As you I discussed last week, we added risk exposure to portfolios with the breakout to new highs that came in conjunction with a short-term “buy signal” as shown below.

However, when we zoom out a bit, a different picture emerges. Note that in all 3-cases, there was a “Stage-1 Advance” followed by a correction which led to a “Stage-2 Advance.” The correction that followed then provided for the final bullish advance which I call the “Charge Of The Light Brigade.”

The “Charge of the Light Brigade” was a charge of British light cavalry led by Lord Cardigan against Russian forces during the Battle of Balaclava in 1854, during the Crimean War. Lord Raglan, the overall commander of the British forces, had intended to send the Light Brigade to prevent the Russians removing captured guns from overrun Turkish positions, a task well-suited to light cavalry. However, due to miscommunication in the chain of command, the Light Brigade was instead sent on a frontal assault against a different artillery battery, one well-prepared with excellent fields of defensive fire.

Although the Light Brigade reached the battery under withering direct fire and scattered some of the gunners, the badly mauled brigade was forced to retreat immediately. Thus, the assault ended with very high British casualties and no decisive gains. War correspondent William Russell, who witnessed the battle, declared:

“Our Light Brigade was annihilated by their own rashness, and by the brutality of a ferocious enemy.”

This current set up is very much like what faced the British Calvary. A market is that overly bullish, overly complacent and overly valued has already had horrible outcomes for those that charged headlong into it.

Simon Maierhofer recently noted much the same in a recent article:

“The blue arrows in the updated chart below show where the S&P 500 is currently within the larger bull market cycle.”

“Regardless of where exactly the market’s at, a correction is getting closer. The initial correction will likely be a wave 4 correction (see labels). Waves 4 are notoriously choppy and frustrating. This choppy correction should be followed by another rally (wave 5) and a more pronounced drop (likely late 2017 or early 2018).

In a nutshell, although the S&P 500 is unlikely to make net progress in the coming year, there will be an opportunity for investors to lock in profits (at higher prices) and avoid a significant draw down.”

I agree with Simon. Whether it is sooner, or later, the current run-up in stocks will end very much the same as they always have with investors “annihilated by their own rashness and the brutality of a ferocious enemy.”

For now, investors race forward with swords drawn, shouting the “bull market passive indexing” battle cry in the face of insurmountable odds solely with a conviction of invincibility.

But such is the nature of every bull market cycle in throughout history.

In the meantime, this is what I am reading.




Research / Interesting Reads

 ““Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria.” – Sir John Templeton

Questions, comments, suggestions – please email me.

Just recently, Bloomberg ran a fascinating article discussing a new study from the McKinsey Institute.

American manufacturing could be poised to rebound as technological disruption shakes up global production chains, but that will offer little relief to displaced factory workers, according to new research by the McKinsey Global Institute.

Now, McKinsey sees conditions changing in a way that could favor U.S. producers: automation is weakening the case for labor arbitrage as wages rise in emerging market economies and developing market residents are coalescing into a new consumer class, among other factors.

While the U.S. could seize on those manufacturing growth opportunities, especially if the government and companies invest to make production more competitive, there are catches. Importantly, production might bounce back without bringing a lot of jobs in tow.

‘Even if we rebuild factories here and you build plants here, they’re just not going to employ thousands of people — that just doesn’t happen,’ said report co-author and McKinsey Global Institute Director James Manyika. ‘Find a factory anywhere in the world built in the last 5 years — not many people work there.’”

McKinsey is absolutely correct. While the President recently started a discussion on “Buy American,” most of the root belief in the efficacy of tax cuts, tax reform, and nationalism is rooted in the history of “Reagan-omics.”

The thing most overlooked by the majority of economists, politicians, and commentators, is the stark difference in the underlying economic and monetary fundamentals which provided the massive tailwind Reagan’s policies that simply don’t exist currently. As my partner, Michael Lebowitz, illustrated previously:

Many investors are suddenly comparing Trump’s economic policy proposals to those of Ronald Reagan. For those that deem that bullish, we remind you that the economic environment and potential growth of 1982 was vastly different than it is today.  Consider the following table:’”


The issue of working harder, and earning less, continues to plague the economic minds driving both monetary and fiscal policy. Since the turn of the century, there has been a steady erosion of the growth rate in compensation as advancements in technology has limited the ability for workers to demand higher wages.

Whether it has been McDonald’s installing kiosks to replace cashiers or manufacturing companies automating assembly line jobs, the decision simply comes down to which is more cost-effective to increase bottom-line profitability. The answer is always – automation. This is shown in the chart below from McKinsey which shows which industries are the most susceptible to automation.

This continuing drive for profitability by reducing the cost of labor through increased productivity also explains the other conundrum of the “hidden unemployment.”

Businesses remain keenly focused on the bottom line, particularly as payroll and benefit costs continue to climb each year, as aggregate end demand drags. However, if businesses can increase productivity without increasing employment those net gains flow directly to the bottom line. This attitude, of course, not only stifles the need for employment but also lowers wage requirements as the available labor pool competes for fewer jobs.

Skills Lacking

Bloomberg ran a second article recently discussing the second problem which is further suppressing wage growth – a lack of requisite skill sets. To wit:

“A growing number of companies are finding it difficult to recruit skilled workers, which threatens to curtail profits and growth, according to a quarterly survey conducted by the Washington-based National Association for Business Economics.

The results of NABE’s July Business Conditions Survey published on Monday showed that 34 percent of respondents have had trouble hiring skilled employees over the last three months, up from 27 percent in January. The Washington-based association polled 101 panelists, who are economists from companies and industry associations.

In response, companies are sponsoring foreign workers, expanding their search and hiring more independent contractors, according to the survey. They’re also boosting automation, stepping up internal training and in some cases improving pay, Jankowski said.

Perhaps at least partially as a result, more than a third of respondents cited labor costs as having the largest negative impact on their profits so far this year.”

In a nutshell, there is the entirety of the problem and the reason why wage growth remains nascent. Mike Shedlock summed up what is going on, stating:

  • It’s not just salaries. Obamacare and benefits are hurting many companies.
  • Cheap money from the Fed keeps zombie companies alive.
  • Cheap money from the Fed induced (and still does) over-expansion fast of food restaurants and retail stores of all sorts.
  • Workers really are not worth benefit costs plus an extra 3% so companies seek to automate.
  • Are McDonald’s workers worth $15? Please be serious.
  • Amazon and online shopping are weakening retail profits.

Increasing productivity, lowering costs and increasing profit margins. In a slow growth economy, this has become the clarion call to corporate CEO’s. This is why, as shown on Tuesday, that while earnings per share have exploded, actual revenue growth remains feeble.

Working more and earning less. That is struggle faced by the average American today as each dollar buys less than it did before. Statistically, the economy may be recovering. However, for the average American it is a far more depressing reality. Capacity utilization still remains far weaker than at the peak of the last economic cycle and employment relative to the total working age population remains mired at lows. These components all feed back into the mental and financial state of the consumer which, in turn, impacts businesses future investment and hiring decisions – or lack thereof.

The real story here is that there is little hope for an already struggling middle class to gain any ground in an economic climate that continues to stack the cards against them.

But who knows, maybe someone will develop an “app” for that.

“What we’re seeing is an increase in the evolutionary pace of IED (improvised explosive device) design. It’s increasing at a pace we previously haven’t seen.”  – Ben Venzke

The traditional benchmark asset allocation is 60/40 – 60% in stocks, 40% in bonds. Such a “balanced” allocation is  considered to be a moderately conservative investment posture as drawdowns in equity prices have typically been partially offset by gains on fixed income holdings. Since the financial crisis of 2008, the appetite for higher returns sparked by historically low yields on many fixed income assets may have changed that asset allocation calculus. What may appear to be nuance to some could cause a gross underestimation of risk if equity prices fall.

To explain, consider a simple proxy 60/40 portfolio. We assign the S&P 500 to represent the 60% equity component. Many investors opt for a split between the Dow, NASDAQ or Russell 2000, but for purposes of this analysis, the S&P 500 will suffice. On the fixed income side there are many types of debt securities in which to invest but for the 40% allocation we allocated 20% to U.S. Treasuries, 10% to investment grade corporates and 10% to high-yield corporate bonds.

The primary drawback of the fixed income allocation in recent years is the low yields delivered by Treasuries (end of June average 1.90%) and investment grade bonds (end of June average 3.20%). Thus, many investors have chosen to boost the income potential of their portfolios by increasing their exposure to high yield bonds (end of June average 6.05%). While done under the guise of safe fixed-income investing, this adjustment introduces a hidden risk which increases the probability of loss.

Data Courtesy: Barclays

The chart above illustrates the cumulative total return profile of 3-7 year Treasuries, the S&P 500 index, aggregate corporate investment-grade index and the aggregate corporate high-yield index since December 1997. It is evident that the returns of high-yield bonds (blue) closely mimic those of the S&P 500 (red) and bare much less resemblance to the other fixed income measures. So instead of the 60/40 portfolio that many investors think they have, the reality is that the allocation described above is more accurately labeled as 70/30 and higher for those with a more aggressive high-yield allocation.

High yield bonds cloaked as a “safe” holding represents a veiled risk especially given that valuation of high yields bonds, like equities, are at extremes. Using data going back to 2000, Option-adjusted-spreads are in the 17th percentile while yield-to-maturities are in the 2nd percentile.  When such extreme valuations on high-yield bonds are combined with an appreciable risk of default and potential recovery values of less than 30%, this allocation more appropriately resembles an equity allocation and should be considered as such.

The high yield bond market has come to resemble an IED in the financial markets for investors with risks that are both disguised and highly destructive. Awareness of these risks is the first step toward defusing them.

This brief article will serve as a springboard for future articles that will provide an in depth look at high yield valuations and offering various trade ideas.  




With the current health care bill yo-yoing between picking up momentum and flaming out altogether there has been a lot of noise about Health Savings Accounts or HSA’s for short. The role or lack of that people use a Health Savings Account as investment vehicles in their financial plans has been highly debatable.

Health Savings Accounts are becoming common place now that employers are shifting toward high deductible health plans. If you don’t have access to one now, those days may be numbered.

With all of the attention HSA’s have been given; there has been an enormous amount of “advice” on how you should use these accounts. Let’s take a look at what your advisor probably isn’t telling you:

Your broker confuses an HSA and FSA.

Everyone is not eligible for a Health Savings Account, to have access to an HSA you must be in a High-Deductible Health Plan. Meaning your out of pocket deductibles must be between $1,300- $6,550 for a single insured and $2,600-$13,100 for a family in 2017.

If your health insurance plan meets those parameters you can contribute to a Health Savings Account. The annual 2017 contribution limit, (employer+employee) is $3,400 for a single insured and $6,750 for a family. If you’re over 55 you’re allowed an additional $1,000 catch up contribution annually.

Most employers who have high deductible health plans are beginning to start HSA’s for their employees. However, if you’re not satisfied with your company’s plan or they don’t offer one you can certainly shop around for your own HSA. Do keep in mind if your company offers a plan and makes contributions to your account it would be wise to use your employer’s plan. A study from the Employee Benefit Research Group found that in 2015 employers who contributed averaged an annual contribution of $948.

When doing your own shopping, remember to check costs, ease of use and investment options available.

Flexible Spending Accounts are offered through an employer-established benefit plan.  Unlike the HSA if you are self-employed, you aren’t eligible for a FSA.  A Flexible Spending Account will allow participants to put up to $2,600 annually in their account. In a FSA, you also have the ability to access funds throughout the year for qualified medical expenses even if you haven’t contributed them to the account yet.

Some Key differences:

HSA’s will allow you to retain all of your funds each year-even if you don’t use them. An FSA may allow for a rollover of up to $500, but only if your company agrees to it and anything over the $500 will go back to the company’s coffers.

The HSA’s ability to contribute and not use each year make this a great new tool workers have to utilize in their financial plans.

The HSA allows employees to retain their funds long after their employment.

When a worker starts Medicare they can no longer contribute to an HSA-the key word here is start Medicare not reach 65. Medicare can be delayed if you’re still covered under an employer plan, but one should be familiar with the system and potential penalties if not done properly.

Once on Medicare you can use your HSA to pay premiums, meet deductibles and cover other qualified medical expenses.

Your broker doesn’t care about the trend in health care costs

As discussed in our last week’s RIA Financial Guardrails, the cost of health care is growing twice as fast as the typical Cost of Living Adjustment in Social Security benefits.

The out of pocket expenses as reported from Healthview services estimates the average 65 year old couple will exceed $400,000 in health care costs and also projects a 5.5% annual increase in health care costs over the next decade.

These are scary numbers if you ask me. Is your advisor using standard income replacement ratios of the past or are they updating their numbers annually or is this even a consideration in your overall financial plan?

Time and time again financial plans use unrealistic return numbers, little or no inflation and health care considerations have been either missed or altogether an after thought.  Ask your advisor what type of assumptions they are using, this should be an easy conversation to have and if it’s a conversation you don’t feel comfortable having with your advisor it may be time to start kicking tires on advisors. Your advisor’s job is to be your advocate and more importantly in financial planning to play devil’s advocate.

