Tag Archives: financial planning

10 Planning Rules that Drive Financial Success


Are You A “Basement” Thinker?

Too often, we tend to focus on individual stocks and other investments that will hopefully lead to wealth. 

While that is O.K., it isn’t enough.

The issue is investing without a sound “plan” is the same as building a house without a “blueprint.” Yes, you will get something, but it probably won’t be the result you set out to get.

Be A Rooftop Thinker!

By starting with a proper plan you take into account all assets, liabilities and sources of income. From there it becomes much easier to focus on the investments YOU NEED to meet your financial goals.

Work from rooftop to basement for financial success!

Investment Manager, Lance Roberts and Certified Financial Planner, Richard Rosso we’ll help you understand:

  1. How proper Social Security and Medicare strategies can boost retirement income,
  2. Our concept of financial life benchmarking which is there to help you become more self aware of your financial goals, wants and needs,
  3. How using the wrong, or enthusiastic investment returns can place your retirement in jeopardy,
  4. When housing decisions in retirement can affect your quality of life, and;
  5. The art of talking about your gifting and estate intentions with loved ones.

This 30-minute webinar can keep your from making costly investment mistakes and help bring clarity to your future financial plan.

If you would like to access this recorded webinar please click here.

Anatomy of The Bear. Lessons from Russell Napier.

One of my annual re-reads is Russell Napier’s classic tome “Anatomy of the Bear.”

A mandatory study for every financial professional and investor who seeks to understand not only how damaging bear markets can be but also the traits which mark their bottoms. Every bear is shaken from hibernation for different reasons. However, when studying the four great bottoms of bears in 1921, 1932, 1949 and 1982, there are several common traits to these horrendous cycles.  I thought it would be interesting to share them with you.

First, keep in mind, bear markets characteristically purge weakness – weak companies, weak advisors, weak investors. I want you to consider them less a bloodletting and more a cleansing of a system. There will be unsuitable investors who will never return to the market and justifiably so. Businesses that were patronized pre-Covid, will either be gone or completely reinvent. Bear markets slash equity valuations. Unfortunately, this doesn’t mean that stocks return to healthy valuations quickly after a bear departure. Some believe the global economy can turn on and off like a light switch without major repercussions. In other words,  the belief is once the worst of this horrid virus ceases,  business activity invariably will return to normal. I believe it’ll be quite the contrary.

I mentioned on the radio show in December that I expected wage growth to top out in 2019. Keep in mind, through this yet another outlier economic upheaval, there will be employers who will realize they don’t require as many employees and will let them go or cap their wages for years to rebuild profit margins. Without the tailwind of stock buybacks to equity prices, corporate employees will bear the brunt of the pain. In addition, organizations will realize many of their remaining employees are equipped to work from home and perhaps gather in-person perhaps once a month or every couple of weeks. Thus, large commercial space will no longer be required which is going to require massive reinvention by the commercial real estate industry.
The cry of nationalism will rise. Products manufactured overseas especially China, will take a hit which means Americans will face greater inflationary challenges while also dealing with muted or non-existent wage growth. We will experience ‘ more money chasing too-few goods.’ Many, especially younger generations will continue to strip themselves down to basics (I especially envision this in Generation Z;  those born in the mid-late 1990s such as my daughter Haley).  This sea-change will require most of the U.S. population to finally live below their means, dramatically downsize, reinvent, expand, the definition of wealth to include more holistic, ethereal methods that go way beyond household balance sheets and dollars.
I hope I’m wrong. So very wrong about most of what I envision for the future.
Here are several traits that every major market bottom share – courtesy of Russell Napier:

  1. Bears tend to die on low volume, at least the big bears do. 

Low volume represents a complete disinterest in stocks. Keep in mind this clearly contradicts the tenet which states that bears end with one act of massive capitulation – a  downward cascade on great volume. Those actions tend to mark the beginning of a bear cycle, not the end. A rise in volume on rebounds, falling volumes on weakness would better mark a bottoming process in a bear market.

2. Bears are tricky.

There will appear to be a recovery; an ‘all-clear’ for stock prices. It’ll suck in investors who believe the market recovery is upon us just to be financially ravaged again. Anecdotally, I know this cycle isn’t over as I still receive calls from people who are anxious to get into the market and perceive the current market a buying opportunity. At the bottom of a bear, I should be hearing great despair and clear disdain for stock investing.

3. Bears can be tenacious.

They refuse to die or at the least, quickly return to hibernation. The 1921 move from overvaluation to undervaluation took over ten years. Bear markets, where three-year price declines make overvalued equities cheap, are the exception, not the rule. As of this writing,  the Shiller P/E is at 24x – hardly a bargain.  At the bottom market cycle of the Great Recession, the Shiller CAPE was at 15x. There is still valuation adjustment ahead.

4. Bears can depart before earnings actually recover.

Investors who wait for a complete recovery in corporate earnings will arrive late to the stock-investment party.  Most likely it’s going to take a while (especially with their debt burden), for the majority of U.S. companies to reflect healthy earnings growth. CEOs who employ stock buybacks to boost EPS will be considered pariahs and gain unwanted attention from Congress and even the Executive Branch. My thought is a savvy investor should look to minimize indexing and select individual stocks with strong balance sheets which include low debt and plenty of free cash flow within sectors and industries that are nimble to adjust to the global economy post-crisis.

5. Bear market damage can be inconceivable, especially to a generation of investors who never experienced one.

The bear market of 1929-32 was characterized by an 89% decline. The average is 38% for bears;  however, averages are misleading. I have no idea how much damage this bear ultimately unleashes. The closest comparison I have is the 1929-1932 cycle. However, with the massive fiscal and monetary stimulus (and I don’t believe we’ve seen the full extent of it yet),  my best guess is a bear market contraction somewhere between the Great Depression and Great Recession. At the least, I believe we re-test lows and this bear is a 40-45% retracement from the highs.

6. Bear markets end on the return of general price stability and strong demand for durables such as autos.

In 1949, as in 1921 and 1932, a return of general price stability coincided with the end of the equity bear market. Demand and price stability of selected commodities augured well for general price stabilization.  Watch how industrial metals recover such as copper, now at the lowest levels since the fall of 2017. The Baltic Dry Index is off close to 20% so far this year. Low valuations (not there yet), when combined with a return to normalcy in the general price level, may provide the best opportunity for future above-average equity returns. We are not there.

7. Bear markets that no longer decline on bad news are a positive.

The combination of large short positions in conjunction with a market that fails to decline on bad news was overall a positive indicator of a rebound in 1921, 1932 and 1949. Also, limited stock purchases by retail investors may be considered an important building block for a bottom.  Since the worst of economic numbers haven’t been witnessed yet, there remains too much hope of a vicious recovery in stock prices as well as the overall global economies.

8. Not all bear markets lead the economy by six-to-nine months.

Generally, markets lead the economy. However, this tenet failed to hold true for the four great bears. At extreme times, the bottoms for the economy and the equity market were aligned and in several cases, the economy LED stocks higher!  It’s unclear whether this bear behaves in a similar fashion only because of massive fiscal and monetary stimulus. We’re not done with stimulus methods either. If anything, they’ve just begun! I know. Tough to fathom.

For me and the RIA Team, every bear provides an important lesson. The beast comes in all sizes; their claws differ in sharpness. However, they are all dangerous to financial wealth.

I believe the market will eventually witness a “V” shaped recovery due to unprecedented stimulus. Unfortunately, I believe the economy will remain sub-par for a long period. Here’s a vision I shared on Facebook recently:

Let me give you one example how an economy cannot turn off, then on, like a light switch.

Joe’s Donuts is closed. Joe lets his 2 employees go, at least temporarily. Joe employs his wife Emily to assist as she’s just been laid off from her job. Joe is a quick thinker. He creates pre-packaged dough-to-go bags and sells them outside the store. His sales are off 75% as most businesses around him are shuttered. Joe was able to negotiate postponement of his rent for one month but will have to pay two months in May.

Joe has a profitable business but he’s already eaten through a quarter of his cash reserves to pay for supplies, maintain expenses to keep going. He can’t afford another month of quarantine.

The quarantine is lifted May 1 (best case scenario). Joe’s establishment is open! He’s hesitant to have employees return because he wants to gauge business for a month. He discovers that business is still off 40% from last year at the same time. Why? Because his patrons have either been let go or in repair of ravaged household balance sheets. In addition, he notices that purchasing boxes of donuts for office meetings is way off.

Joe contacts his former 2 employees. He tells them he still doesn’t require them. He’s handling the traffic sufficiently alone at this time. Joe now owes 2 months of rent. He takes one month from the business’ reserve account; distributes another from his retirement account.

Joe’s wife Ellen has been called back to work by her former employer, a local car dealership. She’s been asked to work the same job, same responsibilities. However, the pay is 10% less. Out of desperation, she takes the job. Meanwhile, Joe tells Ellen that they need to find a way to continue to cut household expenses…. Well, you get the picture.

I think this is reality for at least a year after the ‘all clear.’

There’s never been a better time to catch up on reading. Russell’s book is available through Amazon. For those interested in market history,  the pages hold invaluable insights.

For me, markets are always battlefields, but I’ve survived several conflicts.

Consider “Anatomy of The Bear,” part of your financial literary war chest.

#MacroView: The Fed Can’t Fix What’s Broken

“The Federal Reserve is poised to spray trillions of dollars into the U.S. economy once a massive aid package to fight the coronavirus and its aftershocks is signed into law. These actions are unprecedented, going beyond anything it did during the 2008 financial crisis in a sign of the extraordinary challenge facing the nation.” Bloomberg

Currently, the Federal Reserve is in a fight to offset an economic shock bigger than the financial crisis, and they are engaging every possible monetary tool within their arsenal to achieve that goal. The Fed is no longer just a “last resort” for the financial institutions, but now are the lender for the broader economy.

There is just one problem.

The Fed continues to try and stave off an event that is a necessary part of the economic cycle, a debt revulsion.

John Maynard 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 force producers to take defensive actions to reduce output. Such a confluence of actions would lead to a recession.

On Thursday, initial jobless claims jumped by 3.3 million. This was the single largest jump in claims ever on record. The chart below shows the 4-week average to give a better scale.

This number will be MUCH worse next week as many individuals are slow to file claims, don’t know how, and states are slow to report them.

The importance is that unemployment rates in the U.S. are about to spike to levels not seen since the “Great Depression.” Based on the number of claims being filed, we can estimate that unemployment will jump to 20%, or more, over the next quarter as economic growth slides 8%, or more. (I am probably overly optimistic.)

More importantly, since the economy is 70% driven by consumption, we can approximate the loss in full-time employment by the surge in claims. (As consumption slows, and the recession takes hold, more full-time employees will be terminated.)

This erosion will lead to a sharp deceleration in economic confidence. Confidence is the primary factor of consumptive behaviors, which is why the Federal Reserve acted so quickly to inject liquidity into the financial markets. While the Fed’s actions may prop up financial markets in the short-term, it does little to affect the most significant factor weighing on consumers – their job. 

Another way to analyze confidence data is to look at the consumer expectations index minus the current situation index in the consumer confidence report.

This measure also says a recession is here. The differential between expectations and the current situation, as you can see below, is worse than the last cycle, and only slightly higher than prior to the “dot.com” crash. Recessions start after this indicator bottoms, which has already occurred.

Importantly, bear markets end when the negative deviation reverses back to positive. Currently, we have only just started that reversion process.

While the virus was “the catalyst,” we have discussed previously that a reversion in employment, and a recessionary onset, was inevitable. To wit:

“Notice that CEO confidence leads consumer confidence by a wide margin. This lures bullish investors, and the media, into believing that CEO’s really don’t know what they are doing. Unfortunately, consumer confidence tends to crash as it catches up with what CEO’s were already telling them.

What were CEO’s telling consumers that crushed their confidence?

“I’m sorry, we think you are really great, but I have to let you go.” 

Confidence was high because employment was high, and consumers operate in a microcosm of their own environment.

“[Who is a better measure of economic strength?] Is it the consumer cranking out work hours, raising a family, and trying to make ends meet? Or the CEO of a company who is watching sales, prices, managing inventory, dealing with collections, paying bills, and managing changes to the economic landscape on a daily basis? A quick look at history shows this level of disparity (between consumer and CEO confidence) is not unusual. It happens every time prior to the onset of a recession.

Far From Over

Why is this important?

Hiring, training, and building a workforce is costly. Employment is the single largest expense of any business, but a strong base of employees is essential for the prosperity of a business. Employers do not like terminating employment as it is expensive to hire back and train new employees, and there is a loss of productivity during that process. Therefore, CEOs tend to hang onto employees for as long as possible until bottom-line profitability demands “leaning out the herd.” 

The same process is true coming OUT of a recession. Companies are “lean and mean” and are uncertain about the actual strength of the recovery. Again, given the cost to hire and train employees, they tend to wait as long as possible to be certain of justifying the expense.

Simply, employers are slow to hire and slow to fire. 

While there is much hope that the current “economic shutdown” will end quickly, we are still very early in the infection cycle relative to other countries. Importantly, we are substantially larger than most, and on a GDP basis, the damage will be worse.

What the cycle tells us is that jobless claims, unemployment, and economic growth are going to worsen materially over the next couple of quarters.

“But Lance, once the virus is over everything will bounce back.” 

Maybe not.

The problem with the current economic backdrop, and mounting job losses, is the vast majority of American’s were woefully unprepared for any type of disruption to their income going into recession. As discussed previously:

“The ‘gap’ between the ‘standard of living’ and real disposable incomes is shown below. Beginning in 1990, incomes alone were no longer able to meet the standard of living so consumers turned to debt to fill the ‘gap.’ However, following the ‘financial crisis,’ even the combined levels of income and debt no longer fill the gap. Currently, there is almost a $2654 annual deficit that cannot be filled.”

As job losses mount, a virtual spiral in the economy begins as reductions in spending put further pressures on corporate profitability. Lower profits lead to more unemployment, and lower asset prices until the cycle is complete.

