single best education in picking winning investments were from the grandstands and paddock at the New York Racetracks. Losing some of your hard earnings on foolish bets did wonders for concentrating the mind. The purpose of this blog is not to discuss handicapping horseraces, but to share an approach for avoiding losses and making betting profits overall.

For purposes of this blog, there are three analytical elements from the track I find useful in picking investments. These elements also help in limiting losses and produce winners over time. (Hopefully, some of my grandchildren and great-grandchildren will learn these approaches as they invest time, money, and emotion in their lives.)

While both security analysis and racetrack handicapping delve into history going back three generations or more, handicapping is more focused on future races or tomorrow’s newspapers than the extrapolation of current trends. One handicapper advantage is the identified conditions of the race are stipulated. How tomorrow’s headlines will impact tomorrow’s investments is unknown. The first analytical task at the track is to compare the conditions, including: distance, weather, track conditions, weight carried on the horse, the jockey, and equipment on the horse. These items, among other things, should be evaluated for all the horse’s recent races and for the upcoming races. (I only wish I had the same level of detail in making marketable invest decisions.) 

In studying the past races of horses, it is worth noting how the horse reacted under past conditions and what the anticipated changes are in upcoming race. Some horses, if they get to the front early on a muddy track, can hold on and win if they are not too tired. Others, that have a lineage or history of regularly coming from behind, particularly on a muddy track, can beat tiring horses. (Some CEOs have no experience being raided or losing a crucial patent case, while others have campaigned successfully in these contests.)

Speaking of the difference in CEOs. Some jockeys use their whip frequently and punish horses not running to their capacity, whereas others ride with a light touch and coax the best out their horses. While one might like one type of jockey over another, the horse owner and future breeder, or the trainer, is probably a better judge. (The Board of Apple fired Steve Jobs who was not doing a good job, but then rehired him after he got more experience at managing a company. They later replaced Jobs, who was ill, with a much different Tim Cook. I have made a lot of money investing in companies that had CEOs I would not want being the trustee of my children or on a desert island, although they did a great job running the company.)

Currently, one of the most useful techniques is to look for horses not moving the fastest in the previous part of the race. Although not winning the previous part of the race, they were passing tiring horses or were accelerating. They did this because it’s the way they run in the early part of a race, or because they didn’t have sufficient racing room. In science & tech, biotech, and entertainment companies, the future is dictated by what is in development, not past financial records.

Applying Track Lessons to Current Investment Policy

For the next generation, the investment world is likely to be dominated by China and the US. In future generations, India, Indonesia, and Nigeria could become fully competitive. Today, a dollar-based score card would have the US far in the lead, probably making it the single biggest component in a long-term investment account. However, China is the fastest moving economy. We may not like the way their jockey rides his horse (Nation), but he has been very effective. He has also recognized the provincial debt problem, which has political implications and needs to be watched. 

There is no reason to doubt China will exceed the US in many ways in the foreseeable future. The actual timing of their taking the lead is a function of the additional weight we are putting in the US saddlebags to slow us down. Thus, any investment should be analyzed with an eye toward what China is doing both at home and globally. Hedging large US investments may require some investment in Chinese enterprises.

A Slowing/Maturing US and Redistribution

On a secular basis, US operating margins have been slipping for some time. We have not noticed it in reported earnings per share due to a combination of issues, camouflaged by increased debt, lower taxes, more foreign earnings, and buy-backs. We have become a mature economy with a small working age population. Furthermore, our school systems are producing people with insufficient real-world education and poor work attitudes.

 

In many ways the current administration is repeating the errors of the 1930s, where the government took a somewhat normal recession caused by excessive leverage and turned it into a depression by attempting to use authoritative top-down social mandates. They terrorized private capital, leading to a slump in capital investment and the formation of new companies. 

As is often the case, one should not pay heed to what professional politicians say, but to the impact of what they do. The “COVID $1.9 Trillion Bill” rammed through the Senate should be relabeled “The 9% COVID Solution to Political Problems Bill”, “The First Redistribution Act”, or “The How to Kill Your Children’s Opportunity Bill”.  