Fund your HSA over your 401(k)

Now this one tends to scare the bejesus out of people, but hear me out.  According to an economic release by the Bureau of Labor Statistics the median number of years an employee stays at one job is 4.6 years. Now that number is even smaller (3.2 years) if you’re between the ages of 25-34. The trend that people are spending less time at one employer is probably why we have seen an increase in vesting schedules for employer matching contributions or an all-out stop in employer matches.

The U.S. Bureau of Labor Statistics 2015 National Compensation study shows that of the only 56% of employers who offer a 401k plan, 49% of them don’t even offer a match.  As labor markets tighten hopefully we’ll see employers begin to sweeten the pot on 401(k) plans as they try to retain talented workers.

Now if you’re lucky enough to get that illusive bonus of a match you must think about your company’s vesting schedule.

Companies matching contributions are vested a couple of different ways: immediately, a cliff vesting schedule or graded vesting schedule. An immediate schedule works just like it sounds once your funds are matched in your 401k the employer contribution is 100% vested. I think of that as a unicorn in this day and age, those good companies are few and far between.

A cliff schedule means that once you have worked at an employer for a specified period of time (think years) you will be 100% vested in their contributions. When using a cliff schedule by Federal law the company must transfer their match to you by the end of year 3.

A graded schedule will vest employer contributions gradually.  In many cases we see the magic number of 20% per year, but employers can’t take that any longer the six years before you are fully vested.

Why is this important? With so many people on the move looking for employment opportunities you must be mindful of your expected time with a company to make the most of any match. As people spend less time at one employer one must consider the length of how long you may continue your employment in regards to your vesting schedule. This will certainly play a factor in determining if funding an HSA prior to your 401k makes sense for you.

When funding an HSA you get to utilize a TRIPLE TAX ADVANTAGE: Employee contributions are tax deductible, interest is allowed to grow tax free and you can pull the funds out for qualified medical expenses at no tax! This is extremely powerful and is one reason why there is so much buzz around these accounts.


In a traditional 401k plan your contributions are put in pretax, funds grow tax deferred and THEN your distributions are taxed when you begin to use them.

As health care expenses become a larger part of our spending in retirement it only makes sense to use an HSA to your family’s advantage.

Medicare and Cobra Payments

Unlike most other accounts utilized for retirement or health care you can use your HSA funds for not only your day to day qualified medical expenses, but also your Medicare and Cobra premiums without incurring taxes or a penalty. The ability to use the funds to pay premiums is a great benefit that is often overlooked.

As referenced earlier in our RIA Financial Guardrails. Per Medicare Trustees as reported by Savvy Medicare, a training program for financial planners, Part B and Part D insurance costs have averaged an annual increase of 5.6% and 7.7% respectively, over the last 5 years and are expected to grow by 6.9% and 10.6% over the next five years.

As inflationary pressure has been weighing on Medicare premiums and expectations for increasing costs to continue now may be a great time to start saving in your HSA.

How to invest your HSA properly

This is one of those things that when I open my computer and see article after article on how to invest aggressively in your Health Savings Accounts it makes me want to bang my head against a wall.

Let’s get this straight, an HSA has the ability to be a powerful investment vehicle with the triple tax free benefits when used the right way. However, just like with any good financial plan you need to start by having a cushion of emergency funds. This cushion will look different for everyone, but we would recommend having 3-5 years of deductibles saved in a very low risk allocation to your account before you started dipping your toes in the markets with these funds. Life has a way of slapping you upside the head from time to time, just as markets do. When life takes you for a ride we want you to be ready to access your hard earned funds should you need to use them in a medical emergency without regard for asset prices.

Do you pay top dollar for your houses, real estate or a business venture? Or are you looking for a deal? No one wants to buy anything only to have to turn around and sell it later for a loss.

Valuations are high- Not just a little bit high, but near all time. If we look at Shillers CAPE-10 Valuation Measures & Forward Returns we can see that current valuation levels are above what we have seen at every previous bull market.

I’m not saying we’re headed into our next recession; the momentum of this market could continue to carry on for some time. Like any other investment thoughtful allocations need to be made in late stage market cycles-especially in an account such as an HSA where you may need the funds sooner rather than later.

There is no one size fits all in the use of a Health Savings Account, but if you use these tips as a template and factor your HSA into your financial plan you’ll be well on your way to success in retirement.

You’ve done all the right things.

There was that formal retirement analysis 5-7 years before your anticipated target date, a consistent plan of saving, investing, and portfolio risk management coupled with a tax-smart retirement income distribution and Social Security maximization strategies.

However, mistakes have potential to pop up in the most unusual of places: Spaces that are dark, unexpected and far from finances.

They live in your head.

The genesis of these errors is a complex soup of emotional and cognitive pitfalls; financial plans, as a blend of numbers, a snapshot along the road to goals or financial life benchmarks, can’t decrypt behavioral context. Emotions and money are formed early in life – through observation and experience. Your money script was formed a long time ago.

So what pitfalls should soon-to-be retirees try to avoid?

You battle too late, or get thrown too soon into, a mental lane change that comes with retirement.

If you’re two years or sooner to retirement, it’s time for what I call a “Return-On-Life” assessment.

Are you asking yourself the right questions so it’s an easier transition to the next iteration of you?

How will I feel when I’m not accomplishing tasks, or on deadline in a work environment?”

“How will I remain active?”

“Where can I contribute?”

“How can I learn new things and keep my mind sharp?”

“What steps will I take to pursue my passions?”

“What are the hobbies or interests I’ve put aside and would like to pursue?”

Retirement is as much an emotional as it is a lifestyle and financial adjustment. In some cases, more so.

Those who don’t consciously prepare to redefine life’s purpose and passively wait to see what develops, may discover the adjustment process is arduous.

Consider two years before retirement a new self-discovery phase, the next iteration of growth – Retirement prep work, so to speak. Yes, emotional imbalance is imminent. Shifting to the right lane, visualizing the destination sign, and knowing an exit is drawing closer will help you mentally prepare.

I never discount how challenging it is for new retirees to acclimate to a new schedule or in some cases, no schedule at all.

Due to a rise in interest rates and corporate America in perpetual cost/head-count cut mode, retirement time-line decisions are increasingly compressed – also due to employees with pensions who must decide whether working an additional year or two is worth the loss in lump sum pension payouts.

The closer retirement gets, the nearer the exit sign, the stronger your commitment to go through a return-on-life exercise should become. A successful evolution occurs when new retirees redefine success on their own terms.

Transition steps that I’ve seen initiated successfully: Working part-time to ease into a retirement mindset, giving of time to a favorite charity, family vacations especially with grandkids, a new pet, a house renovation project, courses on photography and cooking, and rigorous physical endeavors like yoga and aerobics.

Ignoring your investment allocation, especially near retirement.

With the current Shiller P/E at 30x and an assorted number of market metrics at a stretching point, (read: Technically Speaking: Valuation Measures & Forward Returns), those who are less than 5 years from retirement are in the “red zone,” or too close to target date and must take action today to reduce risk in their portfolios.

It’s best to ignore market and financial media that are in a fevered frenzy to validate rich valuations. As we’ve always witnessed, this doesn’t end well. It’s a matter of when reversion to the mean occurs. While navigating the right lane, financial surprises need to be minimized. Heavy portfolio losses will throw off your time line and compel you to work longer than originally anticipated.

Complacency at this juncture is dangerous. Generally, a stock allocation that doesn’t exceed 40% should be considered. If greater, a sell discipline must be employed to minimize losses. There’s nothing wrong with an overweight to cash, laddered short-term bonds or certificates of deposit that are staggered in maturities from six months to two years.

Brick & mortar banks are going to be late to the game raising rates on savings vehicles. Consider FDIC-insured online banks right now. For example,, as of July 16, has a special offer of 1.55% APY for a 15-month CD.

There should be a sense of urgency to meet with a financial professional, preferably a fiduciary, who can assist with portfolio rebalancing suggestions.

Supporting adult children and grandchildren during retirement years.

Since the Great Recession, multigenerational households where children and grandchildren are cohabitating under one roof, is now commonplace. Society is also witnessing grandparents taking on parental or childcare responsibilities for younger generations. According to Pew Research, one-in-ten children are living with a grandparent.

Retirees must not be afraid to ask family to contribute to household expenses or utilize an independent third party to hold a family meeting and share difficult news about household financial challenges. In addition, retirees should take their emotions out of financial decisions when it comes to lending money to others when it places their long-term retirement plans in jeopardy.

If saying “no” isn’t an option or an emotional obstacle, then a financial plan requires an update to determine how it impacts long-term plans before a lending decision is made.

You’re too much house, no enough cash.

Many pre-retirees and new retirees I counsel own their primary residences free of mortgage obligations and planned it to where ownership doesn’t endanger their retirement income requirements. Cash flow is the lifeblood of a successful retirement and the liquid assets required to generate it are a priority. Several have downsized and decluttered 3-5 years before retirement to accomplish the task; an effective strategy I highly endorse.

Unfortunately, over the last 17 years it has taken a much larger investment bucket to service income needs compared to the previous stock and bond market bull cycle. So, if paying off a house places liquidity and the ability to generate income in jeopardy, then the harsh reality is you may need to carry mortgage debt or retire later.

More than three-quarters of Americans of retirement age are homeowners; Close to 37% of those over 65 retire with mortgage debt according to the Urban Institute’s Health and Retirement Study. Those with outstanding mortgages tend to work longer and delay receiving Social Security.

As a general financial guardrail, if paying off a home consumes 30% or more of the assets you set aside for retirement, then it may be best to live smaller with a mortgage that doesn’t exceed twice your total retirement income including pensions (if any), and Social Security. Or perhaps, you must navigate away from the right-lane retirement exit and consider it years down the road.

In theory, a paid-off house may sound like security, however it may freeze up liquidity at a time it’s required the most.

If downsizing isn’t an attractive option or you feel you must pay off your mortgage liability, then a Home Equity Conversion Mortgage option should be considered. Don’t worry. Reverse mortgages are not what they used to be. There’s volumes of financial academic research that now support this option as a viable source of retirement income. Read: Frequently Asked Questions about HUD’s Reverse Mortgages.

Even with best of intentions, a retirement journey can be uneven. Such is a life. Ostensibly, retirement plans are rarely perfect.

The key is awareness to recognize when financial decisions are based primarily on emotion or ingrained false senses of security which place an otherwise secure retirement at risk.

As we get into the midst of the Q2 earnings season, we can take a closer look at the results through the 1st quarter of the year. Despite the exuberance from the media over the “number of companies that beat estimates” during the most recent reported period, 12-month operating earnings per share rose from $106.26 per share in Q4 of 2016 to $111.11 which translates into an increase of 4.56%. While operating earnings are widely discussed by analysts and the general media; there are many problems with the way in which these earnings are derived due to one-time charges, inclusion/exclusion of material events, and outright manipulation to “beat earnings.”

Therefore, from a historical valuation perspective, reported earnings are much more relevant in determining market over/undervaluation levels. It is from this perspective the news improved as 12-month reported earnings per share rose from $94.55 in Q4 of 2016 to $100.29, or 6.07% in Q1.

However, despite the improvement in reported earnings for the quarter, the thing that jumped out was the decline in revenues which slumped from $301.12/share in Q4 to $292.78/share in Q1. This was a decline of -2.77% for the quarter.

In other words, while top line SALES fell, bottom line revenue expanded as share buybacks and accounting gimmickry escalated for the quarter.

Earnings Manipulation Reaching Limits

There is no arguing corporate profitability improved in the first quarter as oil prices recovered. The recovery in oil prices specifically helped sectors tied to the commodity such as Energy, Basic Materials, and Industrials. However, such a recovery may be fleeting as the dollar remains persistently strong which continues to weigh on exports and the recovery in oil prices continues to remain muted.

Furthermore, as stated previously, the decline in oil prices during Q2 puts earnings estimates at risk. To wit:

“First, with respect to oil, the bounce in oil following the crash in prices that began in 2014 resulted not only in the bulk of the decline in earnings initially but also the recovery in earnings with the bounce. However, that bounce has now faded but forward earnings expectations have likely not been revised lower. Per FactSet, the energy sector is expected currently to post a 396% gain in earnings on a year-over-year basis. Given the recent fall in oil prices, there is a huge risk of disappointment.”

“The biggest issue facing S&P 500 earnings going forward is the analyst community’s ‘miss’ on oil price estimates for the bulk of 2017, not just the second quarter. According to FactSet’s estimates, analysts are expecting the following average prices per barrel for WTI crude for the yet-to-be-reported final three-quarters of 2017:

  • 2Q17: $51.96
  • 3Q17: $54.29
  • 4Q17: $55.72

With oil prices closer to $45 than $50, this could be a problem as, according to FactSetanalysts made the smallest cuts to Q2 earnings-per-share estimates in three years ahead of the reporting season.”

A secondary risk is in the rise in “profitability” since the recessionary lows which has come from a variety of cost-cutting measures and accounting gimmicks rather than actual increases in top line revenue. As shown in the chart below, there has been a stunning surge in corporate profitability despite a lack of revenue growth. Since 2009, the reported earnings per share of corporations has increased by a total of 265%. This is the sharpest post-recession rise in reported EPS in history. However, that sharp increase in earnings did not come from revenue which is reported at the top line of the income statement. Revenue from sales of goods and services has only increased by a marginal 32% during the same period.