While the virus may end, the disruption to the economy will last much longer, and be much deeper, than analysts currently expect. Moreover, where the economy is going to be hit the hardest, is a place where Federal Reserve actions have the least ability to help – the private sector.

Currently, businesses with fewer than 500-employees comprise almost 60% of all employment. 70% of employment is centered around businesses with 1000-employees, or less. Most of the businesses are not publicly traded, don’t have access to Wall Street, or Federal Reserve’s bailouts.

The problem with the Government’s $2 Trillion fiscal stimulus bill is that while it provides one-time payments to taxpayers, which will do little to extinguish the financial hardships and debt defaults they will face.

Most importantly, as shown below, the majority of businesses will run out of money long before SBA loans, or financial assistance, can be provided. This will lead to higher, and a longer-duration of, unemployment.


What does this all mean going forward?

The wealth gap is going to explode, demands for government assistance will skyrocket, and revenues coming into the government will plunge as trillions in debt issuance must be absorbed by the Federal Reserve. 

While the top one-percent of the population will exit the recession relatively unscathed, again, it isn’t the one-percent I am talking about.

It’s economic growth. 

As discussed previously, there is a high correlation between debts, deficits, and economic prosperity. To wit:

“The relevance of debt growth versus economic growth is all too evident as shown below. Since 1980, the overall increase in debt has surged to levels that currently usurp the entirety of economic growth. With economic growth rates now at the lowest levels on record, the growth in debt continues to divert more tax dollars away from productive investments into the service of debt and social welfare.”

However, simply looking at Federal debt levels is misleading.

It is the total debt that weighs on the economy.

It now requires nearly $3.00 of debt to create $1 of economic growth. This will rise to more than $5.00 by the end of 2020 as debt surges to offset the collapse in economic growth. Another way to view the impact of debt on the economy is to look at what “debt-free” economic growth would be. 

In other words, without debt, there has been no organic economic growth.

Notice that for the 30-year period from 1952 to 1982, the economic surplus fostered a rising economic growth rate, which averaged roughly 8% during that period. Since then, the economic deficit has only continued to erode economic prosperity.

Given the massive surge in the deficit that will come over the next year, economic growth will begin to run a long-term average of just one-percent. This is going to make it even more difficult for the vast majority of American’s to achieve sufficient levels of prosperity to foster strong growth. (I have estimated the growth of Federal debt, and deficits, through 2021)

The Debt End Game

The massive indulgence in debt has simply created a “credit-induced boom” which has now reached its inevitable conclusion. While the Federal Reserve believed that creating a “wealth effect” by suppressing interest rates to allow cheaper debt creation would repair the economic ills of the “Great Recession,” it only succeeded in creating an even bigger “debt bubble” a decade later.

“This unsustainable credit-sourced boom led to artificially stimulated borrowing, which pushed money into diminishing investment opportunities and widespread mal-investments. In 2007, we clearly saw it play out “real-time” in everything from sub-prime mortgages to derivative instruments, which were only for the purpose of milking the system of every potential penny regardless of the apparent underlying risk.”

In 2019, we saw it again in accelerated stock buybacks, low-quality debt issuance, debt-funded dividends, and speculative investments.

The debt bubble has now burst.

Here is the important point I made previously:

“When credit creation can no longer be sustained, the markets must clear the excesses before the next cycle can begin. It is only then, and must be allowed to happen, can resources be reallocated back towards more efficient uses. This is why all the efforts of Keynesian policies to stimulate growth in the economy have ultimately failed. Those fiscal and monetary policies, from TARP and QE, to tax cuts, only delay the clearing process. Ultimately, that delay only deepens the process when it begins.

The biggest risk in the coming recession is the potential depth of that clearing process.”

This is why the Federal Reserve is throwing the “kitchen sink” at the credit markets to try and forestall the clearing process.

If they are unsuccessful, which is a very real possibility, the U.S. will enter into a “Great Depression” rather than just a “severe recession,” as the system clears trillions in debt.

As I warned previously:

“While we do have the ability to choose our future path, taking action today would require more economic pain and sacrifice than elected politicians are willing to inflict upon their constituents. This is why throughout the entirety of history, every empire collapsed eventually collapsed under the weight of its debt.

Eventually, the opportunity to make tough choices for future prosperity will result in those choices being forced upon us.”

We will find out in a few months just how bad things will be.

But I am sure of one thing.

The Fed can’t fix what’s broken.

While the financial media is salivating over the recent bounce off the lows, here is something to think about.

  • Bull markets END when everything is as “good as it can get.”
  • Bear markets END when things simply can’t “get any worse.”

We aren’t there yet.

Fed Trying To Inflate A 4th Bubble To Fix The Third

Over the last couple of years, we have often discussed the impact of the Federal Reserve’s ongoing liquidity injections, which was causing distortions in financial markets, mal-investment, and the expansion of the “wealth gap.” 

Our concerns were readily dismissed as bearish as asset prices were rising. The excuse:

“Don’t fight the Fed”

However, after years of zero interest rates, never-ending support of accommodative monetary policy, and a lack of regulatory oversight, the consequences of excess have come home to roost. 

This is not an “I Told You So,” but rather the realization of the inevitable outcome to which investors turned a blind-eye too in the quest for “easy money” in the stock market. 

It’s a reminder of the consequences of “greed.” 

The Liquidity Trap

We previously discussed the “liquidity trap” the Fed has gotten themselves into, along with Japan, which will plague economic growth in the future. To wit:

“The signature characteristics of a liquidity trap are short-term interest rates that are near zero and fluctuations in the monetary base that fail to translate into fluctuations in general price levels.

Our “economic composite” indicator is comprised of 10-year rates, inflation (CPI), wages, and the dollar index. Importantly, downturns in the composite index leads GDP. (I have estimated the impact to GDP for the first quarter at -2% growth, but my numbers may be optimistic)

The Fed’s problem is not only are they caught in an “economic liquidity trap,” where monetary policy has become ineffective in stimulating economic growth, but are also captive to a “market liquidity trap.”

Whenever the Fed, or other Global Central Banks, have engaged in “accommodative monetary policy,” such as QE and rate cuts, asset prices have risen. However, general economic activity has not, which has led to a widening of the “wealth gap” between the top 10% and the bottom 90%. At the same time, corporations levered up their balance sheets, and used cheap debt to aggressively buy back shares providing the illusion of increased profitability while revenue growth remained weak. 

As I have shown previously, while earnings have risen sharply since 2009, it was from the constant reduction in shares outstanding rather than a marked increase in revenue from a strongly growing economy. 

Now, the Fed is engaged in the fight of its life trying to counteract a “credit-event” which is larger, and more insidious, than what was seen during the 2008 “financial crisis.”  

Over the course of the next several months, the Federal Reserve will increase its balance sheet towards $10 Trillion in an attempt to stop the implosion of the credit markets. The liquidity being provided may, or may not be enough, to offset the risk of a global economy which is levered roughly 3-to-1 according to CFO.com:

“The global debt-to-GDP ratio hit a new all-time high in the third quarter of 2019, raising concerns about the financing of infrastructure projects.

The Institute of International Finance reported Monday that debt-to-GDP rose to 322%, with total debt reaching close to $253 trillion and total debt across the household, government, financial and non-financial corporate sectors surging by some $9 trillion in the first three quarters of 2019.”

Read that last part again.

In 2019, debt surged by some $9 Trillion while the Fed is injecting roughly $6 Trillion to offset the collapse. In other words, it is likely going to require all of the Fed’s liquidity just to stabilize the debt and credit markets. 

Bubbles, Bubbles, Bubbles

Jerome Powell clearly understands that after a decade of monetary infusions and low interest rates, he has created an asset bubble larger than any other in history. However, they were trapped by their own policies, and any reversal led to almost immediate catastrophe as seen in 2018.

As I wrote previously:

“In the U.S., the Federal Reserve has been the catalyst behind every preceding financial event since they became ‘active,’ monetarily policy-wise, in the late 70’s.”

For quite some time now, we have warned investors against the belief that no matter what happens, the Fed can bail out the markets, and keep the bull market. Nevertheless, it was widely believed by the financial media that, to quote Dr. Irving Fisher:

“Stocks have reached a permanently high plateau.”

What is important to understand is that it was imperative for the Fed that market participants, and consumers, believed in this idea. With the entirety of the financial ecosystem more heavily levered than ever, due to the Fed’s profligate measures of suppressing interest rates and flooding the system with excessive levels of liquidity, the “instability of stability” was the most significant risk. 

“The ‘stability/instability paradox’ assumes that all players are rational, and such rationality implies avoidance of complete destruction. In other words, all players will act rationally, and no one will push ‘the big red button.’”

The Fed had hoped they would have time, and the “room” needed, after more than 10-years of the most unprecedented monetary policy program in U.S. history, to try and navigate the risks that had built up in the system. 

Unfortunately, they ran out of time, and the markets stopped “acting rationally.”

This is the predicament the Federal Reserve currently finds itself in. 

Following each market crisis, the Fed has lowered interest rates, and instituted policies to “support markets.” However, these actions led to unintended consequences which have led to repeated “booms and busts” in the financial markets.  

While the market has currently corrected nearly 25% year-to-date, it is hard to suggest that such a small correction will reset markets from the liquidity-fueled advance over the last decade.

To understand why the Fed is trapped, we have to go back to what Ben Bernanke said in 2010 as he launched the second round of QE:

“This approach eased financial conditions in the past and, so far, looks to be effective again. Stock prices rose and long-term interest rates fell when investors began to anticipate the most recent action. Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending.”

I highlight the last sentence because it is the most important. Consumer spending makes up roughly 70% of GDP; therefore increased consumer confidence is critical to keeping consumers in action. The problem is the economy is no longer a “productive” economy, but rather a “financial” one. A point made by Ellen Brown previously:

“The financialized economy – including stocks, corporate bonds and real estate – is now booming. Meanwhile, the bulk of the population struggles to meet daily expenses. The world’s 500 richest people got $12 trillion richer in 2019, while 45% of Americans have no savings, and nearly 70% could not come up with $1,000 in an emergency without borrowing.

Central bank policies intended to boost the real economy have had the effect only of boosting the financial economy. The policies’ stated purpose is to increase spending by increasing lending by banks, which are supposed to be the vehicles for liquidity to flow from the financial to the real economy. But this transmission mechanism isn’t working, because consumers are tapped out.”

This was shown in a recent set of studies:

The “Stock Market” Is NOT The “Economy.”

Roughly 90% of the population gets little, or no, direct benefit from the rise in stock market prices.

Another way to view this issue is by looking at household net worth growth between the top 10% to everyone else.

Since 2007, the ONLY group that has seen an increase in net worth is the top 10% of the population.

“This is not economic prosperity. This is a distortion of economics.”

As I stated previously:

“If consumption retrenches, so does the economy.

When this happens debt defaults rise, the financial system reverts, and bad things happen economically.”

That is where we are today. 

The Federal Reserve is desperate to “bail out” the financial and credit markets, which it may  be successful in doing, however, the real economy may not recover for a very long-time. 

With 70% of employment driven by small to mid-size businesses, the shutdown of the economy for an extended period of time may eliminate a substantial number of businesses entirely. Corporations are going to retrench on employment, cut back on capital expenditures, and close ranks. 

While the Government is working on a fiscal relief package, it will fall well short of what is needed by the overall economy and a couple of months of “helicopter money,” will do little to revive an already over leveraged, undersaved, consumer. 

The 4th-Bubble

As I stated previously:

“The current belief is that QE will be implemented at the first hint of a more protracted downturn in the market. However, as suggested by the Fed, QE will likely only be employed when rate reductions aren’t enough.”

The implosion of the credit markets made rate reductions completely ineffective and has pushed the Fed into the most extreme monetary policy bailout in the history of the world. 

The Fed is hopeful they can inflate another asset bubble to restore consumer confidence and stabilize the functioning of the credit markets. The problem is that since the Fed never unwound their previous policies, current policies are having a much more muted effect. 

However, even if the Fed is able to inflate another bubble to offset the damage from the deflation of the last bubble, there is little evidence it is doing much to support economic growth, a broader increase in consumer wealth, or create a more stable financial environment. 

It has taken a massive amount of interventions by Central Banks to keep economies afloat globally over the last decade, and there is little evidence that growth will recover following this crisis to the degree many anticipate.

There are numerous problems which the Fed’s current policies can not fix:

  • A decline in savings rates
  • An aging demographic
  • A heavily indebted economy
  • A decline in exports
  • Slowing domestic economic growth rates.
  • An underemployed younger demographic.
  • An inelastic supply-demand curve
  • Weak industrial production
  • Dependence on productivity increases

The lynchpin in the U.S., remains demographics, and interest rates. As the aging population grows, they are becoming a net drag on “savings,” the dependency on the “social welfare net” will explode as employment and economic stability plummets, and the “pension problem” has yet to be realized.

While the current surge in QE may indeed be successful in inflating another bubble, there is a limit to the ability to continue pulling forward future consumption to stimulate economic activity. In other words, there are only so many autos, houses, etc., which can be purchased within a given cycle. 

There is evidence the cycle peak has already been reached.

One thing is for certain, the Federal Reserve will never be able to raise rates, or reduce monetary policy ever again. 

Welcome to United States of Japan.


Much of what passes for orthodoxy in economics and finance proves, on closer examination, to be shaky business.” The Misbehavior of Markets – by Benoit Mandelbrot & Richard L. Hudson.

If as households we do crumble financially yet another time, will this ‘outlier’ event finally teach us a valuable lesson? One we’ll never forget (again)? I mean, how many Black Swans or events that create wholesale economic and financial devastation must we endure to work diligently, effortlessly, to shore up our family’s finances?

Unfortunately, as humans, we focus on risk and financial stability too late. Always. Too. Late. We are creatures of complacency and mainstream financial advice does nothing but fuel our overconfidence bias. Only when a storm is upon us, wreaking havoc, do we seek to board the windows and secure what’s important to us. 

We’re cajoled by ‘experts’ during good times. We’re taught how outlier events occur every 1,000 years. Strange how rare occurrences aren’t so rare. They seem to happen every decade. So, let me ask you – How many times do these so-called ‘rare’ events need to occur before fiscal discipline becomes a priority for all of us?