The real intent of the Administration is to increase the deficit in any way it can, requiring taxes to be raised through one large omnibus bill or many separate acts. Their main purpose is to capture private-sector money and use it to fulfill socialist goals. What they forget is that close to half of all employees work for small companies, which large companies depend on to train their future workers. These small companies also produce products and services at lower cost, in part due to their lower compensation and benefits.

The initial capital supporting a small business is the after-tax savings of the entrepreneur. Support also comes from the after-tax savings of family and friends. The more successful small businesses can occasionally tap into private equity and debt funds, which are also funded with after-tax dollars. The pool of after-tax savings comes from the net profits after inflation, and the declining value of the US dollar will curtail the purchasing power of domestic earnings.

Looking to the future of our grandchildren and great grandchildren. They should be prepared to live outside of the US, possibly in Asia, as the reduction of private capital will reduce job opportunities in the US. Sound retirement planning suggests that US investments should be hedged by appropriate investments beyond the control of the US government.

There is Some Hope

Both the current occupant of The White House and his predecessor are doing a brilliant job adding to the base of their rivals. As both leaders pull more away from the center, some will want protection against the extremes. The 2022 congressional elections are an opportunity to accomplish a strong center by electing centrist Senate and House members of both parties. This could prevent The White House from accomplishing its redeployment of capital and other socialist goals. 

It could happen. The current topping of the US stock market and collapsing US Treasury prices, along with the declining value of the US dollar, should be enough of a warning. If not, we could see a copy of the long depression, leading eventually to an economically provoked war.

Questions of the Week:

1. Do you think this kind of problem set is possible?
2. Do you have any plans to include this possibility in your investment planning?

Did you miss my blog last week? Click here to read.

https://mikelipper.blogspot.com/2021/02/did-something-happen-last-week-weekly.html

https://mikelipper.blogspot.com/2021/02/debt-inflation-and-markets-weekly-blog.html

https://mikelipper.blogspot.com/2021/02/mike-lippers-monday-morning-musings.html

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Copyright © 2008 - 2020

A. Michael Lipper, CFA

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Normal or Abnormal Decline Approaching?Weekly Blog # 499

Introduction

Future stock market declines are inevitable unless we modify human behavior. Also, as days follow nights, after the declines there will be future rises. None of these statements are new or profound. The critical questions are, what to do in anticipation and during a decline?

John Vincent messaging through Seeking Alpha, regularly reviews the 13F reports filed by investment management organizations as to their stock holdings. In reviewing a number of independent investment managers with over $1 Billion in their portfolios for the third quarter, I have observed some trends.

First, many managers who have sold recently acquired positions did not report significant profits. Secondly, sales of shares acquired years ago are producing large returns, some on the order of two, three, or four times original cost. Since my investment clients and I are long-term investors, it is the second observation that becomes something of a guide to our management philosophy.

Since few or any managers consistently buy at the bottom (or sell at the top), there will be periods of time that they will likely hold positions at a loss before they eventually sell at a profit. Thus, the critical question is how big a loss is acceptable as a price to earning large profits? A further and more difficult question is, how long does one have to wait to get into a profit condition?

Accurately predicting the future without incorporating a mistake is a fool’s errand. However one can apply both logic and past history as a guide. Stock prices regularly decline for periods of one year or longer, “normally” two to three times over a decade. These corrections may be 10% or more up to so-called “bear markets of 20%+.  Few investors have experienced getting out at or near the top of a “normal” decline and getting back in before prior peaks have been achieved. Thus one is probably better off holding through a cyclical downturn and subsequent recovery.

On the other hand once a generation stock prices decline in the range of 50% or more. We have had bouts of these types of declines in 1973, 1987, and 2007-9. In the last two cases we held through the declines in part because we recognized the potential market risks after the decline had begun. There is a greater risk that the recovery period could be extended. The recovery from the “Great Depression” of the 1930s lasted until the mid 1950s for the average stock and in the case of one of the popular growth stocks, RCA, until the mid 1960s. Thus, there is a real advantage to attempt to sidestep an “abnormal” market decline.

Even if we can determine the odds of a forthcoming decline, particular diligence is required to separate a future “normal” decline when the odds favor holding through the decline and an “abnormal” decline when side stepping would be advantageous. I am considering to attempt the last task. I do this with the hope that my heritage will give me an advantage. The family folklore is that in the late 1920’s my Grandfather persuaded  his clients to pay off their margin loans and go to cash. The family legend is that they did.