In order for profitability to surge, despite rather weak revenue growth, corporations have resorted to four primary weapons:  wage reduction, productivity increases, labor suppression and stock buybacks. The problem is that each of these tools creates a mirage of corporate profitability which masks the real underlying weakness of the overall economic environment.

One of the primary tools used by businesses to increase profitability has been the accelerated use of stock buybacks. The chart below shows the total number of outstanding shares as compared to the difference between operating earnings on a per/share basis before and after buybacks.

The reality is that stock buybacks create an illusion of profitability.  If a company earns $0.90 per share and has one million shares outstanding – reducing those shares to 900,000 will increase earnings per share to $1.00. No additional revenue was created, no more product was sold, it is simply accounting magic. Such activities do not spur economic growth or generate real wealth for shareholders. However, it does provide the basis for with which to keep Wall Street satisfied and stock option compensated executives happy.

It is also worth noting that debt funded stock buybacks have been the primary source of stock purchases since 2009. To wit:

“In fact, according to a chart from Credit Suisse, Fink may be more correct than he even knows. As CS’ strategist Andrew Garthwaite writes, ‘one of the major features of the US equity market since the low in 2009 is that the US corporate sector has bought 18% of market cap, while institutions have sold 7% of market cap.’

What this means is that since the financial crisis, there has been only one buyer of stock: the companies themselves, who have engaged in the greatest debt-funded buyback spree in history.”

Ultimately, the problem with cost cutting, wage suppression, labor hoarding and stock buybacks, along with a myriad of accounting gimmicks, is that there is a finite limit to their effectiveness. Eventually, you simply run out of people to fire, costs to cut and the ability to reduce labor costs.

Lastly, there is also the problem of the long-term relationship between stocks prices and underlying fundamentals. While there is much hope that earnings will eventually play “catch up” to stock prices, there is a significant risk to that outcome. As shown below, sales per share is roughly at the same level as it was in Q4-2012, but stock prices have risen by 65.7% during the same period. With stock prices already “priced to perfection,” any shortfall will likely be problematic.

Furthermore, the surge in earnings expectations were based on tax cuts/reform and the lowering of corporate taxes to 15%. As I wrote previously, that cut to 15% was never likely to come to fruition. To wit:

“Add to this, the offset of the Border Adjustment Tax (BAT), the remaining ACA taxes on both corporations and individuals, and the reality that corporate tax reform will likely be less than advertised (25% vs 15-20%), and you have the makings of a substantial shortfall in current forward earnings estimates.”

I hate to say I told you so, but on Monday, Reuters released the following:

“Republican leaders in the House of Representatives and the Senate are unlikely to allow the budget deficit to grow, so officials said they now hope for a corporate tax at the low end of a 20 percent to 25 percent range.”

Given that stocks have surged based on “hopes” of deeper tax cuts, a tax cut only roughly half of previous estimates certainly puts valuations at risk. Once again, the market has already priced in earnings growth through 2018, making disappointment a much higher probability.

Considering that forward estimates are generally overstated by 33% on average, the risk is high of disappointment.  As shown below, there was a $10 difference between what earnings were expected to be in 2017 at the beginning of 2016 and today. Furthermore, forward earnings have only risen by $4.15/share for the end of 2018. Yet, as shown, above prices have more than priced in that future growth.

With analysts once again hoping for a “hockey stick” recovery in earnings in the months ahead, it is worth noting this has always been the case. Currently, there are few, if any, Wall Street analysts expecting a recession at any point the future. Unfortunately, it is just a function of time until the recession occurs and earnings fall in tandem.

There is virtually no “bullish” argument that will currently withstand real scrutiny. Yield analysis is flawed because of the artificial interest rate suppression. It is the same for equity risk premium analysis. Valuations are not cheap, and any increase in interest rates by the Fed will only act as a further brake on economic growth.

However, because optimistic analysis supports our underlying psychological “greed”, all real scrutiny to the contrary tends to be dismissed. Unfortunately, it is this “willful blindness” that eventually leads to a dislocation in the markets.

This past week, the lovely, and talented, Danielle DiMartino-Booth and I shared a discussion on the ongoing debate of why “Rates Must Rise.”  

For the last several years, I have produced a litany of commentary (see this, this and thison why rates WILL not rise anytime soon, they CAN’T rise because of the relationship between debt and economic activity.

Most of the arguments behind the “rates must rise” scenario are based solely on the premise that since “rates are so low,” they must now go up. This theory certainly applies to the stock market which is driven as much by human emotion, as fundamentals. However, rates are an entirely different animal.

Let me explain my position using housing as an example. Housing is something everyone can understand and relate to, but the same premise applies to everything bought on credit.

People Buy Payments – Not Houses

When the average American family sits down to discuss buying a home they do not discuss buying a $125,000 house. What they do discuss is what type of house they “need” such as a three bedroom house with two baths, a two car garage, and a yard.

That is the dream part.

The reality of it smacks them in the face, however, when they start reconciling their monthly budget.

Here is a statement I have not heard discussed by the media. People do not buy houses – they buy a payment. The payment is ultimately what drives how much house they buy. Why is this important?   Because it is all about interest rates.

Over the last 30-years, a big driver of home prices has been the unabated decline of interest rates. When declining interest rates were combined with lax lending standards – home prices soared off the chart.  No money down, ultra low interest rates and easy qualification gave individuals the ability to buy much more home for their money.

The problem, however, is shown below. There is a LIMIT to how much the monthly payment can consume of a families disposable personal income.

In 1968 the average American family maintained a mortgage payment, as a percent of real disposable personal income (DPI), of about 7%. Back then, in order to buy a home, you were required to have skin in the game with a 20% down payment. Today, assuming that an individual puts down 20% for a house, their mortgage payment would consume more than 23% of real DPI. In reality, since many of the mortgages done over the last decade required little or no money down, that number is actually substantially higher. You get the point. With real disposable incomes stagnant, a rise in interest rates and inflation makes that 23% of the budget much harder to sustain.

To illustrate this point, look at the chart below. Let’s assume we buy a $125,000 home. I have projected the monthly payment of that home assuming a rise in interest rates going forward back to the long-term median of roughly 8%. Pick a rate in the future and you can see what the payment would be.

With this in mind let’s review how home buyers are affected. If we assume a stagnant purchase price of $125,000, as interest rates rise from 4% to 8% by 2027 (no particular reason for the date – in 2034 the effect is the same), the cost of the monthly payment for that same priced house rises from $600 a month to more than $900 a month – more than a 50% increase. However, this is not just a solitary effect. ALL home prices are affected at the margin by those willing and able to buy and those that have “For Sale” signs in their front yard. Therefore, if the average American family living on $55,000 a year sees their monthly mortgage payment rise by 50% it is a VERY big issue.

Assume an average American family of four (Ward, June, Wally and The Beaver) are looking for the traditional home with the white picket fence. Since they are the average American family their median family income is approximately $55,000. After taxes, expenses, etc. they realize they can afford roughly a $600 monthly mortgage payment. They contact their realtor and begin shopping for their slice of the “American Dream.”

At a 4% interest rate, they can afford to purchase a $125,000 home. However, as rates rise that purchasing power quickly diminishes. At 5% they are looking for $111,000 home. As rates rise to 6% it is a $100,000 property and at 7%, just back to 2006 levels mind you, their $600 monthly payment will only purchase a $90,000 shack. See what I mean about interest rates?

This also explains WHY America has become a nation of renters as affordability for many is no longer an option.

Since home prices, on the whole, are affected by those actively willing to sell – a rise of interest rates would lead to declines in home prices across the board as sellers reduce prices to find buyers. Since there are only a limited number of buyers in the pool at any given time, the supply / demand curve is critically affected by the variations in interest rates. This is particularly the problem when the average American is more heavily leveraged than at any point in history.

Not Just Houses, It’s Everything

The ramifications of rising interest rates do not only apply to home prices, but also on virtually every aspect of the economy. As rates rise so do rates on credit card payments, auto loans, business loans, capital expenditure profitability, leases, etc. Credit is the life blood of the economy and, as we can already see, even small changes to rates can have a big impact on demand for credit as shown below.

More importantly, despite economic reports of rising employment, low jobless claims, surging corporate profitability and continuing economic expansion, consumers have sunk themselves deeper into debt. With the gap between wages and the costs of supporting the required “standard of living” at record levels, there is little ability to absorb higher rates before it drastically curbs consumption.  

There are basically only TWO possible outcomes from here, both of them not good.

First, Janet Yellen and gang continue to hike rates until an economic recession occurs which requires them to lower rates again. As an aging demographic strains the pension and social welfare systems, the economic malaise contains rates at the lower bound. This cycle continues, as it has over the last 30-years, which has created the “Japan Syndrome” in the U.S.

The second outcome is far worse which is an economic decoupling that leads to a massive deleveraging process. Such an event started in 2008 but was stopped by Central Bank interventions which has led to an even more debt laden system currently.

The problem with most of the forecasts for the end of “low interest rates” is the assumption that we are only talking about the isolated case of a shifting of asset classes between stocks and bonds.

However, the issue of rising borrowing costs spreads through the entire financial ecosystem like a virus. The rise and fall of stock prices have very little to do with the average American and their participation in the domestic economy. Interest rates are an entirely different matter.

Since interest rates affect “payments,” increases in rates quickly have negative impacts on consumption, housing, and investment which ultimately deters economic growth. 

Again, given the current demographic, debt, pension and valuation headwinds, the future rates of growth are going to be low over the next couple of decades until a “clearing” process is completed. (This is what the “Great Depression” provided.)

While there is little room left for interest rates to fall in the current environment, there is also not a tremendous amount of room for increases.

This is what the bond market continues to tell you if you will only listen. With the 10-year bond close to 2%, and the yield curve flattening, future rate increases are limited due to limited GDP growth due to “secular stagnation.” Therefore, bond investors are going to have to adopt a “trading” strategy in portfolios as rates start to go flat-line over the next decade.

As I noted in yesterday’s missive, Yellen’s recent testimony on Capitol Hill sent robots frantically chasing asset prices on Thursday even before testimony began. The catalyst was the release of prepared testimony which included this one single sentence:

“Because the neutral rate is currently quite low by historical standards, the federal funds rate would not have to rise all that much further to get to a neutral policy stance.”

And on that statement, doves flew and algorithms kicked into to add risk exposure to portfolios. Why? Because she just said that rates will remain low forever. As my partner, Michael Lebowitz, noted yesterday:

“Per Janet Yellen’s comment, the ‘neutral policy stance’ is another way of saying that the Fed funds rate is appropriate or near appropriate given current and expected future economic conditions. Said differently, Janet Yellen is admitting what we’ve been saying for years – the economy has been stagnant, is stagnating and will continue to stagnate.

If we assume that Yellen is referring to a range of 1.25-1.75% as an appropriate Fed Funds rate, based on statistical analysis of data since 1955, we forecast that real GDP growth rate is likely to average somewhere between 2.00-2.50% for the foreseeable future. For perspective, the graph below plots the range of expected GDP growth vs historical secular (3-year average) GDP growth. In years past, such a slow rate of growth (highlighted in yellow) was considered nearly recessionary.”

The problem, of course, is that a 2% economic growth rate is not conducive to a strongly expanding economic environment and does not support current market valuations. The first chart below compares the cumulative growth rate of the real S&P 500 as compared to GDP. The great “bull markets of the 50’s and 60’s, the 80’s, and now the 10’s have all previously ended when the growth of the S&P 500 exceeded the growth of the economy. 

The next chart compares the inflation adjusted market capitalization rate of the S&P 500 to GDP. As noted on Tuesday, valuations have everything to do with forward returns on investments over the long-term.

The problem for the Fed remains the rising risk of a monetary policy error against a backdrop of an over valued, over leveraged and overly bullish financial market. Historically such combinations have tended not to turn out well.

While markets may well continue to remain bullish in the short-term, the longer-term outcomes remain heavily weighted against investors currently. Of course, the “chase for return” is always the most prevalent when markets remain illogical longer than investors can remain rational. 

In the meantime, this is what I am reading.



Research / Interesting Reads

 “Most investors want to do today what they should have done yesterday.” – Larry Summers

Questions, comments, suggestions – please email me.

In Janet Yellen’s semi-annual testimony on Capitol Hill yesterday, she made reference to the ongoing strength of employment as one of the reasons for continuing to “normalize” monetary policy by lifting interest rates and reducing the existing bond holdings of the Federal Reserve. To wit:

“Since my appearance before this committee in February, the labor market has continued to strengthen. Job gains have averaged 180,000 per month so far this year, down only slightly from the average in 2016 and still well above the pace we estimate would be sufficient, on average, to provide jobs for new entrants to the labor force. Indeed, the unemployment rate has fallen about 1/4 percentage point since the start of the year, and, at 4.4 percent in June, is 5‑1/2 percentage points below its peak in 2010 and modestly below the median of Federal Open Market Committee (FOMC) participants’ assessments of its longer-run normal level.”

However, while the Fed is talking about normalizing interest rates, to a level of 2% which would be in-line with their long-term economic growth forecasts, the issues with employment likely don’t support such a move.

Note: What is often missed in this discussion is that while the Fed talks about the “economy growing at a moderate pace,” that pace of growth is at the lowest average rate since WW-I.