Over the last three years, at RIA we have created several financial tenets to guard against financial vulnerability. I don’t mean to preach; I mean to teach.

I hope over the next few years, once this pandemic is past and we rummage through the economic rubble, we’ll take it upon ourselves to remain vigilant through the complacency and take the following rules to heart.

1. A painful reminder about the ‘buy and hold’ investment philosophy or whatever horrid expletive you’re probably calling it right now.

Never forget that convincing words, piles of academic studies and mined data from big-box financial retailers in pretty packages make it easy to share convincing stories to push stocks. Hopefully, investors who spent most of their time and money getting back to even remain comforted by the narratives. They’ll now do it again.

I’ll admit – I’m nonplussed by the appeal of buy-and-hold to the purists. I truly envy them.

It seems to be a “What Me Worry?” kind of existence. There seems to be an eerie comfort to throwing money into a black hole of overvalued investments and hoping that it transforms into a white light of wealth 20 years down the road (even if it’s a very dim bulb). I truly wish I could be convinced that a blind buy-and-hold fable is truth.

I so passionately want investors to achieve returns and exceed their financial life benchmarks or goals; it’s good for me too. I also would like to minimize the damage from bears. Is that too much to ask?

At Real Investment Advice we think it’s one of a money manager’s primary responsibilities.

Buy-and-hold at the core wrapped in rules of risk management is a healthy, long-term strategy to build and protect wealth. That’s what we’re doing at this juncture.

If you’re completely out of the market for an extended period, I mean zilch, zero, then stock investing may not be appropriate for you. Hey, it isn’t for everyone, especially today when the flood of central bank liquidity (I’ve never witnessed anything like it), algos (the robots), probably $4 trillion in fiscal stimulus coming, tries to stem the devastation. The bull market is dead, a bear is tricky to navigate. I am grateful to be a partner at a firm where all members understand the devastation of bear markets and are not ‘deer in headlights’ as this crisis is upon us. Take heart – the bear will die; the bull will run again. As investors we will bleed. The key is not to hemorrhage. There is a difference.

It’s not too late to undertake a quick gut check – Realize that an allocation of 10-20% to domestic and international stocks can drop 40% on average in bear markets. Investors fail to realize that diversifying between foreign and U.S. stocks doesn’t manage the risk they care about most – risk of principal loss. We are witnessing this now – one more time on the disaster hit parade. The world has become increasingly an Irwin Allen (The Poseidon Adventure; The Towering Inferno), film and we are the actors.

Let’s say your retirement plan balance is $90,000. In a conservative allocation, $18,000 (20%), may be allocated to stocks. If a bear cycle takes the stock balance down to $10,800 and makes you a bit queasy, then certainly the market doesn’t fit into your overall investment philosophy.

If you do have the intestinal fortitude to maintain an allocation to stocks, your financial partner is a buy-and-hold zealot (highly likely), and you haven’t taken profits (a tenet of risk management) or rebalanced this year, then there’s still an opportunity to do so on rallies. It’s acceptable to maintain additional cash as much as buy-and-hold purists abhor cash.   

You’re not the ‘idiot’ who sells at the bottom just because you adhere to rules of risk management.

Granted, investors can be their worst emotional enemies. If risk management rules are employed as an integration to an overall investment process, then selling at the very bottom may be avoided. From my experience, the dumbest actions of those who did sell at the bottom in March 2009, rest almost solely on their brokers.

You see, if financial professionals would have empathized with their clients and took enough (any) action to preserve capital as clients were calling with concern in late 2007, maybe, just maybe, those distressed investors wouldn’t have sold out of everything pretty much at the bottom.

The advice “not to worry, markets always come back,” regurgitated repeatedly did nothing to allay concerns; frankly hollow words made brokers appear as if they employed market blinders or were in a state of denial. They appeared ignorant, not aware of the severity of the crisis.

I listened enough to begin surgically trimming positions (I explained to clients we sought to take a scalpel, not a machete to reducing stock exposure in portfolios), and was proactive to sell clients out of a Charles Schwab bond fund described as “stable in price,” an “alternative to cash,” in November 2007 when the mutual fund share price was doing nothing but faltering.

Although Schwab portfolio management assured us in the field repeatedly that there was “nothing wrong with the fund,” and it wasn’t suffering mass redemptions, it did eventually go bust and Schwab was held accountable for lack of oversight.

Unfortunately, the company got off easy as the settlement with the SEC was nothing but a financial slap on the wrist when the fund held $13.5 billion at its peak.

You tell me this stuff isn’t rigged against retail investors? I believe differently. I always will.

Proactive behavior allowed me to maintain a semblance of stock ownership and then begin to increase exposure through the summer of 2009.  I deemed it buy-and-hold with a “protective twist.”

If your broker isn’t actively listening and is discounting concerns, it’s time to replace him or her. Answers received should be thorough and backed by analysis.

If you must invest today, consider dollar-cost averaging.

Usually, dollar-cost averaging where you add a fixed dollar amount to variable investments on a regular schedule, underperforms value or lump-sum investing. Unless the cyclically adjusted price-to-earnings ratio or CAPE exceeds 18.6 (today, it exceeds 25).

An impressive analysis and paper by Jon M. Luskin, CFP® for the Journal of Financial Planning titled “Dollar-Cost Averaging Using the CAPE Ratio: An Identifiable Trend Influencing Outperformance,” outlines how investment periods with a CAPE greater than 18.6 is beneficial to dollar-cost averaging with investment returns .45% greater than lump-sum investing.

The other side of the coin of buy-and-hold isn’t active trading.

Cop out. Lame excuse. I can’t be clearer. Not only are you branded a ‘bear’ if you employ a sell discipline, it appears that the buy-and-hold purists can’t think outside of extremes. They tend to associate selling with active trading. It’s a clever ploy designed to avoid the conversation or even the thought of a sell process. It’s just impossible.

Not it isn’t. And it isn’t active trading either. Active trading isn’t going to generate returns, just activity. Plus, if you consider that trades cost ZERO at most big-box financial retailers, transaction costs aren’t a concern anymore.

For years, the investment industry has tried to scare clients into staying fully invested in the stock market, no matter how high stocks go or what’s going on in the economy. Investors are repeatedly warned that doing anything otherwise is simply foolish because “you can’t time the market.” 

Here’s why per Lance Roberts:

“Wall Street firms, despite what the media advertising tells you, are businesses. As a business, their job is to develop and deliver products to investors in whatever form investor appetites demand…Wall Street is always happy to provide ‘products’ to the consumers they serve.

As Wall Street quickly figured out that it was far more lucrative to collect ongoing fees rather than a one-time trading commission…The mutual fund business was booming, and business was ‘brisk’ on Wall Street as profits surged.”

I’ll add:

Frankly, it’s too much work. Financial experts are primarily peddlers of managed products. They’re hired to regurgitate sell-side biased data mined from their employer’s research department. What they’re implying is they’re too busy meeting sales goals to consider risk management (the way you define it as an investor), important.

With that being said, consider other rules to protect your household for when the next ‘outlier’ event occurs (I mean, after this one).

 2. The FVC – The Financial Vulnerability Cushion.

The main purpose of the Financial Vulnerability Cushion is to fortify the foundation of a financial house. You’ve heard about maintaining three to six months of living expenses in cash for emergencies. Well, define an emergency. The car breaks down, sure. The A/C goes out? Right. Expenses such as these fit well into a three to six-month cash cushion. However, Black Swan events remind us this cushion isn’t enough.  We must finally learn to separate emergency from crisis.

Over the last six months we’ve been discussing on the radio how important it is to build a cash war chest of one to two years’ worth of living expenses and maintain it above everything else. These reserves are for crisis. A sudden job loss; major illness. Unfortunately, millions will be out of work here. Some, long term. I’m increasingly concerned about those who work in the energy sector. Never forget. Don’t listen to mainstream financial media again. Remember this time and work diligently to build a FVC.

3. Create financial rules around debt control and savings. Then stick to them. No matter what. Good times or bad.

Consider strict debt management and savings habits as the blend of robust soil which allows opportunities to be realized. Excessive debt and limited ability to buffer against financial emergencies and crisis can limit a person’s ability to take on riskier but rewarding ventures like career change, entrepreneurial endeavors and risks that may lead to significant, long-term wealth.

Mortgage debt: Primary residence mortgage = 2X gross salary.

Student loan debt:  Limited to one year’s worth of total expense, tuition, room & board, expenses.

Personal, unsecured debt (credit card, auto): No more than 25% of gross monthly household income.

4. Be smarter with credit.

Today, credit cards are used for various reasons – convenience, cash back, travel reward points and the most unfortunate, to meet ongoing living expenses in the face of structural wage stagnation. So, consider the following.

Credit Card Debt = No greater than 4% of monthly gross income.

If your household gross income is $50,000 then credit card debt shouldn’t exceed $2,000. Per WalletHub, Texas ranks 46 with $2,848 in average credit card debt.

Survival tip: Take control of your money. Contact your credit card provider today and request a lower interest rate, perhaps the favorable balance transfer rate along with delayed payments. We are in this catastrophe together and it’s the least they can do for at least the rest of the year.

Car Loan Debt-to-Income Ratio:

Cars are required like breathing here in Houston and Texas, overall. However, they are not investments. Their values do not appreciate. If anything, auto values decrease as soon as you drive away from the dealership.

Car Loan Obligation = No greater than 25% of monthly gross income.

For example, a household bringing in $60,000 a year shouldn’t have more than $15,000 in outstanding auto loan debt. In my household, the ratio is less than 10%. I drive a Toyota RAV4. Put your ego aside; consider reliability first.

As I complete interviews with media and news outlets in Houston and across the country, my heart is overwhelmed with sorrow for those who are suffering through this, yet another ‘rare’ historical episode.

Please reach out to our team with questions and for guidance.

Every question is a good question.

Never be afraid to ask.


“No One Saw It Coming” – Should You Worry About The 10-Best Days

Pippa Stevens via CNBC recently had some advice:

“Panic selling not only locks in losses, but also puts investors at risk for missing the market’s best days.

Looking at data going back to 1930, Bank of America found that if an investor missed the S&P 500′s 10 best days in each  decade, total returns would be just 91%, significantly below the 14,962% return for investors who held steady through the downturns.”

But here was her key point, which ultimately invalidates her entire premise:

“The firm noted this eye-popping stat while urging investors to ‘avoid panic selling,’ pointing out that the ‘best days generally follow the worst days for stocks.’” 

Think about that for a moment.

“The best days generally follow the worst days.

The statement is correct, as the S&P 500’s largest percentage gain days, tend to occur in clusters during the worst of times for investors.

Here is another way to look at this through Friday’s close. For an investor trying to catch the markets best 10-days, they wound up losing almost 30% of their portfolio, an astounding -9,254 points over the span of 3 weeks.

The analysis of “missing out on the 10-best days” of the market is steeped in the myth of the benefits of “buy and hold” investing. (Read more: The Definitive Guide For Investing.Buy and hold, as a strategy works great in a long-term rising bull market. It fails as a strategy during a bear market for one simple reason: Psychology.

I agree investors should never “panic sell,” as such “emotional” decisions are always made at the worst possible times. As Dalbar regularly points out, individuals always underperform the benchmark index over time by allowing “behaviors” to interfere with their investment discipline.

In other words, investors regularly suffer from the “buy high/sell low” syndrome.

Such is why investors should follow an investment discipline or strategy which mitigates volatility to avoid being put into a situation where “panic selling” becomes an issue.

Let me be clear; an investment disciple does NOT ensure your portfolio against losses if the market declines. This is particularly the case when it plummets, as we’ve seen in the last couple of weeks. However, in any event, it will work to minimize the damage to a recoverable state.

The Market Timing Myth

We previously stated, that when the “crash” came, the mainstream media’s response would be: “Well, no one could have seen it coming.” 

Simply always being “bullish,” like Mr. Santolli, is what leads investors into being blindsided by rising risks in the market.

Yes, you can see, and predict, when risks exceed the grasp of rationality.

This brings us to the basic argument from the financial media which is simply you are NOT smart enough to manage your investments, so your only option is to “buy and hold.”

In 2010, Brett Arends wrote an excellent commentary entitled: “The Market Timing Myth” which primarily focused on several points we have made over the years. Brett really hits home with the following statement:

For years, the investment industry has tried to scare clients into staying fully invested in the stock market at all times, no matter how high stocks go or what’s going on in the economy. ‘You can’t time the market,’ they warn. ‘Studies show that market timing doesn’t work.’

He goes on:

“They’ll cite studies showing that over the long-term investors made most of their money from just a handful of big one-day gains. In other words, if you miss those days, you’ll earn bupkis. And as no one can predict when those few, big jumps are going to occur, it’s best to stay fully invested at all times. So just give them your money… lie back, and think of the efficient market hypothesis. You’ll hear this in broker’s offices everywhere. And it sounds very compelling.

There’s just one problem. It’s hooey.

They’re leaving out more than half the story.

And what they’re not telling you makes a real difference to whether you should invest, when and how.”

The best long-term study relating to this topic was conducted a few years ago by Javier Estrada, a finance professor at the IESE Business School at the University of Navarra in Spain. To find out how important those few “big days” are, he looked at nearly a century’s worth of day-to-day moves on Wall Street and 14 other stock markets around the world, from England to Japan to Australia.

Correctly, the study did find that if you missed the 10-best days of the market, you did indeed give up much of the gains. What he also found is that by missing the 10-worst days, you did remarkably better.

(The blue highlight shows, as of Friday’s close, investors will need a more than 40% return just to get back to even.)

Clearly, avoiding major drawdowns in the market is key to long-term investment success. If I am not spending the bulk of my time making up previous losses in my portfolio, I spend more time compounding my invested dollars towards my long term goals.

Over an investing period of about 40 years, just missing the 10-best days would have cost you about half your capital gains. But successfully avoiding the 10-worst days would have had an even bigger positive impact on your portfolio. Someone who avoided the 10-biggest slumps would have ended up with two and a half times the capital gains of someone who simply stayed in all the time.