Next I am examining the current conditions to separate which of the current trends point to a future “normal” decline and which could be indicating a larger problem. 

Trends that Presage a Decline

No single present trend guarantees a future event and even the aggregate weight of trends do not guarantee a particular result. One of the useful concepts learned at the race track and as an analyst is to assign odds to various factors that could influence the result. Always leave room for “racing luck” or “unknown unknowns” as well as unintended consequences. Nevertheless, reasoned analysis is better than relying exclusively on hope.

Sentiment Overriding Numbers

Utilizing the distinction that S&P* is making between Growth and Value components of the S&P 500, one can see two different stock markets being created. Value stocks are being evaluated on both the basis of their financial statements and the near-term price and volume trends in their business. Using many measures these stocks are being valued within the range of fair value. Their stock price trend is moving up in tandem with an economy that is somewhat errantly expanded. However, the value stocks are moving slowly compared to the growth component.

Led by a little more than a handful of stocks labeled as the FAANG group, Growth stocks are significantly outperforming the aforementioned Value stocks. This is happening globally and particularly in terms of Asian security prices.

One of the reasons that up to the present I felt that the next market decline would be of a “normal” type that we would hold our good stocks through the cycle, is the general lack of enthusiasm for stocks. I have not seen the kinds of enthusiasm I saw in the run up for the Dot Com bubble. Nor did it reach the levels of enthusiasm seen many years earlier in the South Sea Bubble or the Tulip Bulb craze. But the level of enthusiasm for certain stocks and for the market in general is worth watching. Two of the lenses that I look through are the research that Liz Ann Sonders puts out for Charles Schwab & Co.*  and the weekly survey by the American Association of Individual Investors (AAII). This is a very volatile time series. In the latest week only 29.4% of those surveyed are bullish as compared with the prior week when the reading was 45.1%. If, over time, the bullish contingent numbered consistently over 40% and the bearish group is below 30%, I would be nervous short-term, as I view this particular indicator as a contemporaneous measure.

Fixed Income Signals

As has been often pointed out that most of the modern declines in stock prices were preceded by some disruptions in the fixed income markets. We have already seen some price nervousness directed at the High Yield bond  market in spite of no generally expected increase in defaults by the major credit rating agencies. This nervousness has not yet been felt in the intermediate credit market. Barron’s has two bond indices, one labeled Best Grade Bonds which saw its yield rise 5 basis points this last week. The other  measure, for the Intermediate Grade bonds, saw its yield drop by a single basis point. This suggests to me that there is wide scale disenchantment with the credit market this week.

My main worry after the collapse of Lehman Brothers and Bear Stearns is not the price/yield of credit instruments but their availability in a stressed market. Recently I have mentioned that the market for US Treasuries is considered to be the most crowded and is under investigation for price manipulation in the related foreign exchange currency markets. There are some professional press articles raising concerns about liquidity. A liquid market is one where trades can be executed without moving prices. Most high grade markets are extremely liquid almost all the time. The meaning of the last sentence pivots on “almost.” At the final point of their crunch both Bear Stearns and Lehman could not access the repo market to satisfy their desperate need to refinance short-term debt.

I don’t have any independently derived measures of liquidity.  However, I may something of a mirror image of available liquidity looking at major Money Market funds. (Remember when Lehman went down it caused one large Money Market fund to “break the buck” or to be slightly valued below the level of its deposits including interest earnings? They had to suspend redemptions which could have created a “run” on Money Market funds if the government did not step in. Thus, liquidity is very important to Money Market funds.  JP Morgan has four large multi billion dollar funds in the US. These four range in size between $21 Billion and $140 billion. What is perhaps of interest in this matter is that three of the four have between 50% and 64% of their investments maturing in eight days or under. Only their 100% US Treasury Securities Money Market Fund is much more exposed to longer maturities, with only 21% maturing in eight days or less. This difference could be due to a belief that the owners of this fund are less likely to need cash as quickly as the owners of the other funds.