While Ms. Yellen remains focused on the “official unemployment rate” as a reason to continue her rate hiking campaign, there are several reasons she might want to reconsider her aggressiveness. Furthermore, this also goes to the very reason why sub-5% unemployment rates aren’t leading to surges in wage growth or economic prosperity.

The chart below shows the “real situation” with respect employment.

Has there been “job creation” since the last recession? Absolutely.

If you take a look at the actual number of those “counted” as employed, that number has risen from the recessionary trough. Unfortunately, employment remains far below the long-term historical trend that would suggest healthy levels of economic growth. Currently, the deviation from the long-term trend is the widest on record and has made NO improvement since the recessionary lows.

However, as it relates to economic growth, what is always overlooked is the number of new entrants into the working-age population each month.

As you can see in the chart above, while total employment has grown by 15-million, the working age population has grown by 19-million leaving a 4-million person deficit sitting idle in the economy. Of course, after a period of time, these individuals are no longer counted as part of the labor force. This is why, despite monthly headlines of employment growth, those no longer in the labor force (NILF) continues its pace higher.

This also explains why the labor force participation rate, of those that SHOULD be working (16-54 years of age), remains at the lowest levels since the 1970’s. This chart alone should give Ms. Yellen pause in her estimations on the strength of the underlying economy.

If we look those no longer counted as a percentage of prime working age (16-54) individuals, we can see the direct correlation to the fall in the unemployment rate.

Those individuals not counted as part of the labor force has swelled to 94,813,000 as of June, 2016. Given that the total population in the U.S. is estimated to be 325 million currently, this would mean that roughly 1/3rd of the entire population is sitting on the sidelines. This is why the labor force participation rate remains stuck at the lowest levels in 40-years. The important difference is that in the 80’s the participation rate was rising – not falling. 

There are two very negative ramifications of this large and “available” labor pool. The first is that the longer an individual remains unemployed the degradation in job skills weighs on future employment potential and income.  The second, and most importantly, is that with a high level of competition for existing jobs; wages remain under significant downward pressure.

Business owners are highly aware of the employment and business climate, and regardless of the ranting and raving about the “cash on the sidelines”, businesses are not in the business of charity. Business owners are milking the current employment climate for all it is worth in order to maintain profitability. With high competition levels for existing jobs, and the impending threat of job loss for those working, employers can work employees longer hours with only a modest increases in wages. This is great for profit margins, and workers won’t complain because there are plenty of individuals that will be happy to take their job and do it for less pay.

This impact on wages, as other inflationary pressures rise such as surging health care costs, rental rates, and college tuition, hits the consumer where it hurts the most. This bleed on incomes has led to significant slides in the real savings rates and the ability for the consumer to continue to spend outside of the main necessities to meet their basic standard of living. As I discussed previously in “The Illusion Of Declining Debt To Income Ratios:”

“Given this information, it should not be surprising that personal consumption expenditures, which make up roughly 70% of the economic equation, have had to be supported by surging debt levels to offset the lack wage growth in the bottom 90% of the economy.

Furthermore, this explains why the gap between wages and the cost of supporting the required ‘standard of living’ continues to expand.

“More importantly, despite economic reports of rising employment, low jobless claims, surging corporate profitability and continuing economic expansion, the percentage of government transfer payments (social benefits) as compared to disposable incomes have surged to the highest level on record.”

While Ms. Yellen continues to assess that employment growth remains encouraging, giving her the “cover” to hike interest rates further, the reality is employment, as an economic measure, has not been beneficial for identifying changes to the underlying economic cycles. 


The table details every recession going back to 1948 as identified by the “Start Date” which is the first month of the recession as identified by the National Bureau of Economic Research. The table shows the month-over-month increases in payrolls beginning 3, 2 and 1 months before the actual first month of an economic recession.

The first thing to notice is that there are only 4 months in the entire table that actually show job losses. Employers are generally very slow to hire, and fire, employees which is why employment is a lagging indicator. However, if we look at the net change of employment over a 3 month period what we notice is that job gains were actually quite strong just prior to the onset of an economic recession. That should not be surprising as employers are generally overly optimistic about the future at the peak of an economic cycle.

One of the key questions to be answered is whether or not the recent increases in employment are sustainable going forward considering the current length of this ongoing economic expansion. Furthermore, the weakness seen in consumption, credit expansion, and oil prices, could lead to further hiring pressures as corporations adjust to protect their bottom line.

But this is why I often discuss the importance of looking at the TREND of the data rather than just a specific data point. The chart above of the 3-month net change in jobs shows this a little more clearly. The net change in jobs tends to peak just prior to the onset of a recession historically. Importantly, the 3-month net change in jobs has already peaked at normal historical levels and has begun to TREND lower.

With respect to Ms. Yellen, without employment growing fast enough to offset labor pool overhang we are unlikely to reduce the real unemployment problem that persists in the U.S. This bodes poorly for the consumer, the economy and ultimately the markets as this weakness leaves all three very susceptible to unexpected system shocks.

If the economy, and employment, are as strong as Ms. Yellen portends, then she is certainly making the right decision. However, the data suggests this is likely not the case, and the economy, and the markets, are littered with corpses of “monetary policy errors” of the past. 

“I know you think you understand what you thought I said, but I’m not sure you realize that what you heard is not what I meant – Alan Greenspan

On July 12, 2017 in her semiannual testimony to Congress, Janet Yellen stated the following:

“The Federal Funds rate would not have to rise all that much further to get to a neutral policy stance.”

Currently the target for the Federal Funds rate is a range of 1.00-1.25%, having been raised four times since December 2015. Despite the increase from the zero level that persisted for seven years following the “Great Financial Crisis,” it is still at microscopic levels as shown below.

Data Courtesy: St. Louis Federal Reserve (FRED)

Per Janet Yellen’s comment, the “neutral policy stance” is another way of saying that the Fed funds rate is appropriate or near appropriate given current and expected future economic conditions. Said differently, Janet Yellen is admitting what 720Global has been saying for years – the economy has been stagnant, is stagnating and will continue to stagnate.

If we assume that Yellen is referring to a range of 1.25-1.75% as an appropriate Fed Funds rate, based on statistical analysis of data since 1955, we forecast that real GDP growth rate is likely to average somewhere between 2.00-2.50% for the foreseeable future. For perspective, the graph below plots the range of expected GDP growth vs historical secular (3-year average) GDP growth. In years past, such a slow rate of growth (highlighted in yellow) was considered nearly recessionary.

Data Courtesy: St. Louis Federal Reserve (FRED)

A similar analysis comparing Yellen’s “neutral” Fed funds rate versus inflation (CPI) yields inflation expectations of approximately 1.75%. Again, such an inflation rate is emblematic of a stagnant economy.

We are gratified that Janet Yellen is finally coming around to our perspective and only sorry that it has taken her the entirety of her tenure to do so. Unfortunately, the levels of growth to which she conceded in this testimony imply further challenges for the economy due to the large debt overhang, weak fundamentals supporting overvalued financial markets and higher risks of recession.


Today’s comments are not a revelation. The Fed is currently forecasting long term economic growth of 1.90%. Those trading on hope and momentum are translating her message as a green light to buy stocks because the Fed will remain ultra-accommodative. While it is nice some see a silver lining in her message, one must remember that equity valuations are perched at levels that imply tremendous economic and earnings growth. If what Yellen is saying is true, equity holders are grossly overpaying for a stream of future earnings that will most certainly be disappointing.

Conversely, the message in Yellen’s testimony is bond friendly. In fact, we argue that continued stagnation and weak price growth could result in even lower yields than those we have seen over the past five years.





On the “Real Investment Hour” on Tuesday night, I addressed the issue of price versus fundamentals. In the short-term, a period of one-year or less, political, fundamental, and economic data has very little influence over the market. This is especially the case in a late-stage bull market advance, such as we are currently experiencing, where the momentum chase has exceeded the grasp of the risk being undertaken by unwitting investors.

As shown in the chart below, the longer-term price trend of the market remains clearly bullish. However, despite commentary on valuations, sentiment, economics, or politics, the PRICE of the market suggests a weakening trend in investor confidence at current levels. That weakness has also instigated a short-term “sell signal” which suggests prices may struggle more in the days ahead. One thing we need to pay attention to is a potential break of the bullish trend line running along the 50-day moving average. Such a break would likely coincide with a correction back to 2330 in the short term.

Alternatively, if the market can reverse the current course of weakness and rally above recent highs, it will confirm the bull market is alive and well, and we will continue to look for a push to our next target of 2500.

With portfolios currently fully allocated, we are simply monitoring risk and looking for opportunities to invest “new capital” into markets with a measured risk/reward ratio.

However, this is a very short-term outlook which is why “price is the only thing that matters.” 

Price measures the current “psychology” of the “herd” and is the clearest representation of the behavioral dynamics of the living organism we call “the market.”

But in the long-term, fundamentals are the only thing that matters. I have shown you the following chart many times before. Which is simply a comparison of 20-year forward total real returns from every previous P/E ratio.

I know, I know.

“P/E’s don’t matter anymore because of Central Bank interventions, accounting gimmicks, share buybacks, etc.”

Okay, let’s play.

In the following series of charts, I am using forward 10-year returns just for consistency as some of the data sets utilized don’t yet have enough history to show 20-years of forward returns.

The purpose here is simple. Based on a variety of measures, is the valuation/return ratio still valid, OR, is this time really different?

Let’s see.

Tobin’s Q-ratio measures the market value of a company’s assets divided by its replacement costs. The higher the ratio, the higher the cost resulting in lower returns going forward.

Just as a comparison, I have added Shiller’s CAPE-10. Not surprisingly the two measures not only have an extremely high correlation, but the return outcome remains the same.

One of the arguments has been that higher valuations are okay because interest rates are so low. Okay, let’s take the smoothed P/E ratio (CAPE-10 above) and compare it to the 10-year average of interest rates going back to 1900.

The analysis that low rates justify higher valuations clearly does not withstand the test of history.

But earnings can be manipulated, so let’s look at “sales” or “revenue” which occurs at the top-line of the income statement. Not surprisingly, the higher the level of price-to-sales, the lower the forward returns have been. You may also want to notice the current price-to-sales is pushing the highest level in history as well.

Corporate return on equity (ROE) sends the same message.

Even Warren Buffett’s favorite indicator, market cap to GDP, clearly suggests that investments made today, will have a rather lackluster return over the next decade.

If we invert the P/E ratio, and look at earnings/price, or more commonly known as the “earnings yield,” the message remains the same.

No matter, how many valuation measures I use, the message remains the same. From current valuation levels, the expected rate of return for investors over the next decade will be low.

There is a large community of individuals which suggest differently as they make a case as to why this “bull market” can continue for years longer. Unfortunately, any measure of valuation simply does not support that claim.

But let me be clear, I am not suggesting the next “financial crisis” is upon us either. I am simply suggesting that based on a variety of measures, forward returns will be relatively low as compared to what has been witnessed over the last eight years. This is particularly the case as the Fed, and Central Banks globally, begin to extract themselves from the cycle of interventions. 

This does not mean that markets will just produce single-digit rates of return each year for the next decade. The reality is there will be some great years to be invested over that period, unfortunately, like in the past, the bulk of those years will be spent making up the losses from the coming recession and market correction.

That is the nature of investing in the markets. There will be fantastic bull market runs as we have witnessed over the last 8-years, but in order for you to experience the up, you will have to deal with the eventual down. It is just part of the full-market cycles that make up every economic and business cycle.

Despite the hopes of many, the cycles of the market, and the economy, have not been repealed. They can surely be delayed and extended by artificial interventions, but they can not be stalled indefinitely.

No. “This time is not different,” and in the end, many investors will once again be reminded of this simple fact:

 “The price you pay today for any investment determines the value you will receive tomorrow.” 

Unfortunately, those reminders tend to come in the most brutal of manners.  

“The emergence of money manager capitalism means that the financing of the capital development of the economy has taken a back seat to the quest for short-run total returns.” – Circa 1992.

Wall Street has forgotten the great financial crisis.

A sense of relief has settled firmly on the legendary asphalt artery between Trinity and the FDR Drive.

Looks like they got away with another one.

Nobody else will, so let me say it (at least mean it): Thank you, Mr. & Mrs. Taxpayer.

Again. Sincerely. Thank you. Now, let’s get on with blowing your wealth out of the water again, just as portfolios have made it back to even. Older, a bit pudgier, more forehead than before.

Oh wait, that’s me.

As the Great Recession gets pulled into the mist, obfuscated by the misleading but comforting math of market return averages and a bull that has rarely stumbled, Wall Street is more defiant than ever to broadcast:

“See? We told you so! The markets always rebound in time!”

Time. That precious commodity you’d pay more than you’re worth, for.

The concept of time holds little relevance to Wall Street. After all, its life expectancy may be considered perpetual. Eight years, seventeen years, whatever time it takes to recover from a poor cycle is irrelevant and may be celebrated. A human life is different. We die. We can’t be so flippant over lost time.

You know all too well about how painful it is to recover from losses.

Understandable why it makes sense that Main Street, or why Americans vividly recall the Great Recession. They’re older and unless in the top 1%, not much richer. They’re also skeptical of the so-called economic recovery as inflation-adjusted median incomes have remained stagnant for close to a decade. Read: The Illusion of Declining Debt-To-Income Ratios.