As Brett concluded:

“In other words, it’s something of a wash. The cost of being in the market just before a crash, are at least as great as being out of the market just before a big jump, and may be greater. Funny how the finance industry doesn’t bother to tell you that.”

The reason that the finance industry doesn’t tell you the other half of the story is because it is NOT PROFITABLE for them. The finance industry makes money when you are invested – not when you are in cash. Since a vast majority of financial advisors can’t actually successfully manage money, they just tell you to “stay the course.”

However, you DO have options.

A Simple Method

Now, let me clarify. I do not strictly endorse “market timing,” which is specifically being “all-in” or “all-out” of the market at any given time. The problem with market timing is consistency.

You cannot, over the long term, effectively time the market. Being all in, or out, of the market will eventually put you on the wrong side of the “trade,” which will lead to a host of other problems.

However, there are also no great investors in history who employed “buy and hold” as an investment strategy. Even the great Warren Buffett occasionally sells investments. True investors buy when they see the value, and sell when value no longer exists.

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 the long term holding periods. Will such a method ALWAYS be right? Absolutely not. However, will such a method keep you from losing large amounts of capital? Absolutely.

The chart below shows a simple 12-month moving average crossover study. (via Portfolio Visualizer)

What should be obvious 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. 

Here are the comparative results.

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, that is the time when individuals should perform some basic portfolio risk management such as:

  • Trim back winning positions to original portfolio weights: Investment Rule: Let Winners Run
  • Sell positions that simply are not working (if the position was not working in a rising market, it likely won’t in a declining market.) Investment Rule: Cut Losers Short
  • Hold the cash raised from these activities until the next buying opportunity occurs. Investment Rule: Buy Low

By using some measures, fundamental or technical, to reduce portfolio risk by taking profits as prices/valuations rise, or vice versa, 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.

As Brett continues:

Let’s be clear what it doesn’t mean. It still doesn’t mean you should try to ‘time’ the market day to day. Mr. Estrada’s conclusion is that a small number of big days, in both directions, account for most of the stock market’s price performance. Trying to catch the 10-biggest jumps, or avoid the 10-big tumbles, is almost certainly a fool’s errand. Hardly anyone can do this sort of thing successfully. Even most professionals can’t.

But, second, it does mean you that you shouldn’t let scare stories dominate your approach to investing. Don’t let yourself be bullied. Least of all by someone who isn’t telling you the full story.”

There is little point in trying to catch each twist and turn of the market. But that also doesn’t mean you simply have to be passive and let it wash all over you. It may not be possible to “time” the market, but it is possible to reach intelligent conclusions about whether the market offers good value for investors.

There is a clear advantage of providing risk management to portfolios over time. The problem, as I have discussed many times previously, is that most individuals cannot manage their own money because of “short-termism.”

Despite their inherent belief that they are long-term investors, they are consistently swept up in the short-term movements of the market. Of course, with the media and Wall Street pushing the “you are missing it” mantra as the market rises – who can really blame the average investor “panic” buying market tops, and selling out at market bottoms.

Yet, despite two major bear market declines, and working its third, it never ceases to amaze me that investors still believe they can invest their savings into a risk-based market, without suffering the eventual consequences of risk itself.

Despite being a totally unrealistic objective, this “fantasy” leads to excessive speculation in portfolios, which ultimately results in catastrophic losses. Aligning expectations with reality is the key to building a successful portfolio. Implementing a strong investment discipline, and applying risk management, is what leads to the achievement of those expectations.

#MacroView: Mnuchin & Kudlow Say No Recession?

“Treasury Secretary Steven Mnuchin on Sunday downplayed the likelihood of an economic recession as the economy takes a beating from the coronavirus outbreak.

When asked on ABC’s ‘This Week’ if the US was now in an economic recession as some have suggested, Munchin said, ‘I don’t think so.’ ” – CNN

However, it wasn’t just Mnuchin making such a claim, but Larry Kudlow as well:

“I just think, in general, I would be very careful to put too much emphasis on what bond rates are doing, what interest rates are doing. Or even in the short, short run, the stock market. I think you have a lot of mood swings here and I don’t think it reflects the fundamentals.” – Larry Kudlow via CNBC

I understand they have to pander to the administration, but this is a stretch to say the least. 

Let’s dig into some facts to determine our real risks.

Even before COVID-19 had infected the planet, economic data, and inflationary pressures were already weakening. This already suggested the decade long economic expansion was “running lean.”

However, the sharp decline in both 5- and 10-year “breakeven inflation rates,” are suggesting economic growth over the next couple of quarters will drop markedly. The last time there was such a sharp drop in inflation expectations at the beginning of the “financial crisis.”

Since then, the markets have been rocked as concerns over the spread of the“COVID-19” virus. The U.S. has shut down sporting events, travel, consumer activities, restaurants, bars, stores, and a host of other economically sensitive inputs. This is on top of the collapse in oil prices, which impacts a very important economic sector of the economy. (The O&G sector either directly or indirectly creates millions of jobs, has some of the highest wages, and is responsible for about 1/4th of all capital expenditures.)

However, this is just in the United States. This is a “global issue,” and the supply chains of the world are tightly interconnected. As we discussed previously:

“Given that U.S. exporters have already been under pressure from the impact of the ‘trade war,’ the current outbreak could lead to further deterioration of exports to and from China, South Korea, and Japan. This is not inconsequential as exports make up about 40% of corporate profits in the U.S.”

Our Economic Output Composite Indicator (EOCI) was already at levels which warned of weak economic growth. Furthermore, as shown below, even the Leading Economic Indicators (LEI) were already suggesting something was amiss long before the virus became “a thing.”

Data as of February 2020.

(The EOCI is comprised of the Fed Regional Surveys, CFNAI, Chicago PMI, NFIB, LEI, and ISM Composites. The indicator is a broad measure of hard and soft data of the U.S. economy)”

One reason we are confident the economic data will worsen near term is the correlation between the index and the annual rate of change of the S&P 500 index.

The financial markets lead the economy by about 6-months as markets begin to “price in” changes to earnings due to the outlook for economic strength. The recent plunge in the S&P 500 has deviated from the current EOCI index reading suggesting the index will decline towards recessionary levels over the next two months.

The Question Isn’t If…

The U.S. economy, along with the bulk of the globe, is already in “recession.”

Let’s start with a bit of historical context. Since the 1800’s, the average length of an economic recession has been 18-months. Some of that length is skewed by a more agricultural-based economy at the beginning, with more modern recessions having been shorter. (We are assuming that March 2020 was the start of a new recession at one-month.)

While the average recession has been somewhat shorter in recent decades, the recessions of 1973, 1991, and 2007 have pushed those long-term averages. The chart below also shows the subsequent decline in asset prices during subsequent recessions.

Given, declines of these magnitudes only occur during recessionary periods, the recent near 30% decline is likely good confirmation a recession has begun. (However, at just one-month, it may be overly optimistic to assume it is over with already. )

Yields Are Screaming: “Recession”

Interest rates are also a very good confirmation of recessionary periods as well. 

Since 2013, I have disagreed the mainstream analysis (including Jeff Gundlach and Bill Gross) that the “bond bull market” was dead. The reality has been substantially different as rates have continued to trend lower, and recently approached our long-term target of ZERO.

“There is an assumption that because interest rates are low, the bond bull market has come to its inevitable conclusion. The problem with this assumption is three-fold:

  1. All interest rates are relative. With more than $10-Trillion in debt globally sporting negative interest rates, the assumption that rates in the U.S. are about to spike higher is likely wrong. 
  2. The coming budget deficit balloon. Given the lack of fiscal policy controls in Washington, and promises of continued largesse in the future, the budget deficit is set to swell back to $1 Trillion or more in the coming years. 
  3. Central Banks will continue to be a buyer of bonds to maintain the current status quo, but will become more aggressive buyers during the next recession. The next QE program by the Fed to offset the next economic recession will likely be $2-4 Trillion, which will push the 10-year yield towards zero.” – August 30, 2016

So, where are we nearly 4-years later?

  • 23% of global debt is now supporting negative interest rates. 
  • The U.S. deficit has well surpassed $1 Trillion on its way to $2 Trillion.
  • Central Banks continue to be a primary buyer of bonds as the Fed’s balance sheet has swelled back to its previous peak and the Fed recently dropped rates to zero and started a $700 billion QE program.

Here is the relevant chart I posted in 2016. At that time rates were hitting lows of 1.6%, which was unthinkable at the time. And, where are rates, today? Approaching zero.

As shown above, over the last sixty years, the yield on the 10 year has approximated real GDP plus inflation (shown in the chart below). Given this historical fact, we can do some basic math to determine what yields are currently predicting for the U.S. economy currently. 

Via Doug Kass:

“Given ZIRP and QE policies around the globe which has pulled an extraordinary amount of sovereign debt into negative territory coupled with secular headwinds to energy prices, I have assumed that the 10 year yield will fall from 1.0x nominal GDP and average about 0.8x nominal GDP. 

According to my pal Peter Boockvar, the 10 year inflation breakeven (in the tips market) stands at 1.41% this morning:

So, let’s solve for what the market expects Real GDP to be (over the next 1-2 years) with this formula:

10 Year Yield (0.744% Actual) = 0.8x (Real GDP + 1.41% Actual (inflation))

The implied U.S. Real GDP of this equation is now negative — at -0.48%. (This compares to the consensus 2020 Real GDP growth forecast of between +1.75% to +2.00%) It also implies that nominal GDP (Real GDP plus Inflation) will be only about +0.93% – substantially below consensus expectations of slightly above 3%.”

It’s markedly worse now as the collapse in oil prices has sent breakeven rates below 1%. 

As we noted in “On The Cusp Of A Bear Market,” the collapse in interest rates, as well as the annual rate of change in rates, is screaming that something “has broken,” economically speaking.

Mnuchin’s suggestion the economy will likely avoid “recession,” is a bit ludicrous. The data suggests an entirely different outcome. However, David Rosenberg recently put some numbers on the impact to the economy from the “economic shutdown” from the virus. To wit:

“The pandemic is a clear ‘black swan’ event. There will be a whole range of knock-on effects. Fully 40 million American workers, or one-third of the private-sector labor force, are directly affected ─ retail, entertainment, events, sports, theme parks, conferences, travel, tourism, restaurants and, of course, energy.

This doesn’t include all the multiplier effects on other industries. It would not surprise me at all if real GDP in Q2 contracts at something close to an 8% annual rate (matching what happened in the fourth quarter of 2008, which was a financial event alone).

The hit to GDP can be expected to be anywhere from $400 billion to $600 billion for the year. But the market was in trouble even before COVID-19 began to spread, with valuations and complacency at cycle highs.

Given the average recession is 18-months, and given the severity of the economic impact, even this 12-month forecast is likely overly optimistic. However, we are still missing a LOT of data, which will come to light over the next several months. 

The recession will be quite severe.

As David concludes:

“A 35% slump in global financial stocks and a similar plunge in U.S. small-cap equities cannot be wrong on this forecast. And the massive volume of leverage complicates the outlook that much more.”

I know you shouldn’t point and laugh, but you almost have to when Mnuchin and Kudlow have the audacity to suggest this is a temporary negative shock. This a collision of multiple shocks impacting an overly leveraged, overly valued, and overly bullish market simultaneously.

  • Coronvirus impact
  • Supply chain shutdowns
  • Economy wide “closures”
  • Consumer confidence collapse.
  • Employment shock
  • Debt crisis

The problem for the Federal Reserve is this is NOT a “financial crisis,” or a simple “business cycle” recession, that monetary policy can fix. Governments have opted for to “contain the virus” by shutting down the economy. Giving households $1000 checks sounds great, but not if you can’t spend them. Maybe they will opt to pay down debt, but that doesn’t spur economic activity, or improve earnings, in the near term. 

Of course, since stocks price in future earnings growth, and since we have a feel for the impact of the recession coming, we can guesstimate the impact to earnings.

Profit margins are probably the most mean-reverting series in finance, and if profit margins do not mean-revert, then something has gone badly wrong with capitalism. If high profits do not attract competition, there is something wrong with the system, and it is not functioning properly.” – Jeremy Grantham

The impending recession, and consumption freeze, is going to start the mean-reversion process in both corporate profits and earnings. In the following series of charts, I have projected the potential reversion.

The reversion in GAAP earnings is pretty calculable as swings from peaks to troughs have run on a fairly consistent trend. (The last drop off is the estimate to for a recession)

“Using that historical context, we can project a recession will reduce earnings to roughly $100/share. The resulting decline asset prices to revert valuations to a level of 18x (still high) trailing earnings would suggest a level of $1800 for the S&P 500 index.”

“If our, and Mr. Rosenberg’s, estimates are correct of a 5-8% recessionary drag in the second quarter of 2020, then an average reduction in earnings of 30% is most likely overly optimistic. 

However, here is the math:

  • Current Earnings = 132.90
  • 30% Reduction = $100 (rounding down for easier math)

At various P/E multiples, we can predict where “fair value” for the market is based on historical assumptions:

  • 20x earnings:  Historically high but markets have traded at high valuations for the last decade. 
  • 18x earnings: Still historically high.
  • 15x earnings: Long-Term Average
  • 13x earnings: Undervalued 
  • 10x earnings: Extremely undervalued but aligned with secular bear market bottoms.

You can pick your own level where you think P/E’s will account for the global recession but the chart below prices it into the market.”

Unfortunately, both Larry Kudlow, Steve Mnuchin, and the Fed, are still misdiagnosing what ails the economy, and monetary policy is unlikely to change the outcome in the U.S. Furthermore, the lack of economic growth, resulting in lower earnings growth, will eventually lead to a full repricing of assets.

Yes, we are in a recession, it has just started, and we have quite a ways to go before it is over. 

Fade rallies, and reduce risk accordingly. 

Fox26 Interview: The Economic Impact Of COVID-19

On Friday morning, I visiting with my friends at Fox26 in Houston to discuss the economic, market, and investing impact of COVID-19.

“Will it get worse before it gets better?

Lance Roberts, chief investment strategist with RIA Advisors, explains how the COVID-19 coronavirus is impacting our economy.”