Two of the four funds have more than 50% of their holdings in repurchase agreements, largely with other capital markets providers. (What we do not know is whether JPMorgan is on the other side with the same organizations so their net exposure may well be much less.) The real key to the questions as to the size and nature of short-term liquidity is that it is a matter that is currently being worked on by the major participants - not because they want to for the tiny current interest rates - but because they must to keep the global financial system working.

The Thanksgiving Weekend Visit to the Mall

As many of our long term subscribers to these blogs may know, my wife Ruth and I visit the glitzy Short Hills Mall in New Jersey to frequently do our market/economic research. Due to family commitments, we could not get over to the Mall until Sunday afternoon. The Mall was crowded but not jammed. The high end stores were generally attracting a good crowd, but this was not universally true. While a number of jewelry stores were busy, Tiffany looked sparse as some of the others were almost vacant. Both Verizon and Apple* were doing good to great business, we think. While some couples had a handful of bags, they did not seem to be burdened down. There were a few empty store spaces and ads for sales help were generally lacking. I had the feeling that most merchants were not over-inventoried, as some were in the past. All in all a good but not a great beginning to the shopping season. We don’t yet have a view on the online business and whether shopping habits have shifted.

     

 From an investment viewpoint retail will do okay but won’t be a leader.

*Held personally or in the private financial services fund I manage.

Conclusion

We should be careful with our investing. There are too many moving parts to this puzzle to be dogmatic, but risk levels are probably rising.

__________

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No Guarantees in Fiat Currencies or Retirement

One of our younger relatives told my wife and me years ago that he couldn’t settle down because he had “too many questions in his head.”  Unknowingly he repeated what market sages for years have stated, that the market needs “certainty.”  Thus both the young and the wise are grappling with an unknown and perhaps more correctly, an unknowable future.

To answer our basic concerns, the strongest human marketing powers in business, government, science, and religion have repeatedly provided generally accepted guarantees that answer our concerns. During the current period of global neurotic economic stress, one wonders whether the title of Andy Grove’s book, “Only the Paranoid Survive”  is relevant. I am suggesting that as with all well-marketed messages, guarantees provide necessary comfort, but they may not be complete in each individual case. Given the uncertainties facing the modern world, the backing behind each guaranty needs to be understood.

Briefly this blog will touch on some of the accepted guarantees involved with retirement income and the value of money. As usual at the end of this blog I will suggest investment implications to these views. (Many of the views expressed will be provocative and will hopefully generate feedback.) 

The Promise

The heart or essence of any guaranty is the promise that under specifically-stated events or occurrences a predetermined reaction will automatically be triggered. In effect, the promise is a contract, often ill-defined or in some cases not even written down. As time passes, what is remembered is what someone believes to be the promise, without any review of the contract. In typical wedding vows, the only exit is by death. There is no mention of actions and attitudes that lead to today’s large number of divorces. In Europe and elsewhere, the fear of either the marriage contract or divorce has led to a large portion of the population living together for extended periods of time rather than marrying.

Retirement Income

Rational people for ages have been saving money, in part to meet a future period where they will no longer be sufficiently economically active to provide for their own needs. For centuries hoarders have converted much of their stash of wealth into savings. In turn some or all of their savings have been entrusted to various financial instruments and institutions. Since the 19^th century and that great “humanitarian” Otto van Bismarck, people have increasingly relied on taxing authorities to supply retirement income.  (Bismarck created the first social security system which would pay retirement income starting at age 65. He picked that age because he believed that very few would reach that age.) In a more modern era, recognizing that most employees would not have enough discipline to save for themselves, companies would defer some current compensation to be paid out later in retirement. Unfortunately, these two sources, the government and various employers, represent the bulk of the expected retirement income for those that had a career of working. For the most part these people are not worried now and don’t expect to be worried in the future because they believe that they have been guaranteed these payments.