Sentier Research an organization that focuses on income and demographics publishes monthly updates on household incomes. Their numbers tend to be direr than Lance Roberts’ on the topic. According to Sentier, May 2017’s median household income is roughly 1% above the median of $58,711 set back in January 2000.

The reason I rehash painful memories and current reality, is to conjure a name we haven’t heard since 2007. It’s an attempt to ground myself. Ground you, too.

Meanwhile in the fantasy-land horror ride otherwise known as a central banker’s noggin…

It feels opportune for me; as I write, the head of the Federal Reserve Janet Yellen at a recent event in London, espoused just what the media wanted to hear. Get this: She’s confident that a run on the banking system won’t happen “as long as she lives.” Read: Yes, Ms. Yellen…. There Will Be Another Financial Crisis.

You see, Ms. Yellen’s frame of reference, that of Neoclassical economic texts studied within hallowed walls – where financial crisis, or any shock, with the word “GREAT” attached to it like Depression or Recession, are dismissed as anomalies. Her accepted theories explain away the power of the shadow banking system to take the so-called regulated financial system down with it.

In her naïve corner of economic study, alleged exogenous events are minimized as episodes that may occur, give or take, every 4,000 years. Unfortunately, the result is an unwarranted sense of complacency that ironically, leads to instability the rest of society ultimately pays for.

How else can a Fed chair whose words are taken so seriously expound in public that another financial crisis was not likely in our lifetime? In my lifetime, we’ve experienced multiple so-called outlier events. Unless she’s planning to check out soon, I’m not sure how confident Yellen can be in her statement.

One fact is obvious; the Fed has put to bed that whole financial crisis thing, too.

A reason that justifies the resurrection of this economist’s theories.

You may have missed references to him a decade ago; it’s opportune to revive all the man stood for as iconoclastic economist Hyman P. Minsky in his body of work, was an advocate for Main Street. Not Wall Street.

Explains why he’s rarely discussed these days. Perhaps his name is whispered throughout hallowed academic halls where nobody on Wall Street or yearning to be employed by the Street, can hear.

If anything, I’m regrettably assured his theories are relegated to a brief paragraph in widely-read university economic textbooks under “harebrained theories” or “economists who suffer unjustified paranoia.”

What I am confident of is many professionals in the financial industry and big box financial pundit puppets who publish irresponsible forecasts are thankful Minsky’s framework on risk expansion and subsequent collapse, has vanished from purview.

Now, in the midst of a market cycle of low hum – sluggish growth, benign interest rates, flat-lined volatility, and a period of robust animal spirits, I’m beginning to feel his presence emerge from the calm, once again. At least in my head.

After a decade of complacency as the world remains awash in central bank liquidity, Dr. Minsky and his financial instability hypothesis have faded to distant memory. In 2007, Paul McCulley then Managing Director of behemoth money management firm PIMCO, coined a genius term Minsky Moment to eloquently describe the domino effect of irresponsible risk expansion followed by financial system disruption sparked by a collapse of reckless debt, in this case subprime mortgage liabilities.

Minsky understood how rational profit-seeking activities always held potential over time, especially through calm or boom periods, to ostensibly morph into speculative Ponzi-type activities. The longer the macro-environment allowed such behavior void of repercussion, the greater the spread of the most dangerous of risks.

Unlike neoclassical economists’ belief in the core doctrine that market forces are naturally stabilizing, Minsky’s view was that market forces, human behaviors, were far from efficient or rational. Boom or stable cycles eventually culminated in destabilizing outcomes.

The longer the riskier behavior persisted without repercussion, the greater the imminent collapse. In other words, he believed in ebb and flow or cycles. Shocking. I know.

He outlined three financing tiers that progressed from hedged (where income flows adequately cover all interest and principal payments), to speculative where interest payments are met, but not principal, to the final most dangerous stage – Ponzi, where receipts are insufficient to cover even interest payments. The hope is at this stage, that underlying assets will appreciate sufficiently to cover liabilities.

The subprime mortgage crisis was indeed a Ponzi where the infective narrative “house values always appreciate,” allowed for irresponsible risk taking. Once foreclosures started to climb, or the spark ignited to disprove the housing appreciation story, the entire system we falsely trusted, began to falter.

The cancer of risk collapse spread rapidly through the arteries of the shadow financial underbelly of the economy and surfaced to affect every industry housing touched. The so-called regulated financial system was not spared damage either with the collapse of tenured institutions like Lehman Brothers.

Since the crisis, there have been multiple short-term regulatory patches put in place to fortify the financial industry. For the most part, these regulations are the same inadequate hammers for larger, stronger nails.

As he was a proponent of a pliable system of reform which could be altered based on the innovative risk humans create, Minsky would have been disappointed to know that the interconnected global shadow banking web continues to expand, Federal Reserve policies have created a great misallocation of financial resources, price discovery of risk assets is basically non-existent and the segment of the population or Main Street that was a concern for him, suffers great wealth inequality and wage disparity.

Several catalysts exist today that may remind investors of Minsky. Readers should remain vigilant and keep the following concerns in mind as they invest and manage their personal wealth.

The Federal Reserve has appeared to gravitate from data dependent to data ignorant.

Economic data remains sub-par. Inflation has fallen below the Fed’s target of two percent, yet they appear in their statements, determined to continue hiking short-term rates.

In theory, a rate-tightening cycle is designed to take the edge off, tap the brake on accelerating economic growth. So, with GDP running below the long-term average of three percent and the personal consumption expenditures or PCE Index, the Fed’s preferred measure of inflation slipping to 1.4% year-over-year in May, the lowest in six months, a question begs asking. Read: The Fed just got another big reminder of why it should stop raising interest rates.

Yellen, what are you putting a brake on?

Based on the analysis below, the Fed has no reason to continue rate hikes this year. However, they seem hell-bent to ignore the data.  Why?

The Fed may be on an unofficial mission to curb stock market speculation. Several Fed officials including Vice-Chairman Stanley Fischer and San Francisco Fed President John Williams have voiced their concerns over lofty stock market valuations.

Regardless, of the Fed’s agenda to forge ahead with rate hikes, it’s crucial to remember that low interest rates have been the primary accelerant for stock market appreciation, not earnings growth; rising rates along the yield curve eventually puts a damper on the economy and sets up a prime catalyst for market correction. If the Fed moves too quickly or inflation heats up to warrant swifter action, then a Minsky Moment may be closer than pundits believe.

In a majority of instances, a period of rising rates is not conducive to higher stock prices.

The ethereal nature of confidence vs. the facts of hard data.

Facts inevitably win.

There’s been an undeniable jolt in economic optimism after the presidential election that has spilled over to stock prices. The challenge lies in combating the continued lackluster reality of actual economic performance. The U.S. economy still appears to be chugging along at roughly two percent. A sluggish pattern that hasn’t changed in years.

Eventually, the market will be compelled to narrow the chasm between hope for the future and current hard lines of reality. Either corporate earnings and GDP will exhibit a marked pickup in growth to validate market levels, or prices will moderate to meet the reality of the current environment.

History shows it’s not uncommon for markets to overcompensate, leap ahead, especially in the face of fiscal promises like tax cuts, deregulation and infrastructure spending, all which appear to be slow in progressing.

Nobody knows how much time the market is going to allow the President to fulfill his agenda. The deeper the divide between hope and reality becomes, the greater chance of Minsky to graduate to the forefront of hot buzzwords around the squawking circles of financial media.

The complacency of professionals, investors and big-box retail financial talking heads has finally arrived, but how long will it last?

Two recent episodes stand out for me.

It’s not all about numbers – I heed anecdotal evidence as contrarian, a qualitative indication of change in narrative. Unless you believe humans aren’t emotional and markets are rational, that is. It’s a nice sentiment to consider market forces as naturally stabilizing and motivated completely by math.

Minsky believed that market forces were exactly opposite. He considered the ‘real world’ unstable; markets had a tendency to keep stretching parameters of risk which required flexible, changing regulatory actions to keep the greater risks from spreading to Main Street.

In the awkward head tilt of conversations overheard on escalators and elevators, I discover jewels in the jabber. Through hundreds of e-mails we receive from readers and investors; from surveys that I don’t consider empirical but important, there are trends we detect.

There’s no doubt a sense of calm is reaching fever pitch. There is an air of stability which may breed instability (if I’m wearing my Minsky cap).

Dreyfus conducted a survey recently and discovered that 61 percent of investors 55+ indicated they have not or will not reevaluate their investment approach in today’s investment environment of low interest rates, low market volatility and uneven economic growth. Overall, six in ten investors without a financial advisor are most likely to put off their plans to address the current market environment.

Now, I’m not certain as to why investors, especially those closer to retirement, are so indifferent about this topic, however, I draw several conclusions.

Recency bias. Let’s face it. Novice investors and financial professionals have never witnessed a correction let alone a bear market. Nor is this sheltered group advised or taught to understand that market winds shift, cycles change. If the only thing you know (and it’s worked), is ‘buy the dips’ then every derail is a buying opportunity. Until it isn’t. Complacency feeds on this mentality.

Loss aversion. For those 55+ in the study who haven’t re-evaluated, it’s plausible they are mired in a Great Recession mindset. Possibly, these investors sold (probably close or at the 2009 bottom), never to return to an allocation they believe requires assessment, as it’s primarily in cash and fixed income. Regardless of the composition of an investment allocation, no matter how conservative, portfolios require periodic attention and re-adjustment.

Overconfidence. It’s possible that low volatility in markets and a massive shift from active to passive investments has blossomed overconfidence and complacency as the financial industry and the media continue to position passive as the latest, greatest panacea for every investment malady. Puzzlingly, investors link passive to safe; a misconception I address almost daily. There’s no such connection between the concepts of ‘safe’ and ‘stocks.’ None.

Last week we received an e-mail from a newsletter reader who indicated that his big-box financial partner explained that barring any geopolitical risk, the stock market would be higher by the end of the year. Bold statement to say the least.

I’m not certain how any financial professional has the crystal balls to know how the market is going to close out the year. I guess this advisor could be correct. Or maybe he or she is behind on a quarterly sales quota. Not sure.

This is only one example of communication we receive along a similar theme.

I know as we get closer to market tops or late stage cycles, I read and hear sloppy statements of overconfidence with increased frequency from financial professionals and occasionally, central bank leadership. Stories are created and spread to authenticate a continued march higher for stocks.

I’m not saying a Minsky Moment is right around the corner. In part, it’s too disconcerting for me to think about how global central banks, stretched to the outer limits of creative monetary theories, don’t have enough firepower to right the ship again. The deep-seeded dysfunction of fiscal authorities across the globe doesn’t make me feel warm and fuzzy, either.

However, resurrecting an alternative economic viewpoint at a time of heightened complacency seems the right thing to do. If anything, Minsky’s work may spark curiosity, discussion, and questions.

I hope to encourage readers and investors to consider his message, assess financial risk in their own households and adjust accordingly.

You can almost hear the announcer for the movie trailer;

“In a world stricken by financial crisis, a country plagued by spiraling deficits and cities on the verge of collapse – a war is being waged; gauntlet’s thrown down and at the heart of it all; two dead white guys battling over the fate of the economy.”

While I am not so sure it would actually make a great movie to watch – it is the ongoing saga we will continue to witness unfold over the next decade. While the video below is entertaining, it does lay out the key differences between Keynesian and Austrian economic theories.

Just last week, the Federal Reserve released a report which forms the basis of the semi-annual testimony Ms. Yellen will give to Congress this week. There was much in this report which suggests the models the Federal Reserve continues to use are at best flawed and, at worst, broken.

For decades, ivory tower economists have heaped high praise on Keynesian policies as they have encouraged Governments to drive deeper into debt with the expectation of reviving economic growth.

The problem is – it hasn’t worked.

Here’s proof. Following the financial crisis, the Government and the Federal Reserve decided it was prudent to inject more than $33 Trillion in debt-laden injections into the economy believing such would stimulate an economic resurgence. Here is a listing of all the programs.

Unfortunately, the results have been disappointing at best, considering it took almost $17 Billion for every $1 of cumulative economic growth.

Keynes contended that a general glut would occur when aggregate demand for goods was insufficient, leading to an economic downturn resulting in losses of potential output due to unnecessarily high unemployment, which results from the defensive (or reactive) decisions of the producers.”  In other words, when there is a lack of demand from consumers due to high unemployment then the contraction in demand would, therefore, force producers to take defensive, or react, actions to reduce output.

In such a situation, Keynesian economics states that government policies could be used to increase aggregate demand, thus increasing economic activity and reducing unemployment and deflation. Investment by government injects income, which results in more spending in the general economy, which in turn stimulates more production and investment involving still more income and spending and so forth. The initial stimulation starts a cascade of events, whose total increase in economic activity is a multiple of the original investment.

Unfortunately, as shown below, monetary interventions and the Keynesian economic theory of deficit spending has failed to produce a rising trend of economic growth.

What changed?

The Breaking Point & The Death Of Keynes

Take a look at the chart above. Beginning in the 1950’s, and continuing through the late 1970’s, interest rates were in a generally rising trend along with economic growth. Consequently, despite recessions, budget deficits were non-existent allowing for the productive use of capital. When the economy went through its natural and inevitable slowdowns, or recessions, the Federal Reserve could lower interest rates which in turn would incentivize producers to borrow at cheaper rates, refinance activities, etc. which spurred production and ultimately hiring and consumption.