#MacroView: Fed Launches A Bazooka To Kill A Virus

Last week, we discussed in Fed’s ‘Emergency Rate Cut’ Reveals Recession Risks” that while current economic data may not suggest a possibility of a recession was imminent, other “off the run” data didn’t agree.

We are likely experiencing more than just a ‘soft patch’ currently despite the mainstream analysts’ rhetoric to the contrary. There is clearly something amiss within the economic landscape, even before the impact of COVID-19, and the ongoing decline of inflationary pressures longer term was already telling us just that.”

The plunge in both 5- and 10-year “breakeven inflation rates,” are currently suggesting that economic growth over the next couple of quarters will drop markedly. The last time there was such a sharp drop in inflation expectations at the beginning of the “financial crisis.”

In the meantime, the markets have been rocked as concerns over the spread of the“COVID-19” virus in the U.S. have shut down sporting events, travel, consumer activities, and a host of other economically sensitive inputs. As we discussed previously:

“Given that U.S. exporters have already been under pressure from the impact of the ‘trade war,’ the current outbreak could lead to further deterioration of exports to and from China, South Korea, and Japan. This is not inconsequential as exports make up about 40% of corporate profits in the U.S. With economic growth already struggling to maintain 2% growth currently, the virus could shave between 1-1.5% off that number.”

As noted, with the U.S. now shutting down and entrenching itself in response to the virus, the economic impact will be worsened. However, given that economic data is lagging, and we only have numbers that were mostly pre-virus, the reports over the next couple of months will ultimately reveal the extent of the damage.

We suspect that it will be more significant than most analysts currently expect.

With our Economic Output Composite Indicator (EOCI) at levels which have previously warned of recessions, the “timing” of the virus, and the shutdown of activity in response, will push the indications lower.

“Given the current level of the index as compared to the 6-Month rate of change of the Leading Economic Index, there is a risk of a recessionary drag within the next 6-months.”

(The EOCI is comprised of the Fed Regional Surveys, CFNAI, Chicago PMI, NFIB, LEI, and ISM Composites. The indicator is a broad measure of hard and soft data of the U.S. economy)”

One reason we are confident the economic data will worsen near term is the correlation between the index and the annual rate of change of the S&P 500 index.

The financial markets lead the economy by about 6-months as markets begin to “price in” changes to earnings due to the outlook for economic strength. The recent plunge in the S&P 500 has deviated from the current EOCI index reading suggesting the index will decline towards recessionary levels over the next few months.

What the chart above obfuscates is the severity of the recent market rout. As shown below, in just three very short weeks, the market has reversed almost the entirety of the “Trump Stock Market” gains since he took office on January 20th.

The estimation of substantially weaker economic growth is not just a random assumption. In a post next week, I am going through the math of our analysis. Here is a snippet.

“Over the last sixty years, the yield on the 10-year has approximated real GDP plus inflation (shown in the chart below). Given this historical fact, we can do some basic math to determine what yields are currently predicting for the U.S. economy currently.”

Doug Kass recently did the math:

“Given ZIRP and QE policies around the globe which has pulled an extraordinary amount of sovereign debt into negative territory coupled with secular headwinds to energy prices, I have assumed that the 10 year yield will fall from 1.0x nominal GDP and average about 0.8x nominal GDP. 

According to my pal Peter Boockvar, the 10-year inflation breakeven (in the tips market) stands at 1.41% this morning:

So, let’s solve for what the market expects Real GDP to be (over the next 1-2 years) with this formula:

10-Year Yield (0.744% Actual) = 0.8x (Real GDP + 1.41% Actual (inflation))

The implied U.S. Real GDP of this equation is now negative — at -0.48%. (This compares to the consensus 2020 Real GDP growth forecast of between +1.75% to +2.00%) It also implies that nominal GDP (Real GDP plus Inflation) will be only about +0.93% – substantially below consensus expectations of slightly above 3%.”

Doug’s estimates were before to the recent collapse in oil prices, and breakeven inflation rates. With oil prices now at $30/bbl and 10-year breakeven rates to 0.9%, the math is significantly worse, and that is what the severity of the recent selloff is telling us. Over the next two quarters, we could see as much as a 3% clip off of current GDP.

This data is not lost on the Federal Reserve and is why they have been taking action over the last two weeks.

The Fed Bazooka

It’s quite amazing that in mid-February, which now seems like a lifetime ago, we were discussing the markets being 3-standard deviations above their 200-dma, which is a rarity. Three short weeks later, the markets are now 4-standard deviations below, which is even a rarer event. 

That swing in asset prices has cut the “wealth effect” from the market, and will severely impact consumer confidence over the next few months. The decline in confidence, combined with the impact of the loss of activity from the virus, will sharply reduce consumption, which is 70% of the economy.

This is why the Fed cut rates in an “emergency action” by 0.50% previously. Then on Wednesday, increased “Repo operations” to $175 Billion.

However, like hitting a patient with a defibrillator, the was no response from the market.

Then yesterday, the Fed brought out their “big gun.”  In a statement from the New York Fed:

The Federal Reserve said it would inject more than $1.5 trillion of temporary liquidity into Wall Street on Thursday and Friday to prevent ominous trading conditions from creating a sharper economic contraction.

‘These changes are being made to address highly unusual disruptions in Treasury financing markets associated with the coronavirus outbreak.’

The New York Fed said it would conduct three additional repo offerings worth an additional $1.5 trillion this week, with two separate $500 billion offerings that will last for three months and a third that will mature in one month.

If the transactions are fully subscribed, they would swell the central bank’s $4.2 trillion asset portfolio by more than 35%.” – WSJ

As Mish Shedlock noted,

“The Fed can label this however they want, but it’s another round of QE.”

As you can see in the chart below, this is a massive surge of liquidity hitting the market at a time the market is sitting on critical long-term trend support.

Of course, this is what the market has been hoping for:

  • Rate cuts? Check
  • Liquidity? Check

For about 15-minutes yesterday, stocks responded by surging higher and reversing half of the day’s losses. Unfortunately, the enthusiasm was short-lived as sellers quickly returned to continue their “panic selling.” 

This has been frustrating for investors and portfolio managers, as the ingrained belief over the last decade has been “Don’t worry, the Fed’s got this.”

All of a sudden, it looks like they don’t.

Will It Work This Time?

There is a singular risk that we have worried about for quite some time.

Margin debt.

Here is a snip from an article I wrote in December 2018.

Margin debt is the ‘gasoline,’ which drives markets higher as the leverage provides for the additional purchasing power of assets. However, that ‘leverage’ also works in reverse as it provides the accelerant for larger declines as lenders ‘force’ the sale of assets to cover credit lines without regard to the borrower’s position.

That last sentence is the most important. The issue with margin debt, in particular, is that the unwinding of leverage is NOT at the investor’s discretion. It is at the discretion of the broker-dealers that extended that leverage in the first place. (In other words, if you don’t sell to cover, the broker-dealer will do it for you.) When lenders fear they may not be able to recoup their credit-lines, they force the borrower to either put in more cash or sell assets to cover the debt. The problem is that “margin calls” generally happen all at once as falling asset prices impact all lenders simultaneously.

Margin debt is NOT an issue – until it is.”

Given the magnitude of the declines in recent days, and the lack of response to the Federal Reserve’s inputs, it certainly has the feel of a margin debt liquidation process. This was also an observation made by David Rosenberg:

“The fact that Treasuries, munis, and gold are getting hit tells me that everything is for sale right now. One giant margin call where even the safe-havens aren’t safe anymore. Except for cash.”

Unfortunately, FINRA only updates margin debt in arrears, so as of this writing, the latest margin debt stats are for January. What we do know is that due to the market decline, negative free cash balances have likely declined markedly. That’s the good news.

Back to my previous discussion for a moment:

“When an event eventually occurs, it creates a rush to liquidate holdings. The subsequent decline in prices eventually reaches a point which triggers an initial round of margin calls. Since margin debt is a function of the value of the underlying ‘collateral,’ the forced sale of assets will reduce the value of the collateral, further triggering further margin calls. Those margin calls will trigger more selling forcing, more margin calls, so forth and so on.

Given the lack of ‘fear’ shown by investors during the recent decline, it is unlikely that the recent drop in margin debt is a function of ‘forced liquidations.’ As I noted above, it will likely take a correction of more than 20%, or a ‘credit related’ event, which sparks broker-dealer concerns about repayment of their credit lines.

The risk to the market is ‘when’ those ‘margin calls’ are made.

It is not the rising level of debt that is the problem; it is the decline which marks peaks in both market and economic expansions.”

That is precisely what we have seen over the last three weeks.

While the Federal Reserve’s influx of liquidity may stem the tide temporarily, it is likely not a “cure” for what ails the market.

However, with that said, the Federal Reserve, and Central Banks globally, are not going to quietly into the night. Expect more stimulus, more liquidity, and more rate cuts. If that doesn’t work, expect more until it does.

We have already reduced a lot of equity risk in portfolios so far, but are going to continue lifting exposures and reducing risk until a bottom is formed in the market. The biggest concern is trying to figure out exactly where that is.

One thing is now certain.

We are in a bear market and a recession. It just hasn’t been announced as of yet.

That is something the Fed can’t fix right away with monetary policy alone, and, unfortunately, there won’t be any help coming from the Government until after the election.

Market Crash Reveals The “Liquidity Problem” Of Passive Investing

When it comes to investing, it’s a losing proposition to try and be anything better than average.

If there’s no point in trying to beat the market through ‘active’ investing – using mutual funds that managers run, selecting what they hope are market-beating investments – what is the best way to invest? Through “passive” investing, which accepts average market returns ­(this means index funds, which track market benchmarks)”Forbes

The idea of “passive indexing” sounds harmless enough, buy an “index” and be an “average” investor.

However, it isn’t as simple as that, and we have spilled a lot of ink digging into the relative dangers of it. Last week, investors saw those risks first hand.

The biggest risk to investors is when “passive indexers” turn into “panic sellers.” 

While the “sell-off” over the last couple of weeks was brutal, with the Dow posting some of the biggest declines in its history, as I will explain, it was exacerbated by the “passive indexing revolution.” 

Jim Cramer previously penned (courtesy of Doug Kass) an interesting note on the active vs. passive conflict.

“The answer is that there are two kinds of sellers in this market: hedge fund sellers, who react off of research, and portfolio shufflers, who buy and sell ETFs and index funds.

The former jumps on anything, right or wrong, as long as it is actionable. The latter, the index funds and ETF traders, rarely jump although they may press down harder on a bedraggled ETF, like one that includes the consumer products group.

But there are two kinds of buyers. The opportunistic buyers, and the index buyers. The opportunists think that the downgrades are noise and give them a chance to buy high-quality stocks with the money that comes in over the transom.

The index and ETF buyers? Well, they just buy.”

The dichotomy explains a lot of the bullish action, and isn’t talked about enough.

While Jim wrote this about those “buying” ETF’s, the same is true when they begin to “sell.” 

“The index and ETF sellers? Well, they just sell.”

It is often suggested that individuals who buy “passive indexes,” such as the SPDR S&P 500 Index (SPY), are they themselves “passive investors.” In other words, these individuals are willing to buy an “index” and hold it for an extended period regardless of market volatility.

Reality has been far different.

This was clear last week as the S&P 500 ETF (SPY) saw some of the biggest outflows in its history with the exception of the February 2018 market plunge as Trump announced his “Trade War with China.” 

The problem with individuals and “passive” investing is they are just “active” investors in a different form. They make all the same mistakes that individual stock investors make, such as “buying high and selling low,” but just using a different instrument to do it.

As the markets declined last week, there was a slow realization “this decline” was something more than another “buy the dip” opportunity. Concerns of the impact on the global supply chain, due to “COVID-19,” slowing earnings, economic growth, and a reduction of liquidity from the Federal Reserve, all culminated in a “panicked exit.”

As losses mounted, anxiety rose until individuals began to sell to “avert further losses” by selling.

Yes….it’s that psychology thing.

Individuals refuse to act “rationally” by holding their investments as losses mount.

The behavioral biases of investors are one of the most serious risks arising from ETFs as too much capital is concentrated into too few places. This concentration risk in ETF’s is not the first time this has occurred:

  • In the early 70’s it was the “Nifty Fifty” stocks,
  • Then Mexican and Argentine bonds a few years after that
  • “Portfolio Insurance” was the “thing” in the mid -80’s
  • Dot.com anything was a great investment in 1999
  • Real estate has been a boom/bust cycle roughly every other decade, but 2007 was a doozy
  • Today, it’s ETF’s and Bitcoin

Risk concentration always seems rational at the beginning, and the initial successes of the trends it creates can be self-reinforcing.

Until it goes in the other direction.

While the sell-off last week was large, it was the uniformity of the price moves, which revealed the fallacy “passive investing” as investors headed for the exits all at the same time.

The Apple Problem

Currently, there more than 1750 ETF”s trading in the U.S., with each of those ETF’s owning many of the same underlying companies. For an ETF company to “sell” you product, they need good performance. In a late-stage market cycle driven by momentum, it is not uncommon to find the same “best performing” stocks proliferating a large number of ETF’s.

For example, out of the 1750 ETF’s in the U.S., there are 175, or 10%, which own Apple (AAPL). Given that so many ETF’s own the same company, the problem of “liquidity” is exposed during a market rout. The head of the BOE, Mark Carney, warned about the risk of “disorderly unwinding of portfolios” due to the lack of market liquidity.

“Market adjustments to date have occurred without significant stress. However, the risk of a sharp and disorderly reversal remains given the compressed credit and liquidity risk premia. As a result, market participants need to be mindful of the risks of diminished market liquidity, asset price discontinuities and contagion across asset markets.”

Howard Marks, also noted in “Liquidity:”

“ETF’s have become popular because they’re generally believed to be ‘better than mutual funds,’ in that they’re traded all day. Thus an ETF investor can get in or out anytime during trading hours. But do the investors in ETFs wonder about the source of their liquidity?’”

Let me explain.

There is a statement often made by individuals about the market.

“For every buyer, there is a seller.” 