These guarantees are increasingly being issued by some  entities  that are having their own financial difficulties. Most federal and some state and municipal governments around the world are operating at a deficit. We, the citizens, consciously or involuntarily are consuming more from the government than is being taxed. Almost all now recognize that this deficit production cannot continue forever. The two standard solutions are to cut expenses or raise taxes. Somewhere in between these two difficult choices there is a stop-gap measure of changing the payment schedule assumed by the government.  Delaying debt repayment to foreign borrowers can lead to materially higher borrowing costs in the future. One can see the possibility that the government could materially change the net effective payment of social security payments. After all, it is difficult or almost impossible to sue the US government without its permission. Most beneficiaries may not realize it, but social security payments are already effectively means tested. The amount of the payment which becomes reportable as taxable income is based on the level of other income received. Remember that half of the benefit received came from your employer or you as self-employed. Changing the date of full retirement is another way of changing the shape of the government debt. For some time I have warned all of my young employees that they should view that FICA (social security) taxes withheld from their pay and matched by their employer are tax payments and they will be unlikely to receive any real retirement income from their tax payments.

What is probably a larger problem for some is the so-called Pension Guaranty Corp, a government body that is meant to guaranty some pension payments for corporate pension plans of bankrupt US corporations. With the government proclivity to bailout pre-packaged bankruptcies of companies with large union member work forces, the guarantor will run out of money and will have to raise fees on those declining number of defined benefit plans or get an infusion from the US Treasury through an act of Congress. Both are uncertain.

Other ways to save are through various financial instruments directly or thru financial institutions. These are only as good as their continuing credit conditions.

Bottom line:  the various sources of retirement income are not perfectly secure under all conditions. The prudent saver needs to be aware that the expressed guarantees have some limits.  

The Value of Money

In the US, much of life’s activities are ultimately measured by colored pieces of paper approximately 6 by 2 ½ inches called the dollar. The pretty paper which circulates around the world in various denominations has little face value, but has substantial spending and trading value based on the belief that there is some almost universally accepted value because of a series of ill-defined guarantees.  Thanks to President Nixon,  the US dollar no longer has direct backing of gold or even now a fixed basket of currencies. As long as others will exchange goods and services for these painted pieces of paper, the dollar and other fiat currencies have value. Around the world the dollar trades against other currencies 24/7. In theory the Federal Reserve currency  has the vastly expanded Fed balance sheet as backing. These are supported by various issues of  US Treasuries that are the debt of the US government. What makes this curious to a financial analyst is that we have never seen a published balance sheet for the US government. We can speculate as to the enormous value of the government’s real and intellectual property. Most of us don’t know the size of the debt against these assets, particularly the future contingent debt. Value-oriented investors regularly arbitrage the difference between a quoted price and its intrinsic value. I cannot perform this equation as I lack any sort of precise knowledge as to the value of the dollar other than what is trading for now versus other currencies, including gold. Thus, I do not recognize fiat currencies such as the dollar have a guaranteed conversion price.

The Terrible Link

Both the value of future retirement income and the value of the dollar are linked to the rate of future inflation, which itself has no guaranty. The value of the current dollar, euro, pound, yen, and Renminbi is exclusively based on what they can buy today in the way of goods and services. If one isn’t going to spend currency today, one must be concerned as to its future value. Often its future value will be dependent on the path of relative prices. This is particularly true for the retired when an expenditure is likely to draw down retirement income or capital. As these are unknown or probably unknowable, I seriously question the certainty of both currencies and retirement capital that people are using.

 Investment Strategies in a World of Questionable Guarantees

First is my guaranty. My guaranty is that I won’t guaranty any specific future scenario or strategy that will produce only winners.

Second, in a period of increasing uncertainty, excessive concentration is dangerous. 

Third, as I believe significant inflation is eventually probable, I believe up to a quarter of one’s portfolio should be in an inflation defensive mode to include TIPS and selected foreign treasuries of up to five year maturities issued by  small population/commodity rich governments with small to no deficits.

Fourth, all equities should have a global orientation. These companies should have some of these characteristics: exporters, foreign operations, net royalty recipients and managements that think beyond their local borders.

Fifth, technology developers and users should play dominant roles.

Sixth, put at least 25% of your or your clients’ portfolio into stocks of companies that are more flexible than their large competitors. This puts one into smaller capitalization securities.

Seventh, as only a few mutual funds are constructed exactly along these lines, a portfolio of funds that appropriately counterbalance their portfolios will be needed and selected carefully.

Feedback Sought

Please share with me your thoughts on the guarantees discussed and or how one should construct a portfolio for such uncertain times.

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