However, beginning in 1980 the trend changed with what I have called the “Breaking Point.” It’s hard to identify the exact culprit which ranged from the Reagan Administration’s launch into massive deficit spending, deregulation, exportation of manufacturing, a shift to a serviced based economy, or a myriad of other possibilities or even a combination of all of them. Whatever the specific reason; the policies that have been followed since the “breaking point” have continued to work at odds with the “American Dream,” and economic models.

As the banking system was deregulated, the financial system was unleashed upon the unsuspecting American public. As interest rates fell, the average American discovered the world of financial engineering, easy money, and the wealth creation ability through the use of leverage. However, what we didn’t realize then, and are slowly coming to grips with today, is that financial engineering has a very negative side effect – it deteriorated our economic prosperity.

Furthermore, this also explains why the dependency on social welfare programs is at the highest level in history. 


As the use of leverage crept through the system, it slowly chipped away at savings and productive investment. Without savings, consumers can’t consume, producers can’t produce and the economy grinds to a halt.

Regardless of the specific cause, each interest rate reduction that was used from that point forward to stimulate economic growth did, in fact, lead to a recovery in the economy; just not at levels as strong as they were in the previous cycle. Therefore, each cycle led to lower interest rates and economic growth slowed and as a result of consumers and producers turning to credit and savings to finance the shortfall which in turn led to lower productive investment. It was like an undetectable cancer slowing building in the system.

The “Breaking Point” in 1980 was the beginning of the end of the Keynesian economic model.

Hayek Might Have It Right

The proponents of Austrian economics believe that a sustained period of low interest rates and excessive credit creation results in a volatile and unstable imbalance between saving and investment. In other words, low interest rates tend to stimulate borrowing from the banking system which in turn leads, as one would expect, to the expansion of credit. This expansion of credit then, in turn, creates an expansion of the supply of money.

Therefore, as one would ultimately expect, the credit-sourced boom becomes unsustainable as artificially stimulated borrowing seeks out diminishing investment opportunities. Finally, the credit-sourced boom results in widespread malinvestments. When the exponential credit creation can no longer be sustained a “credit contraction” occurs which ultimately shrinks the money supply and the markets finally “clear” which then causes resources to be reallocated back towards more efficient uses.

Unfortunately, as is clearly shown in both charts above, this has hardly been the case.

Time To Wake Up

For the last 30 years, each Administration, along with the Federal Reserve, have continued to operate under Keynesian monetary and fiscal policies believing the model worked. The reality, however, has been most of the aggregate growth in the economy has been financed by deficit spending, credit expansion and a reduction in savings. In turn, this reduced productive investment in the economy and the output of the economy slowed. As the economy slowed and wages fell the consumer was forced to take on more leverage which also decreased savings. As a result of the increased leverage more of their income was needed to service the debt.

Secondly, most of the government spending programs redistribute income from workers to the unemployed. This, Keynesians argue, increases the welfare of many hurt by the recession. What their models ignore, however, is the reduced productivity that follows a shift of resources toward redistribution and away from productive investment.

All of these issues have weighed on the overall prosperity of the economy. What is most telling is the inability for the current economists, who maintain our monetary and fiscal policies, to realize the problem of trying to “cure a debt problem with more debt.”

This is why the policies that have been enacted previously have all failed, be it “cash for clunkers” to “Quantitative Easing”, because each intervention either dragged future consumption forward or stimulated asset markets. Dragging future consumption forward leaves a “void” in the future that has to be continually filled, and creating an artificial wealth effect decreases savings which could, and should have been, used for productive investment.

The Keynesian view that “more money in people’s pockets” will drive up consumer spending, with a boost to GDP being the end result, has been clearly wrong. It hasn’t happened in 30 years.

The Keynesian model died in 1980. It’s time for those driving both monetary and fiscal policy to wake up and smell the burning of the dollar. We are at war with ourselves and the games being played out by Washington to maintain the status quo is slowing creating the next crisis that won’t be fixed with another monetary bailout.

There are two important areas of the market that have historically been good leading indicators of the strength, or weakness, of the markets and the economy. Oil and retail.

Currently, both areas are sending warning signs that should not be readily dismissed. First, with respect to oil, the bounce in oil following the crash in prices that began in 2014 resulted not only in the bulk of the decline in earnings initially but also the recovery in earnings with the bounce. However, that bounce has now faded but forward earnings expectations have likely not been revised lower. Per FactSet, the energy sector is expected currently to post a 396% gain in earnings on a year-over-year basis. Given the recent fall in oil prices, there is a huge risk of disappointment

The biggest issue facing S&P 500 earnings going forward is the analyst community’s “miss” on oil price estimates for the bulk of 2017, not just the second quarter. According to FactSet’s estimates, analysts are expecting the following average prices per barrel for WTI crude for the yet-to-be-reported final three-quarters of 2017:

  • 2Q17: $51.96
  • 3Q17: $54.29
  • 4Q17: $55.72

With oil prices closer to $45 than $50, this could be a problem as, according to FactSet, analysts made the smallest cuts to Q2 earnings-per-share estimates in three years ahead of the reporting season.

Retail is also sending a warning that, despite surging consumer confidence surveys, consumers are not rushing out to “crack open” their wallets. Per Bloomberg Intelligence survey:

  • Retail 2Q sales results may be impaired by weak traffic, as consumers still prefer digital, and they swap shopping for travel, dining out or outdoor recreation
  • Shopping less in-store continues to hurt retailers’ ability to prompt unplanned purchases
  • In the week ending July 1, footfall at luxury retailers was down 9.7%, 8.3% weaker at apparel stores

Considering that retail sales make up roughly 40% of Personal Consumption Expenditures (PCE), which is roughly 70% of the GDP calculation, you can understand why this may well be an issue for the markets going forward. As Tom Lee from BofA noted:

“We have a nominal GDP problem. If real growth is only 2 and inflation expectations are falling, that means nominal growth is only going to be 3. Earnings growth is really essentially going to be 3%, and I think when you see estimates out there that look for 12% growth next year, it’s grounded on this view that inflation picks up and real growth picks up and if neither takes place, then earnings are too high, which is the reason we think estimates are actually way too high out there.”

The risk of disappointment is rising as the hopes for “tax cuts/reform” continue to fade. As Lee concluded:

“I think the problem today is that market growth, the rise in the market has way been ahead of GDP growth.”

Yep. It’s a problem.

In the meantime, this is what I am reading.



Research / Interesting Reads

 “If you are in a poker game and after 20 minutes you don’t know who the patsy is, then you’re the patsy.” – Warren Buffett

Questions, comments, suggestions – please email me.

Over the years, I have regularly addressed the psychological and emotional pitfalls which ultimately lead individual investors to poor outcomes. The internet is regularly littered with a stream of articles promoting the ideas of “dollar cost averaging,” “buy and hold” investing, and “passive indexing” as the solution to achieving your financial dreams.

However, as I addressed in the “Illusion Of Declining Debt To Income,” if this was truly the case, then why is the majority of Americans so financially poor?


But here are some stats from a recent Motley Fool survey:

“Imagine how the 50th percentile of those ages 35 – 44 has a household net worth of just $35,000 – and that figure includes everything they own, any equity in their homes, and their retirement savings to boot.

That’s sad considering those ages 35 and older have had probably been out in the workforce for at least ten years at this point.

And even the 50th percentile of those ages 65+ aren’t doing much better; they’ve got a median net worth of around $171,135, and quite possibly decades of retirement ahead of them.

How do you think that is going to work out?”

So, what happened?

  • Why aren’t those 401k balances brimming over with wealth?
  • Why aren’t those personal E*Trade and Schwab accounts bursting at the seams?
  • Why isn’t there a yacht in every driveway and a Ferrari in every garage?

It’s because investing does NOT WORK they way are you told.  (Read the primer “The Big Lie”)

Here are the 7-Myths you are told that keep you from being a successful investor.

The 7-Myths Of Investing

1) You Can’t Time The Market

Now, let me be clear. I am NOT discussing “market timing” which is specifically being “all in” or “all out” of the market at any given time. The problem with trying to “time” the market is “consistency.”

What I am discussing is “risk” management which is the minimization of losses when things go wrong. While there are many sophisticated methods of handling risk within a portfolio, even using a basic method of price analysis, such as a moving average crossover, can be a valuable tool over long-term holding periods.

The chart below shows a simple moving average crossover study. The actual moving averages used are not important, but what is clear is that using a basic form of price movement analysis can provide a useful identification of periods when portfolio risk should be REDUCED. Importantly, I did not say risk should be eliminated; just reduced.

Again, I am not implying, suggesting or stating that such signals mean going 100% to cash. What I am suggesting is that when “sell signals” are given, it is the time when individuals should perform some basic portfolio risk management.

Using some measure, any measure, of fundamental or technical analysis to reduce portfolio risk as prices/valuations rise, the long-term results of avoiding periods of severe capital loss will outweigh missed short term gains. Small adjustments can have a significant impact over the long run.

2) “Buy and Hold” & “Dollar Cost Average”

While these two mantras have been the “core” of Wall Street’s annuitization and commoditization of the investing business by turning volatile commission revenue into a smooth stream of income, it has clearly not actually worked for the investors that were sold the “scheme.” To two biggest reasons for the shortfalls was:

1) the destruction of investor capital, and;

2) investor psychology. 

Despite the logic behind “buying and holding” stocks over the long term, the biggest single impediment to the success over time is psychology. Behavioral biases that lead to poor investment decision-making is the single largest contributor to underperformance over time. Dalbar defined nine of the irrational investment behavior biases  but the two biggest of these problems for individuals is the “herding effect” and “loss aversion.”

These two behaviors tend to function together compounding the issues of investor mistakes over time. As markets are rising, individuals are lead to believe that the current price trend will continue to last for an indefinite period. The longer the rising trend last, the more ingrained the belief becomes until the last of “holdouts” finally “buys in” as the financial markets evolve into a “euphoric state.”

As the markets decline, there is a slow realization that “this decline” is something more than a “buy the dip” opportunity. As losses mount, the anxiety of loss begins to mount until individuals seek to “avert further loss” by selling.

This behavioral trend runs counter-intuitive to the “buy low/sell high” investment rule and continually leads to poor investment returns over time.

3) More Risk = More Return:

The next “myth” is one that is too often uttered. Investors are continually prodded to take on additional exposure to equities to gain the potential for higher rates of return if everything goes right. What is never discussed, is what happens when everything goes wrong?

If you look up the definition of “risk,” it is “to expose something of value to danger or loss.”

As my partner Michael Lebowitz noted:

“When one assesses risk and return, the most important question to ask is ‘Do my expectations for a return on this investment properly compensate me for the risk of loss?’ For many of the best investors, the main concern is not the potential return but the probability and size of a loss. 

No one has a crystal ball that allows them to see into the future. As such the best tools we have are those which allow for common sense and analytical rigor applied to historical data. Due to the wide range of potential outcomes, studying numerous historical periods is advisable to gain an appreciation for the spectrum of risk to which an investor may be exposed. This approach does not assume the past will conform to a specific period such as the last month, the past few years or even the past few decades. It does, however, reveal durable patterns of risk and reward based upon valuations, economic conditions, and geopolitical dynamics. Armed with an appreciation for how risk evolves, investors can then give appropriate consideration to the probability of potential loss.”

Spending your investment time horizon making up previous losses is not an optimal strategy to build wealth.

4) All The “Cash On The Sidelines” Will Push Prices Higher

How often have we heard this? I busted this myth in detail in “Liquidity Drain” but here is the main point:

Clifford Asness previously wrote:

“There are no sidelines. Those saying this seem to envision a seller of stocks moving her money to cash and awaiting a chance to return. But they always ignore that this seller sold to somebody, who presumably moved a precisely equal amount of cash off the sidelines.”

Every transaction in the market requires both a buyer and a seller with the only differentiating factor being at what PRICE the transaction occurs. Since this must be the case for there to be equilibrium to the markets there can be no “sidelines.” 

Furthermore, despite this very salient point, a look at the stock-to-cash ratios also suggest there is very little available buying power for investors current.

There is no cash on the sidelines.

5) Tax Cuts Will Fuel The Markets

We are told repeatedly that “cutting taxes” will lead to a massive acceleration in economic growth and a boom in earnings. However, as Dr. Lacy Hunt recently discussed, this may not be the case.

“Considering the current public and private debt overhang, tax reductions are not likely to be as successful as the much larger tax cuts were for Presidents Ronald Reagan and George W. Bush. Gross federal debt now stands at 105.5% of GDP, compared with 31.7% and 57.0%, respectively, when the 1981 and 2002 tax laws were implemented. Additionally, tax reductions work slowly, with only 50% of the impact registering within a year and a half after the tax changes are enacted. Thus, while the economy is waiting for increased revenues from faster growth from the tax cuts, surging federal debt is likely to continue to drive U.S. aggregate indebtedness higher, further restraining economic growth.

However, if the household and corporate tax reductions and infrastructure tax credits proposed are not financed by other budget offsets, history suggests they will be met with little or no success. The test case is Japan. In implementing tax cuts and massive infrastructure spending, Japanese government debt exploded from 68.9% of GDP in 1997 to 198.0% in the third quarter of 2016. Over that period nominal GDP in Japan has remained roughly unchanged. Additionally, when Japan began these debt experiments, the global economy was far stronger than it is currently, thus Japan was supported by external conditions to a far greater degree than the U.S. would be in present circumstances.”