The belief has always been that if an individual wants to sell, there will always be a buyer available to execute the transaction at any given price.

However, such is not actually the case.

The correct statement is:

“For every buyer, there is a seller….at a specific price.”

In other words, when the selling begins, those wanting to “sell” overrun those willing to “buy,” so prices have to drop until a “buyer” is willing to execute a trade.

The “Apple” problem, using our example above, is that while investors who are long Apple shares directly are trying to find buyers, the 175 ETF’s that also own Apple shares are vying for the same buyers to meet redemption requests.

This surge in selling pressure creates a “liquidity vacuum” between the current price and the price at which a “buyer” is willing to step in. As we saw last week, Apple shares fell faster than the SPDR S&P 500 ETF, of which Apple is one of the largest holdings.

Secondly, the ETF market is not a PASSIVE MARKET. Today, advisors are actively migrating portfolio management to the use of ETF’s for either some, if not all, of the asset allocation equation. Importantly, they are NOT doing it “passively.” The rise of index funds has turned everyone into “asset class pickers,” instead of stock pickers. However, just because individuals are choosing to “buy baskets” of stocks, rather than individual securities, it is not a “passive” choice, but rather “active management” in a different form.  

While “passive indexing” sounds like a winning approach to “pace” the markets during the late stages of an advance, it is worth remembering it will also “pace” just as well during the subsequent decline.

The correction had the “perma-bulls” scrambling to produce commentary as to why markets will continue only to rise. Unfortunately, that is not the way markets actually work over the long-term, and why the basic rules of investing are REALLY hard to follow.

Despite the best of intentions, individual investors are NOT passive even though they are investing in “passive” vehicles. When these market swoons begin, the rush to liquidate entire baskets of stocks accelerate the decline making sell-offs much more violently than what we have seen in the past.

This concentration of risk, lack of liquidity, and a market increasingly driven by “robot trading algorithms,” reversals are no longer a slow and methodical process but rather a stampede with little regard to price, valuation, or fundamental measures as the exit becomes very narrow.

February was just a “sampling” of what will happen to the markets when the next bear market begins.

Are you prepared?

#MacroView: Fed’s “Emergency Rate Cut” Reveals Recession Risks

Last week, I discussed in “Recession Risks Tick Up” that while current data may not suggest a possibility of a recession was imminent, other “off the run” data didn’t agree.

“The problem with most of the current analysis, which suggests a “no recession” scenario, is based heavily on lagging economic data, which is highly subject to negative revisions. The stock market, however, is a strong leading indicator of investor expectations of growth over the next 12-months. Historically, stock market returns are typically favorable until about 6-months prior to the start of a recession.”

“The compilation of the data all suggests the risk of recession is markedly higher than what the media currently suggests. Yields and commodities are suggesting something quite different.”

In this particular case, while the market is suggesting there is an economic problem coming, we also discussed the impact of the “coronavirus,” or “COVID-19,” on the economy. Specifically, I stated:

But it isn’t just China. It is also hitting two other economically important countries: Japan and South Korea, which will further stall exports and imports to the U.S. 

Given that U.S. exporters have already been under pressure from the impact of the “trade war,” the current outbreak could lead to further deterioration of exports to and from China, South Korea, and Japan. This is not inconsequential as exports make up about 40% of corporate profits in the U.S. With economic growth already struggling to maintain 2% growth currently, the virus could shave between 1-1.5% off that number. 

With our Economic Output Composite Indicator (EOCI) already at levels which has previously denoted recessions, the “timing” of the virus could have more serious consequences than currently expected by overzealous market investors. 

(The EOCI is comprised of the Fed Regional Surveys, CFNAI, Chicago PMI, NFIB, LEI, and ISM Composites. The indicator is a broad measure of hard and soft data of the U.S. economy)”

“Given the current level of the index as compared to the 6-Month rate of change of the Leading Economic Index, there is a rising risk of a recessionary drag within the next 6-months.”

That analysis seemed to largely bypass the mainstream economists, and the Fed, who were focused on the “number of people getting sick,” rather than the economic disruption from the shutdown of the supply chain.

On Tuesday, the Federal Reserve shocked the markets with an “emergency rate cut” of 50-basis points. While the futures market had been predicting the Fed to cut rates at their next meeting on March 18th, the half-percent cut shocked equity markets as the Fed now seems more concerned about the economy than they previously acknowledged.

It is one thing for the Fed to cut rates to support economic growth. It is quite another for the Fed to slash rates by 50 basis points between meetings.

It smacks of “fear.” 

Previously, such emergency rate cuts have not been done lightly, but in response to a bigger crisis which was simultaneously unfolding.

While we have spilled a good bit of digital ink as of late warning about the ramifications of COVID-19:

“Clearly, the ‘flu’ is a much bigger problem than COVID-19 in terms of the number of people getting sick. The difference, however, is that during ‘flu season,’ we don’t shut down airports, shipping, manufacturing, schools, etc. The negative impact on exports and imports, business investment, and potential consumer spending are all direct inputs into the GDP calculation and will be reflected in corporate earnings and profits.”

This is not a trivial matter.

“Nearly half of U.S. companies in China said they expect revenue to decrease this year if business can’t return to normal by the end of April, according to a survey conducted Feb. 17 to 20 by the American Chamber of Commerce in China, or AmCham, to which 169 member companies responded. One-fifth of respondents said 2020 revenue from China would decline more than 50% if the epidemic continues through Aug. 30..”WSJ

That drop in revenue, and ultimately earnings, has not yet been factored into earnings estimates. This is a point I made on Tuesday:

“More importantly, the earnings estimates have not been ratcheted down yet to account for the impact of the “shutdown” to the global supply chain. Once we adjust (dotted blue line) for a negative earnings environment in 2020, with a recovery in 2021, you can see just how far estimates will slide over the coming months. This will put downward pressure on stocks over the course of this year.”

It is quite possible even my estimates may still be too high.

While the markets have been largely dismissing the impact of the virus, the Fed’s “panic” move on Tuesday was confirming evidence that we are on the right track.

The market’s wild correction over the past two weeks, also begins to align with the Fed’s previous rate-cutting cycles. While it initially appeared “this time was different,” as the market continued to rise due to the Fed’s flood of liquidity, the markets seem to be playing catch up to previous rate-cutting cycles. If the economic data begins to weaken markedly, we may will see an alignment with the previous starts of bear markets and recessions.

Of course, we need to add some context to the chart above. Historically, the reason the Fed cuts rates, and interest rates fall, is because the Fed has acted in response to a crisis, recession, or both. The chart below shows when there is an inversion between the Fed Funds rate, and the 10-year Treasury, it has been associated with recessionary onset. (This curve will invert when the Fed cuts rates further at their next meeting.)

Not surprisingly, as suggested by the historical data above, the stock market has yielded a negative return a year after an emergency rate cut was initiated.

There is another risk the Fed may not be prepared for, an inflationary spike in prices. What could potentially impact the economy, and inflationary pressures, is the shutdown of the global supply chain which creates a lack of supply to meet immediate demand. Basic economics suggests this could lead to inflationary pressures as inventories become extremely lean, and products become unavailable. Even a short-term inflationary spike would put the Federal Reserve on the “wrong-side” of the trade, rendering the Fed’s monetary policies ineffective.

The rising recession risk is also being signaled by the collapse in the 10-year Treasury yield, a point which I have made repeatedly over the last several years in discussing why interest rates were headed toward zero.

“Outside of other events such as the S&L Crisis, Asian Contagion, Long-Term Capital Management, etc. which all drove money out of stocks and into bonds pushing rates lower, recessionary environments are especially prone at suppressing rates further. But, given the inflation of multiple asset bubbles, a credit-driven event that impacts the corporate bond market will drive rates to zero.

Furthermore, given rates are already negative in many parts of the world, which will likely be even more negative during a global recessionary environment, zero yields will still remain more attractive to foreign investors. This will be from both a potential capital appreciation perspective (expectations of negative rates in the U.S.) and the perceived safety and liquidity of the U.S. Treasury market. 

Rates are ultimately directly impacted by the strength of economic growth and the demand for credit. While short-term dynamics may move rates, ultimately the fundamentals combined with the demand for safety and liquidity will be the ultimate arbiter.”

A chart of monetary velocity tells you there is a problem in the economy as lower interest rates fails to spark an uptick in the flow of money.

My friend Caroline Baum summed up the Fed’s primary problem given the issue of plunging rates:

“All of a sudden, the reality of revisiting the zero lower bound, which the Fed now refers to as the effective lower bound (ELB), is no longer off in the distance. It could be right around the corner.

And this at a time when Fed officials are still saying that the economy and monetary policy are ‘in a good place’ and the fundamentals are sound. So what do policymakers do when the good place deteriorates into something mediocre, and the fundamentals turn sour?

Forward guidance, which I like to call talk therapy? Large-scale asset purchases? Unfortunately, the Fed goes to war with the tools it has, not the tools it might want or wish to have.”

Unfortunately, the Fed is still misdiagnosing what ails the economy, and monetary policy is unlikely to change the outcome in the U.S.

The reasons are simple. You can’t cure a debt problem with more debt. Therefore, monetary interventions, and government spending, don’t create organic, sustainable, economic growth. Simply pulling forward future consumption through monetary policy continues to leave an ever-growing void in the future that must be filled.

There is already evidence that lower rates are not leading to expanding consumption, business investment, or economic activity. Furthermore, while QE may temporarily lift asset prices, the lack of economic growth, resulting in lower earnings growth, will eventually lead to a repricing of assets.

Furthermore, there is likely no help coming from fiscal policy, either. As Caroline noted:

“Fiscal-policy measures, which entail tax cuts and government spending, will be difficult to enact in this highly charged political environment. There is little evidence that the Republicans and Democrats can put partisan differences aside to work together.”

Or, as Chuck Schumer said to Ben Bernanke just prior to the “financial crisis:”

“You’re the only game in town.” 

The real concern for investors, and individuals, is the real economy.

We are likely experiencing more than just a “soft patch” currently despite the mainstream analysts’ rhetoric to the contrary. There is clearly something amiss within the economic landscape, even before the impact of COVID-19, and the ongoing decline of inflationary pressures longer term was already telling us just that.

The Fed already realizes they have a problem, as noted by Fed Chair Powell on Tuesday:

“A rate cut will not reduce the rate of infection. It won’t fix a broken supply chain. We get that.”

More importantly, this is no longer a domestic question, but rather a global one. Since every major central bank is now engaged in a coordinated infusion of liquidity, fighting slowing economic growth, a rising level of negative yields, and a spreading virus shutting down economic activity, it is “all hands on deck.”

The Federal Reserve is currently betting on a “one trick pony” which is that by increasing the “wealth effect,” it will ultimately lead to a return of consumer confidence, and mitigate the effect of a global contagion.

Unfortunately, there mounting evidence it may not work.

#FPC: Tips For A Volatile Market

These last couple of weeks have been crazy in the markets, last week we saw steady declines and this week we’re yo-yoing from one of the best days in the market to date to one of the worst. It seems like the sky is falling, it always does when we get into one of these environments, but fret not we’ve been here before. The question is what will you do different this time around? Since you’re here you’re probably already doing something different in reading the Real Investment Advice Newsletter, maybe you’re a client or a RIA Pro subscriber. Those resources will help you navigate these choppy waters.

Here are a few additional tips.

  • Understand that it’s ok to take profits and pay taxes.
  • Have a discipline to your investing approach.

Wall Street promotes an “it’s always a good time to buy” philosophy, but rarely does it give advice on when to reduce risk or increase it. For Wall Street it’s always about you… well, you staying invested. Have an exit strategy or a strategy to take profits, reduce risk and eliminate areas you no longer need to invest in. Markets change and so should your investments. Set it and forget it is not good enough.

  • Buy and hold is dead.

Portfolios should be monitored and changes should be made when needed. Not only when you visit or call your advisor. Buy, hold, monitor and sell. Buy and hold is for vampires who live forever, your life is finite. Getting back to even shouldn’t be a long term strategy.

  • Diversification is all but dead.

Wall Street will claim diversification is all you need, but we all know the type of diversification Wall Street refers to is all but dead. Markets are to intertwined in 2020, global supply chains, money flows, coordinated central bank interventions and the speed of information.

  • Speed of information is a loud, but silent killer to portfolios.

Years ago someone may be shot across the globe and we’d never hear about it or if we did by the time we received the information it was old news, outdated or like the game of telephone you may have played as a child: widely inaccurate. Now we get information in minutes if not seconds.

  • Everyone is an expert.

Have a Twitter account and an opinion or following and you are automatically an expert. There are many platforms out there for people to express their views, be careful what you consume. Facebook, Twitter or any other site may be a vacuum for your thoughts or may be a sales pitch in hiding. When I hear or see information I always want to know someone’s motive.

It’s ok to have a motive or promote your business. We promote ours daily by telling people what we do inside our business, how we invest and things you should be doing inside of your own financial plan.

Just remember, most of those so-called expert were in grade school during our last market down turn.

Nothing against being young, we were all there. But more and more advisors or experts have never been through a bear market. Many of these new investing platforms haven’t been around long enough to experience one either.  A bear market or a recession does more than impact your investments it can take a part of your soul. It changes people, I’ve heard many older advisors who’ve been around the block that they may not make it through another bad market. The emotional toll and stress is real. If you’ve never experienced a bad market it’s difficult to guide people through it. All the more reason you must guard against elation and have a process surrounding your investments, your actions and your emotions.

  • Watch for the wolf in sheep’s clothing.

Fear sells. Period. We get lots of calls from readers, our daily radio show or podcast and our television interviews. A big question I get from prospects or in the form of a general question is do you guys sell annuities? Typically the reason why is they were told something bad about one, preyed on by an insurance salesman or have had a bad experience with one. I’m telling you this because just this last week I’ve had more calls asking about annuities with guarantees. Fixed annuities, fixed indexed annuities or any other that will guarantee 7%.

The reasoning for these calls is that fear sells. When markets are as volatile as they currently are we make some of our worst mistakes and the annuity sales force knows this. I’m not saying annuities are bad, just don’t get sold one and live to regret it. We believe that annuities should be planned for not sold.