The outcome of tax reform/cuts at the tail end of an economic expansion may have much more muted effects than the market has currently already “priced in.”

6) Cash Is For Losers:

Investors are often told that holding cash is fooling. Not only are you supposedly “missing out” on the rocketing “bull market” but you cash is being dwindled away by “inflation.” The problem is, and as I will discuss in a second, is the outcome of taking “cash” and investing that cash into the second most overvalued market in history.

As I discussed in the “Real Value Of Cash:” 

The chart below shows the inflation-adjusted return of $100 invested in the S&P 500 (capital appreciation only using data provided by Dr. Robert Shiller). The chart also shows Dr. Shiller’s CAPE ratio. However, I have capped the CAPE ratio at 23x earnings which has historically been the peak of secular bull markets in the past. Lastly, I calculated a simple cash/stock switching model which buys stocks at a CAPE ratio of 6x or less and moves back to cash at a ratio of 23x.

I have adjusted the value of holding cash for the annual inflation rate which is why during the sharp rise in inflation in the 1970’s there is a downward slope in the value of cash. However, while the value of cash is adjusted for purchasing power in terms of acquiring goods or services in the future, the impact of inflation on cash as an asset with respect to reinvestment may be different since asset prices are negatively impacted by spiking inflation. In such an event, cash gains purchasing power parity in the future if assets prices fall more than inflation rises.

While cash DID lose relative purchasing power, due to inflation, the benefits of having capital to invest at lower valuations produced substantial outperformance over waiting for previously destroyed investment capital to recover.

Much of the mainstream media will quickly disagree with the concept of holding cash and tout long-term returns as the reason to just remain invested in both good times and bad. The problem is it is YOUR money at risk and most individuals lack the “time” necessary to truly capture 30 to 60-year return averages.

7) If You’re Not “In,” You Are Missing Out:

As discussed with respect to “holding cash,” periods of low returns have always followed periods of excessive market valuations. In other words, it is vital to understand the “WHEN” you begin investing that affects your eventual outcome.

The chart below compares Shiller’s 20-year CAPE to 20-year actual forward returns from the S&P 500.

From current levels, history suggests returns to investors over the next 20-years will likely be lower than higher.

The Truth

No one can rely on these “myths” for their financial future.

Again, if the “myths” above weren’t “myths,” wouldn’t there be a whole lot of rich people heading into retirement.

In the end, only three things really matter in investing for the “long-term:”

  1. The price you pay.
  2. When you sell, and;
  3. The “risk” you take.

Get any one of those three things wrong, and your outcome will be far less than you have been promised by Wall Street.

The Federal Reserve Act, as mandated by Congress, established a dual mandate of price stability and maximizing employment to guide the Federal Reserve (Fed) in setting monetary policy. Price stability, the topic of this article, allows investors, corporations, and consumers the ability to better predict future prices and optimally allocate their investments and spending. The benefits pay dividends not only to those directly involved but importantly to the health of the economy and prosperity of the populace as well.

To consider why price stability is important, consider an oil producer deciding whether or not to invest in a new well. To simplify, assume the producer needs only to consider three variables to properly evaluate the project: (A) investment costs (fixed/variable), (B) a reliable estimate of the amount of oil that may be extracted, and (C) the future price of oil. If the expected return (B x C / A) projects a return above their bogey they might go ahead with the project. The company has reasonable control over investment costs and comfort around their surveying methods to determine the well’s success. Missing however, is that they have no control over the price of oil in the future. Therefore, the more stable and predictable the future price of oil, the more confidence the producer will have regarding achieving the expected return and the decision about a new well.

As laid out in the above scenario, the Fed’s price stability objective appears to be constructive for people tasked with making investment decisions. The problem we raise here is not the objective, but how the Fed defines “price stability.” Currently, the Fed believes that their mandate to maintain “price stability” would be met if prices, as measured by the Core Personal Consumption Expenditures deflator (Core PCE- Fed’s preferred inflation gauge), were to increase at a rate of 2% per year.

That mandate, as they define it above, is assumed reasonable and to our knowledge has never been challenged in congressional testimony, Fed press conference or during a question-answer session following a speech.

Ask your spouse, family member or friend what price stability means and they will likely describe a constant price for goods and services over time. Corporate executives and investors would likely answer similarly.

It is this juxtaposition between the Fed’s definition of price stability and the definition most people would use that is worth exploring. More specifically, how has the Fed sold the public on the idea that inflation targeted at 2% and price stability are the same thing? The chart below illustrates two annual rates of price changes to help us answer that question.

In this graph, which is more stable, the blue or the green line?

We venture to guess that the intuitive response is the blue line. The problem with that answer is that it does not consider the effects of consistently rising prices over time.

To maximize profits or quality/quantity of consumption, investors, corporations, and consumers are better served with predictability – the effect of price changes over the long term. Given the long time frames associated with investments, capital expenditures and even the consumption of higher-priced goods, monthly or annual variations in the rate of inflation does not impart much information of value. Longer term price trends and their effects on the value of the dollar are what matter most.

The graph below charts the purchasing power of $100 over a 20 year period using the respective annual inflation rates from the graph above.

At a “stable” 2% rate of annual inflation (blue line), the purchasing power of the dollar will diminish appreciably. Said differently, the car you like today priced at $35,000 will cost $52,000 under a “stable price” regime in 20 years. Conversely, under the random scenario (green line), with less predictable year to year price changes, the purchasing power of the dollar remains largely intact for the entire period. Now reconsider the question asked earlier, which scenario is more stable? Which scenario provides decision-making confidence to the oil executives or anyone else deciding how to invest or spend their money?


As the overhang of debt obligations mount and the productivity of debt declines, America finds itself in a hole. From this difficult position, the massive debt burden must be reduced if we are to generate sustainable economic growth of years past. This task can be done organically or it can be done as it has been for the last 20 years, by manufacturing lower than reasonable interest rates to reduce the debt service burden. The other option is to relieve the debt anvil by way of inflation.

The Fed has opted for the expedient but ill-advised policy path of artificially influencing interest rates lower and inflation targeting. This path is not only destructive for the U.S. dollar, but it is also destructive for the standards of living for citizens, the effects of which are only just beginning to become evident. This policy cocktail to “manage” economic growth has created the optics of prosperity through financial asset price inflation, however, it lacks the requisite economic growth to support valuations. Unfortunately, this cocktail ultimately produces a hangover that only promises to get worse.

There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.” – J.M. Keynes





“There is nothing wrong with America that the faith, love of freedom, intelligence, and energy of her citizens cannot cure.” – Dwight D. Eisenhower

“If we just stick together, and remain true to our ideals, we can be sure that America’s greatest days lie ahead.” – Ronald Reagan

Hope you had a great “Independence Day.” 

On Monday, the market was open for a half-day preceding the “Independence Day” holiday, and with the majority of the “human element” on vacation, the markets surged as the “robots” kicked in to “buy the recent dip.”

As I noted in this past weekend’s missive:

“As noted on Friday, the last couple of weeks have experienced a sharp rise in price volatility. While stocks have vacillated in a very tight 1.5% trading range since the beginning of June, there has been little forward progress to speak of. However, notice that support at 2416 has remained solid as ‘robots’ continue to execute their program of ‘buying the dips.’” 

Of course, the problem is what happens when these algorithms begin to reverse and “sell the rallies?”

That is the question I want to explore today which is simply: “how big of a correction is coming?

For the purpose of this exercise, we will look at the S&P 500 Index as the proxy for the markets and use a Fibonacci retracement measure on a daily, weekly and monthly basis spanning various time frames in the market. The analysis will be run using, for each time frame, the most important previous support levels as the starting point.

A quick explanation on Fibonacci retracements in case you are unfamiliar from

“Fibonacci Retracements are ratios used to identify potential reversal levels. These ratios are found in the Fibonacci sequence. The most popular Fibonacci Retracements are 61.8% and 38.2%. Note that 38.2% is often rounded to 38% and 61.8 is rounded to 62%. After an advance, chartists apply Fibonacci ratios to define retracement levels and forecast the extent of a correction or pullback.

Click the link above if you want more detail.


On a daily price basis, which is more important for shorter term holding periods, the bottoms in 2014 and 2016 provide the strongest base of price support from which to calculate retracement levels.

A correction to each potential support level would be as follows:

38.2% Retracement = 10.04%

50.0% Retracement = 13.07%

61.8% Retracement = 16.18%

100% Retracement = 26.14% (Official Bear Market)

As noted, it would currently require a loss of nearly 500 points on the S&P 500 just to officially enter bear market territory from current levels. As discussed yesterday, such a negative impact to portfolios should not be lightly dismissed.

A correction of this magnitude would wipe out all the gains in portfolios since 2014 erasing 3-years of advancement towards financial goals.

Assuming a 6% annual rate of return it would require an additional 4-years to get back to even effectively destroying 7-years of an investor’s time horizon. 


If we expand our time frame to weekly, the picture changes somewhat. In the following example, the prior market peaks of 2000 and 2008 become critical support for the markets.

A correction to each potential support level would be as follows:

38.2% Retracement = 13.82%

50.0% Retracement = 18.14%

61.8% Retracement = 22.24% (Official Bear Market)

100% Retracement = 36.06% (Average Correction During Recessions)

Don’t dismiss the weekly retracement to previous market peaks. A retracement of 36.06%, as noted, is coincident with the onset of a recessionary drag in the economy. Given the current economic expansion is now the second longest in history, at the lowest rate of annual growth, this is a rising risk to longer-term investors.

A correction of this magnitude would wipe out all the gains in portfolios since 2013 erasing 4-years of advancement towards financial goals.

Assuming a 6% annual rate of return it would require an additional 8-years to get back to even effectively destroying 12-years of an investors total time horizon. 


If we step out further using monthly price data, the longer-term investing picture for investors looks exceedingly more risky.

A correction to each potential support level would be as follows:

38.2% Retracement = 26.57% (Official Bear Market)

50.0% Retracement = 35.29% (Average Correction During A Recession)

61.8% Retracement = 43.56% (Less Than The Financial Crisis & Busts)

100% Retracement = 70.57% (Welcome To The “Great Depression 2.0)

When looking at monthly data, we get the clearest picture of the risk related to each potential phase of a correction.  As noted above, a correction to the first retracement level would in actuality be little more than a normal bear market within an ongoing bull market trend.

A 50% retracement would be normal for a recessionary contraction. Even a 61.8% retracement would be “less worse” than what was seen during the previous two bear markets.

Even the most outlandish correction back to previous bear market lows would be LESS THAN the 85% correction witnessed by the Dow following the 1929 peak.

My point is that none of the possibilities should be readily dismissed. They have all happened before and some with more regularity than others.

Here is the important point for each correction level noted above if we assume you are expecting 6% annual rates of return and have a finite time to reach your retirement goals.

A 26.57% correction resets portfolios back to 2014 and requires almost 6-years to get back to even. Total time horizon destroyed is 9-years.

A 35.29% correction resets portfolios back to 2000 and requires almost 8-years to get back to even. Total time horizon destroyed is 25-years. 

A 43.56% correction resets portfolios back to 1999 and requires almost 10-years to get back to even. Total time horizon destroyed is 28-years.

A 70.57% correction resets portfolios back to 1997 and requires 21-years to get back to even. Total time horizon destroyed is 42-years.


While some of these corrections MAY seem outlandish to you currently, giving the current exuberance in the markets, they have all occurred at one point or another in the past. Usually, such corrections have generally occurred at about the same juncture where the majority of investors had come to embrace the “this time is different” mantra.

I am not suggesting that any of the above corrections will happen tomorrow, next month or even this year. But I am stating that a correction will come. The analysis above simply tries to assess the magnitude of such a correction AND the consequences of not “managing risk” in your portfolio.

While the idea of “buying and holding” and “robot driven” allocations is certainly appealing in a seemingly “can’t lose” market, the problem for investors is “when” they occur.

Time is the most precious commodity ANY investor has. Disregarding the impact of time horizons when managing your investments can have very negative consequences. 

Just remember, in the market there really isn’t such a thing as “bulls” and “bears.” However, there are those that “succeed” in reaching their investing goals and those that “fail.” 

At Real Investment Advice, we have revised the staid definition of diversification so that investors will not be caught off guard by what the financial industry preaches. Read: Never Look At Diversification The Same Way Again.

Ownership of rental property could be considered a true diversifier and complement to an overall investment portfolio strategy. Unlike publicly-traded real estate investment trusts or “REITS,” which experience cycles of positive correlation or connection to the moves in the broader stock market like the S&P 500, real property purchased to generate a supplementary stream of income, especially throughout the early phases of retirement, generally is a unique asset class which doesn’t connect at all to gyrations of the stock market.

However, residential rental property isn’t for every investor.

For some, it’s a romantic notion, sounds good in theory, until they experience how much time and effort it takes to select the right property, deal with renters, have a plan for upkeep, and understand that unlike more traditional, liquid investments such as stocks, that it’s tough to unwind from mistakes.

Here are 5 things to consider before prospective investors move forward.

1) A primary residence turned into rental property could be an emotional price that’s not worth the additional cash flow.

I lived this one – that’s why I’m sharing the experience.