  • Understand your financial plan.

Many have financial plans that use only the rosiest of data. Don’t be afraid to stress your plan, use low performance numbers, bad market returns, give yourself a raise annually-stress your plan! I’m not saying that any of those events above will happen, but what if they did? We want you to be prepared. Our job is to educate you on how all of your financial world combines to help you meet your goals and provide you with the best results and the retirement you hoped for your family.

  • Keep your cool.

This is difficult to do when you see your life’s savings eroding quickly. Markets are very reflexive when they are at extreme deviations and markets moving as quick as they have over these last couple of weeks can be a scary event. You will come out on the other side. The markets don’t just go up and no one has taken a recession out of the business cycle. It will be ok, if you work with a good advisor they have a plan, an exit strategy, maybe they’ve already reduced your equity exposure, they’ve accounted for this in your financial plan. It doesn’t feel good. Investing is difficult because we let our emotions get in the way. 

  • Just because we CAN do something doesn’t mean we should. We’re often our own worst enemy.

Our brains and gimmicky marketing often get in our way. Have you ever seen the E Trade commercial where they tell you all about your high school buddy that trades on E Trade from his yacht or the Vanguard ad with the guy next to his personal plane? When the markets go up investing can be fairly easy, but what about when markets begin to drop? Dalbar did a study in 2019 that shows since 1988 the stock market’s average return has been 10% per year, but stock fund investors have earned only 4.1% annually. Why the big difference? Fear. Human nature is for us to get into something when it’s high and get out when it’s bad. We buy high and sell low even when we know the number one rule of investing is buy low and sell high.  I need a degree in Psychology just as much as I do in Finance. We study Behavioral Finance to limit the biases, help with self control and help make rational decisions.

  • Communicate

Reach out to your advisor, we have sent numerous emails, videos, hold investor summits and one on one phone calls or meetings to discuss the overall impact and to reinforce the plan and strategy. This is when good advisors earn their keep.

If you have questions, concerns or want to know more about how to implement these strategies for your family please don’t hesitate to reach out. We’d love to help.

Three Ways to Avoid the ‘Lost Highway’ of Financial ‘Advice.’

Now boys don’t start to ramblin’ round
On this road of sin are you sorrow bound
Take my advice or you’ll curse the day
You started rollin’ down that lost highway

Hank Williams.

On the road to personal financial milestones, investors aspire to reach multiple destinations that are important to them – whether it’s saving for a college education or retirement, we all seek to assess travel risks, regularly track progress and hope to avoid hazardous conditions.

We all long to  -cheer – “I have arrived!”

However, there is imminent danger on the path to our destinations; like a low fog that hangs heavy, there are forces out there which blind and misdirect investors from the major road onto a lost highway. Unfortunately, obstacles to wealth are created by Wall Street, mainstream financial pundits and the social media they employ as a conduit of misinformation. And investors? You’re not off the hook. Your emotions are going to facilitate a major portfolio accident.

As I prepare framework for a screenplay “Lost Highway,” titled after a song written by Hank Williams, Sr., I gravitate to the Johnny Horton version which is slower, more haunting.  Consider the ‘Lost Highway’ one of regret and foreboding, a weigh station between life and death, certainty and the unknown.  Singer Johnny Horton, a spiritualist, knew for certain his demise was imminent and and it would be tragic. On November 5, 1960; at 2 am on a bridge in Milano Texas, Mr. Horton’s premonition became an unfortunate reality. More on that story later.

For now, it’s important for readers to navigate their own financial life highway and avoid the diversions which grow larger, deeper, as this bull market rages on.

As investors, let’s attempt to navigate away from these 3 financial potholes, shall we?

1 – As a retail investor, I’d avoid Twitter.

It’s called ‘FinTwit.’ A lost highway where financial experts who appear to know everything pat each other on the backs with joyous volleys of endless-scrolling bon mot. Most of these Twitter folk were running around the house in their Underoos during the last bear market or blew up portfolios during the financial crisis and conveniently chose to forget it because market recovery cures all ills – except for yours of course, because time is more valuable than money.

I mean, why not? The market recovery gave many advisors and big-box financial retailers a free pass. Of course, markets recover, don’t they? Sure they do. If you’re willing to wait a decade or so to break even. In the span of a human life, lots of events occur, lots of hair is lost, lots of wrinkles, lots of wealth stagnates over the years. The stock market is the Dorian Gray of money and the Twitter Twits believe you, as a human, have the lifespan of a vampire.

Let me show you.

Nothing wrong with Meb; he’s a very academic, smart guy.  I like his work. I understand why he shared this tweet. But as my grandfather would say – OOFA! We’re being shamed as advisors for limited exposure to international stocks. I get it. It’s a big world out there. Most investors – professionals and novices – will never seek to invest outside their borders.  And that’s a bad idea.

It’s a formidable, worldwide issue deemed Home Country Bias. However, over the last decade it’s been a fruitful endeavor for U.S. advisors  and investors to diversify mostly among U.S. stocks. International money managers should have, in hindsight, been overweight in overseas or U.S. stocks. Home-based bias has cost them. The EliteTwits would scoff at me for writing this (not that I care),  – I do not see a reason to invest in an asset class that underperforms for extended periods. I don’t find it of value to be diversified at all or at the least, greatly exposed to dormant asset classes just to ‘spread the risk.’

Diversification can indeed minimize specific company risk. If the majority of retail investors owned individual stock portfolios and sought to own ‘oil’ and ‘bleach’ in their portfolios from various countries,  diversification from an unsystemic perspective would be effective. After all, if oil stocks falter, it’s most likely food & beverage stocks are thriving or at the least, not faltering as hard as non-cyclical stocks.  Anybody you know still own individual stocks? Bueller? Heck, they don’t even split anymore.

Most investors today are encouraged to buy  baskets of stocks through index funds or their exchange-traded brethren. So, if I own an investment that represents the S&P 500  and the MSCI EAFE Index i.e; international stocks,  and one underperforms for an extended period of time, well then, why do I need to own it? Because mainstream financial media tells me so?

You must understand what diversification is and most crucial, what it isn’t. Certainly, it’s not the panacea it’s communicated to be. There’s no ‘free lunch,’ here, although I continue to hear and read this dangerous adage in the media and on Twitter. The word gets thrown around like a remedy for everything which ails a portfolio. It’s the industry’s ‘catch all’ that can lull investors into complacency, inaction.

So, who buys into this free lunch theory, again? After all, what is free on Wall Street? Investors who let their guard down, buy in to the myth of free lunches on Wall Street,  find their money on the menu.

Due to unprecedented central bank intervention, there exists extreme distortion in stock and bond prices. Global risk-averse investors have purchased bonds with a voracious appetite. The odds of negative rates even at least briefly, can manifest here in the states. As I’ve lamented on the radio show in December and January – domestic interest rates will be lower in 2020.

A way to effectively manage risk has morphed into two disparate perceptions. The investor’s definition of diversification and that of the industry has parted, leaving an asset allocation plan increasingly vulnerable.

Today, the practice of diversification is Pablum. Watered down. Reduced to a dangerous buzzword. 

What is the staid mainstream definition of diversification?

According to Investopedia – An internet reference guide on money and investments:

  • Diversification strives to smooth out unsystematic risk events in a portfolio so the positive performance of some investments neutralizes the negative performance of others. Therefore, the benefits of diversification hold only if the securities in the portfolio are not perfectly correlated.
  • Diversification benefits can be gained by investing in foreign securities because they tend to be less closely correlated with domestic investments. For example, an economic downturn in the U.S. economy may not affect Japan’s economy in the same way; therefore, having Japanese investments gives an investor a small cushion of protection against losses due to an American economic downturn.

Now let’s break down the lunch and examine how free it is. 

Unsystematic risk – This is the risk the industry seeks to help you manage. It’s the risks related to failure of a specific business or underperformance of an industry.

To wit:

  • This is a company- or industry-specific hazard that is inherent in each investment. Unsystematic risk, also known as “nonsystematic risk,” “specific risk,” “diversifiable risk” or “residual risk,” can be reduced through diversification.
  • So, by owning stocks in different companies and in different industries, as well as by owning other types of securities such as Treasuries and municipal securities, investors will be less affected by an event or decision that has a strong impact on one company, industry or investment type.

So, think of it this way: A ‘diversified’ portfolio represents a blend of investments – stocks, bonds for example, that are designed to generate returns with less overall business risk. While this information is absolutely valid, the financial industry encourages you to think of diversification as risk management, which it isn’t.

Here’s what you need to remember:

Bleach  (consumer staples) and oil (consumer cyclicals) eventually all run down-hill, in the same direction in corrections or bear markets. 

Sure, ketchup or bleach may run behind, roll slower, but the direction is the one direction that destroys wealth – SOUTH.  Large, small, international stocks. Regardless of the risk within different industries, stocks move together (they connect in down markets).


What are the odds of one or two companies in a balanced portfolio to go bust or face an industry-specific hazard at the same time?

What’s the greater risk to you? One company going out of business or underperforming or your entire stock portfolio suffers losses great enough to change your life, alter your financial plan.

You already know the answer.

Diversification is not risk management, it’s risk reduction.

  • When your broker preaches diversification as a risk management technique, what does he or she mean?
  • It’s not risk management the pros believe in, but risk dilution.
  • There’s a difference. The misunderstanding can be painful.

To you, as an investor, diversification is believed to be risk management where portfolio losses are controlled or minimized. Think of risk management as a technique to reduce portfolio losses through down or bear cycles and the establishment of price-sell or rebalancing targets to maintain portfolio allocations. Consider risk dilution as method to spread or combine different investments of various risk to minimize volatility.

Even the best financial professionals only consider half the equation. Beware the lamb (risk management) in wolf’s clothing (risk dilution). The goal of risk dilution is to “cover all bases.” It employs vehicles, usually mutual funds, to cover every asset class so business risk can be managed. The root of the process is to spread your dollars and risk widely across and within asset classes like stocks and bonds to reduce company-specific risk.

There’s a false sense of comfort in covering your bases. Diversification in its present form is not effective reduce the risk you care about as an individual investor – risk of loss.

Today, risk dilution has become a substitute for risk management, but it should be a compliment to it. Risk dilution is a reduction of volatility or how a portfolio moves up or down in relation to the overall market. 

Risk dilution works best during rising, or up markets as since most investments move together, especially stocksThink about betting on every horse in a race.

  • In other words, a rising tide, raises all boats.

So, why is risk reduction not risk management, the prevailing sentiment?

Sales Goals: Most financial pros are saddled with aggressive sales goals. Risk dilution is a set and forget strategy. Ongoing risk management is time consuming and takes time away from the selling process. Unfortunately, the financial industry as a whole, has watered it down and broadened it to such a degree it’s become absolutely ineffective as a safeguard against losses. One reason are the sales targets that force financial representatives to spend less time with client portfolios.

Compliance Departments: A targeted diversification strategy places accountability on the advisor and poses risk to the firm. A wider approach makes it easier to vector responsibility to broad market ‘random walks’ so if a global crisis occurs and most assets move down together, an advisor and the compliance department, can “blame” everything outside their control. Here’s a perfect compliance department question: “so why isn’t this investor allocated appropriately to international stocks?” Appropriate for whom?

At RIA, we monitor global trends. We don’t believe investors need to participate in an asset class that’s been out of favor for over ten years. That doesn’t mean we won’t; it means our exposure has been minimal.  That stance can change at any time. I mean, isn’t that what your advisor is supposed to do? The average investor holding period is less than two years. So imagine attempting to convince most investors to sit on poor performance for longer than decade. In the trenches, it’s never gonna happen.

I have hundreds of examples of Twitter commentary. that will send you down a Lost Highway. To repeat, my advice to retail investors: Please avoid the medium. It’s generally unhealthy for your psyche. Yes, we’re on Twitter too because we need to be. Avoid our feed too. Follow and read the blog instead.

2 – Avoid an ‘accumulation’ mindset if you’re five years or sooner from retirement, or you may never exit the Lost Highway.

Here’s another unusual tweet. I have yet to meet an investor, average, above-average, HUMAN, over the last 30 years who’s gained 300% after losing 30%. Those who are close to retirement must avoid information like this which fosters overconfidence and complacency.

Investors five years or less until retirement must avoid FOMO or Fear Of Missing Out, when it comes to blowing up their overall asset allocations; tempted to take on more risk than they’re prepared to handle. In January when the S&P 500 was three-standard deviations above its 200-week moving average, retirees or those close to retirement were questioning their tolerance for risk even though their portfolio returns were greater than four times the personalized benchmark rate required to achieve long-term financial goals.  

Lance Roberts recently wrote: “There have only been a few points over the last 25-years where such deviations from the long-term mean were prevalent. In every case, the extensions were met by a decline, sometimes mild, sometimes much more extreme.” 

And while we were trimming gains, rebalancing and facing challenges to add money to equities for new clients, tenured ones were wondering why we were being so cautious. Now that markets have fallen precipitously, the same retirees now question why they sought greater risk in the first place.  Some of the same investors wonder why we’re buying at lower prices or dipping our pinky toe into stock waters. It’s an emotional roller-coaster that ostensibly will destroy portfolio returns.  

As we teach around town at our popular Retirement Right Lane Classes, the financial services industry preaches a wholesale accumulation mindset where every downturn is a buying opportunity. However, retirees who are need to re-create a paycheck, withdraw a fixed amount or percentage from variable assets like stocks and bonds, must realize they need to protect capital over time and severe losses must be avoided. Limited losses are inevitable. That’s the price you pay for investing in stocks. If you cannot handle an ebb and flow of risk assets, you shouldn’t be invested in the market. It’s a harsh reality; the recent downturn my serve as a valuable lesson.

James B. Sandidge, JD in his paper “Adaptive Distribution Theory,” for The Journal of Investment Consulting, describes The Butterfly Effect for retirees. The effect refers to the ability of small changes early on in a process that lead to significant impact later.