Close to a couple of years back, I regrettably broke through one of the financial guardrails (#3), I now preach to others. Read: Financial Guardrails: Financial Planning Rules Of The Road.

I purchased a home for an expected life change, as I was planning to remarry. I allowed another person to cross my financial boundaries. I didn’t say “no.” She lied about a “yes.” And it cost me six figures, not chump change. Ostensibly, the idea was to turn my former primary residence (which I should have never left), into a rental and purchase a new place closer to her employment along with amenities I knew she’d enjoy.

One problem was my ongoing emotional attachment to the old homestead. Oh, the renters were fiscally responsible, the money always came in on time; however, the young couple with children didn’t have the commitment to maintain the property like I did. The landscaping eventually succumbed to Texas heat and deteriorated to resemble an abandoned property, post-apocalypse.

I’d stress constantly over how a house I lived in and cared for was not being maintained; eventually, I spent thousands of dollars getting it back to presentable (and more), which wiped out most of the positive cash flow I received.

It kept me up at night wondering how the interior was being sustained. I realized it wasn’t worth the stress and made a decision to move back into my property once the two-year lease concluded which meant I needed to stress over this oh, for another year and a half. I was thankful when the renters broke the lease a year early to move out of state.

You see, when it comes to investments, you must remain unemotional. We preach this sentiment consistently at RIA. Once your primary residence is re-classified as a rental property in your overall financial-life portfolio, make certain there are no mental obstacles to tackle, first. I learned this lesson after the fact.

If you believe that a former residence can be a rental, there are plenty of resources available to help qualify renters, be the go-between on maintenance items, collect rent and hold security deposits, provide tax documentation, leasing agreements and overall management of the property. Fees are usually a first month or two’s rent along with a nominal monthly fee.

2) Know your potential market inside and out.

Professional residential real estate investors don’t rush into investment decisions. As a matter of fact, I’ve witnessed the most successful of this group undertake a couple of years of thorough due diligence. They live and breathe the cluster or neighborhood they’re interested in. They live close, within 15 miles of the area of interest.

Serious buyers drive every neighborhood and document observations about the quality of structural upkeep and how it changes from street to street. Potential investors study the quality of the school districts, the number of rentals, how long properties remain on the market, property tax history, work with tenured real estate agents, tax advisors who guide them on possible benefits like depreciation and mortgage specialists to understand the interest rate environment. Lending rates on investment real estate tend to be higher, less attractive than what’s available for primary residences (in which you plan to occupy).

If you can’t put in the hours of homework because of your current schedule and family commitments, it’s best to wait and include real estate investing in your overall plan as time permits.

3) Real Investment Advice’s rental real estate down payment and debt management rules.

Do you possess adequate liquidity (savings) to purchase real estate for investment purposes? Can your household balance sheet handle the purchase, maintenance and taxes, especially if properties are empty for extended periods between renters?

Real estate investing where you’re seeking ownership of one or several homes, should only occur once your finances have reached a level where you’re successfully funding retirement goals. In our experience, we see disciplined savers, mid-forties to early sixties in age, who are in prime savings and earnings years consider primary rental real estate.

Interested parties tend to maximize funding to retirement plans first, possibly “over” fund permanent life insurance (yes, permanent life insurance can supplement retirement income), long-term care policies and have accumulated more than one year’s worth of living expenses in a cash reserve. Many are seeking (after formal retirement planning), a venture to keep them busy throughout retirement and additional household cash flow outside of conventional liquid avenues.

To determine if you qualify to purchase rental real estate, RIA suggests you consider the following guardrails:

  • Make certain to have at least a three-year track record of maximizing funding to all retirement accounts, health savings accounts and hold at least one year’s worth of living expenses in an emergency reserve vehicle like a savings account or money market.
  • Have the ability to limit the use of leverage (or mortgage), to no greater than 50% of the purchase price of a rental property.
  • You have taken action to mitigate financial and mortality risk with adequate life, disability and long-term care insurance coverage (which may be determined by meeting with a Certified Financial Planner or qualified insurance agent).
  • Create a rule to take into account management, vacancy and maintenance fees and still generate positive cash flow or rental income that exceeds expenses. Generally, 25% of your rental income should be allocated to expenses.
  • Stick to a two-year cash buildup period where positive rental income proceeds are allocated to a savings reserve to build what I call, a “rental property contingency fund.”

4) Be prepared for the worst.

A working investor couple I counsel lost a renter, required a roof and a new HVAC system. All at the same time. Since they followed the guardrails, there was adequate cash set aside to pay for half of these items out of pocket.

You see, they’ve been putting aside two years of positive cash flow in a savings account which helped them weather unfortunate circumstances and wait for a qualified renter (it took 3 months), without experiencing household financial distress.

5) Never lose sight of the market that interests you.

Like any investment, savvy real estate investors have an exit strategy even if it’s decades down the road. There’s a point where the liquidity from sold properties may be required to fund burdening healthcare, long-term care and senior housing choices. Active retirees eventually grow less active and not able nor willing to keep up with the ongoing responsibilities of rental real estate.

Investors maintain meticulous track of all improvements that affect cost basis as selling a property could eventually result in long-term capital gains.

I’ve learned from those who hold rental real estate for at least 10 years that they never stop monitoring market trends in property taxes, gentrification, school quality, rentals, foreclosures and sales. They gather intelligence by maintaining long-term relationships with experienced realtors who with “boots on the ground,” can provide qualitative information not reflected in the numbers.

Primary rental real estate can provide true diversification, unlike stocks and other liquid investments.

Unfortunately, it can be an illiquid nightmare if rules aren’t followed, especially if markets sour.

Like anything else, real estate cycles.

Experienced real estate owners prepare upfront as they know and expect, over the lifetime of an investment, that the cycle will turn on them.

The successful ones are able to weather the downturns and not place their entire financial picture in jeopardy.

Last week, I received the following email from a reader which I thought was worth further discussion.

“In a recent article “Signs of Excess – Crowding and Innovation” Lance stated ‘Note the chart above is what has happened to a $100,000 investment in the S&P Index. While the S&P index has soared past previous highs, a $100,000 dollar investment has just recently gotten back to even. This demonstrates the important difference about the impact of losses on a dollar-based portfolio on investments versus a market-cap weighted phantom index.” – M. Fitzpatrick

It’s a great question.

Almost daily there is an article touting the soaring “bull market” which is currently hovering near its highest levels in history. The chart below is based on quarterly data back to 1990 and is nominal (not adjusted for inflation) which is how it is normally presented to investors.

The Big Lie

The “Big Lie” is that you can “beat an index” over an extended period of time.

You can’t, ever.

Let me explain.

While individuals are inundated with a plethora of opinions on why the index is moving up or down from one day to the next, a portfolio of dollars invested in the market is vastly different than the index itself. I have pointed out the problems of benchmarking previously stating:

  1. The index contains no cash
  2. It has no life expectancy requirements – but you do.
  3. It does not have to compensate for distributions to meet living requirements – but you do.
  4. It requires you to take on excess risk (potential for loss) in order to obtain equivalent performance – this is fine on the way up, but not on the way down.
  5. It has no taxes, costs or other expenses associated with it – but you do.
  6. It has the ability to substitute at no penalty – but you don’t.
  7. It benefits from share buybacks – but you don’t.

Furthermore, it is also not representative what happens to real dollars invested in the financial markets which are impacted by changes in inflation. The chart below compares the break even times for the nominal index versus an inflation-adjusted index and $100,000 investment into the index.

You will notice in the $100,000 portfolio that investors, once the impact of inflation is added, just got back to even after 16-years of their investment time horizon was lost. The problem with that, as I noted in “The World’s Second Most Deceptive Chart” is the impact of life expectancy on reaching investment goals. To wit:

“For consistency from last week’s article, we will assume the average starting investment age is 35. We will also assume the holding period for stocks is equal to the life expectancy less the starting age. The chart below shows the calculation of total life expectancy (based on the average of males and females) from 1900-present, the average starting age of 35, and the resulting years until death. I have also overlaid the rolling average of the 20-year total, real returns and valuations.”

Here is what you should take away from the two graphs above. Assuming that an individual was 35 at the peak of “” bubble, they are now 51 years of age and are no closer to their goals than they were 16 years ago. Assuming they will retire at 65, this leaves precious little time to reach their retirement goals. 

Of course, this is repeatedly proved out in survey after survey which shows a majority of Americans are woefully behind in their savings goals for retirement.

Of course, this is due to one of the most egregious investing “myths” in the financial world today:

The power of compounding is the most powerful force in investing.” 

Markets Don’t Compound 

There is a massive difference between AVERAGE and ACTUAL returns on invested capital. The impact of losses, in any given year, destroys the annualized “compounding” effect of money.

The chart below shows the impact of losses on a portfolio as compared to the commonly perceived myth that investors “average 8%” annually in the stock market.

As you can see, while investors did finally get back to even by just “buying and holding” their investments, they are far short of the goals they needed to achieve financial security. The problem is due to the fact we “anchor” to our original “peak investment valuation” rather than our ultimate goal.

However, let’s take this one step further and look at a $1000 investment for each peak and trough valuation period with the assumption of a real, total return holding period until death based on life expectancy tables. No withdrawals were ever made. (Note: the periods from 1983 forward are still running as the investable life expectancy span is 40-plus years.)

The gold sloping line is the “promise” of 6% annualized compound returns. The blue line is what actually happened with invested capital from 35 years of age until death, with the bar chart at the bottom of each period showing the surplus or shortfall of the goal of 6% annualized returns.

Again, in every single case, at the point of death, the invested capital is short of the promised goal.

The difference between “close” to goal, and not, was the starting valuation level when investments were made.

This is why, as I discussed in “The Fatal Flaws In Your Retirement Plan,” that you must compensate for both starting period valuations and variability in returns when making future return assumptions. If you calculate your retirement plan using a 6% compounded growth rates (much less 8% or 10%) you WILL fall short of your goals. 

Hang On…That’s Not The End Of Story

There is one more calculation that needs to be accounted for that is too often left out of the “just buy an index because you can’t beat the index” meme.

Let me just state again, as noted above, NO ONE can beat an arbitrary, hypothetical, index. PERIOD.


Because of inflation, taxes, and expenses.

The chart below once again returns us to our $100,000 invested into the nominal index versus a $100,000 portfolio adjusted for “reality.”

$100,000 invested in 1998 has had a compounded annual growth rate of 6.72% on a nominal basis as compared to just a 4.39% rate when adjusted for reality. The numbers are far worse if you started in 2000 or 2008.

Furthermore, both numbers also fall far short of the promised 8% annualized rates of return often promised by the mainstream analysts promising riches if you just buy their investment product or service and hang on long enough.

The reality is, as proven repeatedly over time, such an outcome will likely prove to be extremely disappointing.

In order to win the long-term investing game, your portfolio should be built around the things that matter most to you.

– Capital preservation

– A rate of return sufficient to keep pace with the rate of inflation.

– Expectations based on realistic objectives.  (The market does not compound at 8%, 6% or 4%)

– Higher rates of return require an exponential increase in the underlying risk profile.  This tends to not work out well.

– You can replace lost capital – but you can’t replace lost time.  Time is a precious commodity that you cannot afford to waste.

– Portfolios are time-frame specific.  If you have a 5-years to retirement but build a portfolio with a 20-year time horizon (taking on more risk) the results will likely be disastrous.

As I wrote previously:

“The index is a mythical creature, like the Unicorn, and chasing it takes your focus off of what is most important – your money and your specific goals. Investing is not a competition and, as history shows, there are horrid consequences for treating it as such.”

So, do yourself a favor and forget about what the benchmark index does from one day to the next. Focus instead on matching your portfolio to your own personal goals, objectives, and time frames. In the long run, you may not beat the index but you are likely to achieve your own personal goals.

But isn’t that why you invested in the first place?

Over the last couple of week’s, volatility has certainly picked up. As shown in the chart below, stocks have vacillated in a 1.5% trading range ever since the beginning of June. (Chart through Thursday)

Despite the pickup in volatility, support for the market has remained firm. Importantly, this confirms the conversation I had with Kevin Massengill of Meraglim just recently discussing the impact of Algorithmic Trading and how they are simultaneously currently all “buying the dip.” As he notes, this is all “fine and dandy” until the robots all decide to start “selling rallies” instead. (Start at 00:02:40 through 00:04:00)

But even with the recent pickup in volatility, volatility by its own measure remains extremely compressed and near its historical lows. While extremely low volatility is not itself an immediate issue, like margin debt, it is the “fuel” that when ignited “burns hot” during the reversion process.

Currently, as we head into the extended July 4th weekend, the bull market trend remains clearly intact. With the “accelerated advance” line holding firm on Thursday’s sell-off, but contained below the recent highs, there is little to suggest the advance that began in early 2016 has come to its final conclusion.

However, such a statement should NOT be construed as meaning it WON’T end as it more assuredly will. The only questions are simply when and how deep the subsequent reversion will be?

Volatility is creeping back. The trick will be keeping it contained.

In the meantime, this is what I am reading over the long holiday weekend.

Happy Independence Day.




Research / Interesting Reads


Life is [Stocks] are a fragile thing. One minute you’re chewin’ on a burger, the next minute you’re dead meat.” – Adopted From Lloyd, “Dumb and Dumber”

Questions, comments, suggestions – please email me.