Depending on the length of this correction and damage incurred, systematic withdrawal rates may need to stay the same (do not increase cash flow requirements in any year during the first 5 that has a negative return) or reduced altogether.  James’ chart from his paper below, outlines how the sacred ‘4 percent withdrawal rule,’ can place a retiree in jeopardy if withdrawals aren’t monitored, revisited through bear market cycles.

3 – Emotions are going to be the demise of your portfolio performance.

I get it. Many investors – novice or seasoned – have forgotten markets correct; newer investors are hard-pressed to believe that bear markets are possible. I personally embrace rough markets. They provide valuable lessons, great wisdom; a dose of humility, a chance to purchase stocks at attractive prices.  Each downturn is different and I take notes. It’s through times like this I’m thankful that I’m no longer with my former employer and part of a team who employs a surgical, rules-based sell discipline.

Tenured investors need to be reminded again that portfolios fluctuate! Being all in or all out of stocks is the worst move I’ve ever witnessed. In other words, selling all stocks low, purchasing again higher or ‘when the crisis blows over’ (already too late), tells me that you my friend, should avoid stocks at all costs, through every cycle. It’s a caveman reaction that will lead to very poor returns over time. Stocks are risk assets and over the last decade, we’ve forgotten what the word ‘risk’ means.

Oh, you will bleed through bear markets; it’s crucial not to hemorrhage. Can you surgically sell through down cycles like we do at RIA? If you have solid rules to do so, yes. Should you take a chainsaw to your wealth and sell everything in a panic? No. Personally, I’m using this downturn to place cash I’ve sat on for two years, selectively, slowly, to work in stocks.  Our investment team is doing the same at RIA. We maintain a rules-based, three-prong approach to take profits, sell weak players and add to positions we believe are good opportunities. 

I pray a prolonged downturn doesn’t turn off  yet another generation of young adults from investing in equities.  These generations have embraced Twitter, so I fear the  messages they’ve taken in as gospel from the FinTwit stars over the years.  I believe the FinTwit club members with insensitive tweets which outline how Jeff Bezos lost more wealth (to help followers keep the ‘downturn in perspective,’) are nothing short of idiocy. There’s no way in hell these people deal with clients on a consistent basis. 

To keep it in perspective – Bezos, the founder of Amazon, bled close to $12 billion during the market downturn. Don’t feel bad:  He’s still worth $116 billion.  If you’re not seated at the Bezos table of wealth, big losses can derail future plans. However, an acceptable rate of loss must be accepted and built into a financial plan. Holistic investors are guided by rules; their guidebooks are their personalized financial plans. Investors who fly by the seat of their pants and get absorbed in fear and greed at bottoms and tops are going to find investing a disappointing experience.

Johnny Horton was a singer of folk/country story songs such as The Battle of New Orleans and Johnny Reb. However, my two favorites are North to Alaska and his rendition of  Hank Williams’ Lost Highway.  Mr. Horton was haunted by a premonition that he’d be killed by a drunk driver.  So much so, he cancelled his attendance for the opening of the theatrical film, North to Alaska. He was hesitant to play the famous Skyline Club in Austin.

From Arden Lambert who wrote of the fatal night:

“Soon after the gig was over, he kissed his wife Billie Jean good-bye. Jean was Hank Williams’ widow whom Horton married a year after Williams’ death in 1952. Horton gave his goodbye kiss to Jean in the same place on the same cheek where Hank had kissed her after his last gig at the Skyline.

Horton, together with his bass player Tillman Franks and manager Tommy Tomlinson, headed to Shreveport, Louisiana. From the beginning, Franks noted that Horton was driving too fast (though that wasn’t new about him as he always drove fast). Suddenly, a pick-up truck smashed head-on into Horton’s car. Horton’s companions were severely injured, and he was still alive when the ambulance came. He died, however, on their way to the hospital.”

I imagine Johnny and his bass player still driving that fatal stretch of road in Milano, Texas. Forever trapped on the Lost Highway. Two men who died way too soon.

I implore that you don’t place your portfolio and emotions on a similar road. 

Today, it’s easier than ever to do so.

Here’s Johnny’s version of the song. Let me know what you think…



MacroView: The Ghosts Of 2018?

On Jan 3rd, I wrote an article entitled: “Will The Market Repeat The Start Of 2018?” At that time, the Federal Reserve was dumping a tremendous amount of money into the financial markets through their “Repo” operations. To wit:

“Don’t fight the Fed. That is the current mantra of the market as we begin 2020, and it certainly seems to be the right call. Over the last few months, the Federal Reserve has continued its “QE-Not QE” operations, which has dramatically expanded its balance sheet. Many argue, rightly, the current monetary interventions by the Fed are technically “Not QE” because they are purchasing Treasury Bills rather than longer-term Treasury Notes.

However, ‘Mr. Market’ doesn’t see it that way. As the old saying goes, ‘if it looks, walks, and quacks like a duck…it’s a duck.'” 

As I noted then, despite commentary to the contrary, there were only two conclusions to draw from the data:

  1. There is something functionally “broken” in the financial system which is requiring massive injections of liquidity to try and rectify, and;
  2. The surge in liquidity, whether you want to call it a “duck,” or not, is finding its way into the equity markets.

Let me remind you this was all BEFORE the outbreak of the Coronavirus.

The Ghosts Of 2018

“Well, this past week, the market tripped ‘over its own feet’ after prices had created a massive extension above the 50-dma as shown below. As I have previously warned, since that extension was so large, a correction just back to the moving average at this point will require nearly a -6% decline.”

“I have also repeatedly written over the last year:

‘The problem is that it has been so long since investors have even seen a 2-3% correction, a correction of 5%, or more, will ‘feel’ much worse than it actually is, which will lead to ’emotionally driven’ mistakes.’

The question now, of course, is do you “buy the dip” or ‘run for the hills?’”

Yesterday morning, the markets began the day deeply in the red, but by mid-morning were flirting with a push into positive territory. By the end of the day, the Dow had posted its largest one-day point loss in history.”

That was from February 6th, 2018 (Technically Speaking: Tis But A Flesh Wound)

Here is a chart of October 2019 to Present.

Besides the reality that the only thing that has occurred has been a reversal of the Fed’s “Repo” rally, there is a striking similarity to 2018. That got me to thinking about the corollary between the two periods, and how this might play out over the rest of 2020.

Let’s go back.

Heading in 2018, the markets were ebullient over President Trump’s recently passed tax reform and rate cut package. Expectations were that 2018 would see a massive surge in earnings growth, due to the lower tax rates, and there would be a sharp pickup in economic growth.

However, at the end of January, President Trump shocked the markets with his “Trade War” on China and the imposition of tariffs on a wide variety of products, which potentially impacted American companies. As we said at the time, there was likely to be unintended consequences and would kill the effect of tax reform.)

“While many have believed a ‘trade war’ will be resolved without consequence, there are two very important points that most of the mainstream analysis is overlooking. For investors, a trade war would likely negatively impact earnings and profitability while slowing economic growth through higher costs.”

Over the next few months, the market dealt, and came to terms with, the trade war and the Fed’s tightening of the balance sheet. As we discussed in May 2018, the trade war did wind up clipping earnings estimates to a large degree, but massive share repurchases helped buoy asset prices.

Then in September, the Fed did the unthinkable.

After having hiked rates previously, thereby tightening the monetary supply, they stated that monetary policy was not “close to the neutral rate,” suggesting more rate hikes were coming. The realization the Fed was intent on continuing to tighten policy, and further extracting liquidity by reducing their balance sheet, sent asset prices plunging 20% from the peak, to the lows on Christmas Eve.

It was then the Fed acquiesced to pressure from the White House and began to quickly reverse their stance and starting pumping liquidity back into the markets.

And the bull market was back.

Fast forward to 2020.

“The exuberance that surrounded the markets going into the end of last year, as fund managers ramped up allocations for end of the year reporting, spilled over into the start of the new with S&P hitting new record highs.

Of course, this is just a continuation of the advance that has been ongoing since the Trump election. The difference this time is the extreme push into 3-standard deviation territory above the moving average, which is concerning.” – Real Investment Report Jan, 5th 2018

As noted in the chart below, in both instances, the market reached 3-standard deviations above the 200-dma before mean-reverting.

Of course, while everyone was exuberant over the Fed’s injections of monetary support, we were discussing the continuing decline in earnings growth estimates, along with the lack of corporate profit growth To wit:

With equities now more than 30% higher than they were then, the Fed mostly on hold in terms of rate cuts, and ‘repo’ operations starting to slow, it certainly seems that expectations for substantially higher market values may be a bit optimistic.

Furthermore, as noted above, earnings expectations declined for the entirety of 2019, as shown in the chart below. However, the impact of the ‘coronavirus’ has not been adopted into these reduced estimates as of yet. These estimates WILL fall, and likely markedly so, which, as stated above, is going to make justifying record asset prices more problematic.”

Just as the “Trade War” shocked the markets and caused a repricing of assets in 2018, the “coronavirus” has finally infected the markets enough to cause investors to adjust their expectations for earnings growth. Importantly, as in 2018, earnings estimates have not been revised lower nearly enough to compensate for the global supply chain impact coming from the virus.

While the beginning of 2020 is playing out much like 2018, what about the rest of the year?

There are issues occurring which we believe will have a very similar “feel” to 2018, as the impact of the virus continues to ebb and flow through the economy. The chart below shows the S&P 500 re-scaled to 1000 for comparative purposes.

Currently, the expectation has risen to more than a 70% probability the Fed will cut rates 3x in 2020. Historically, the market tends to underestimate just how far the Fed will go as noted by Michael Lebowitz previously:

“The graph below tracks the comparative differentials (Fed Funds vs. Fed Fund futures) using the methodology outlined above. The gray rectangular areas represent periods where the Fed was systematically raising or lowering the Fed funds rate (blue line). The difference between Fed Funds and the futures contracts, colored green or red, calculates how much the market over (green) or under (red) estimated what the Fed Funds rate would ultimately be. In this analysis, the term overestimate means Fed Funds futures thought Fed Funds would be higher than it ultimately was. The term underestimate, means the market expectations were lower than what actually transpired.”

Our guess is that in the next few weeks, the Fed will start using “forward guidance” to try and stabilize the market. Rate cuts, and more “quantitative easing,” will likely follow.

Such actions should stabilize the market in the near-term as investors, who have been pre-conditioned to “buy” Fed liquidity, will once again run back into markets. This could very well lift the markets into second quarter of this year.

But it will likely be a “trap.”

While monetary policy will likely embolden the bulls short-term, it does little to offset an economic shock. As we move further into the year, the impact to the global supply chain will begin to work its way through the system resulting in slower economic growth, reduced corporate profitability, and potentially a recession. (See yesterday’s commentary)

This is a guess. There is a huge array of potential outcomes, and trying to predict the future tends to be a pointless exercise. However, it is the thought process that helps align expectations with potential outcomes to adjust for risk accordingly.

A Sellable Rally

Just as in February 2018, following the sharp decline, the market rallied back to a lower high before failing once again. For several reasons, we suspect we will see the same over the next week or two, as the push into extreme pessimism and oversold conditions will need to be reversed before the correction can continue.

While 2019 ended in an entirely dissimilar manner as compared to 2018, the current negative sentiment, as shown by CNN’s Fear & Greed Index is back to the extreme fear levels seen at the lows of the market in 2018.

On a short-term technical basis, the market is now extremely oversold, which is suggestive of a counter-trend rally over the next few days to a week or so.

It is highly advisable to use ANY reflexive rally to reduce portfolio risk, and rebalance portfolios. Most likely, another wave of selling will likely ensue before a stronger bottom is finally put into place. 

Lastly, our composite technical overbought/oversold gauge is also pushing more extreme oversold conditions, which are typical of a short-term oversold condition.

In other words, in 2019 “everyone was in the pool,” in 2020 we just found out “everyone was swimming naked.” 

Rules To Follow

One last chart.

I just want you to pay attention to the top panel and the shaded areas. (standard deviations from the 50-dma)

We were not this oversold even during the 2015-2016 decline, much less the two declines in 2018.

Currently, not only is the market extremely oversold on a short-term basis, but is currently 5-standard deviations below the 50-dma.

Let me put that into perspective for you.

  • 1-standard deviation = 68.26% of all possible price movement.
  • 2-standard deviations = 95.45% 
  • 3-standard deviations = 99.73%
  • 4-standard deviations = 99.993%
  • 5-standard deviations = 99.9999%

Mathematically speaking, the bulk of the decline is already priced into the market.

“I get it. We are gonna get a bounce. So, what do I do?”

I am glad you asked.

Step 1) Clean Up Your Portfolio

  1. Tighten up stop-loss levels to current support levels for each position.
  2. Take profits in positions that have outperformed during the rally.
  3. Sell laggards and losers (those that lagged the rally, probably led the decline)
  4. Raise cash, and rebalance portfolios to reduced risk levels for now.

Step 2) Compare Your Portfolio Allocation To Your Model Allocation.

  1. Determine areas where exposure needs to be increased, or decreased (bonds, cash, equities)
  2. Determine how many shares need to be bought or sold to rebalance allocation requirements.
  3. Determine cash requirements for hedging purposes
  4. Re-examine the portfolio to ensure allocations are adjusted for FORWARD market risk.
  5. Determine target price levels for each position.
  6. Determine “stop loss” levels for each position being maintained.

Step 3) Be Ready To Execute

  • Whatever bounce we get will likely be short-lived. So have your game plan together before-hand as the opportunity to rebalance risk will likely not be available for very long. 

This is just how we do it.

However, there are many ways to manage risk, and portfolios, which are all fine. What separates success and failure is 1) having a strategy to begin with, and; 2) the discipline to adhere to it.

The recent market spasm certainly reminds of 2018. And, if we are right, it will get better, before it gets worse.

Technically Speaking: Markets Start To Price In “Viral Impacts”

At the end of January, I wrote a piece titled “This Is Nuts: Why We Reduced Risk” discussing why we took profits in our portfolios. Here is the important point:

“When you sit down with your portfolio management team, and the first comment made is ‘this is nuts,’ it’s probably time to think about your overall portfolio risk.” 

At that time, we began the orderly process of reducing exposure in our portfolios:

In the Equity Portfolios, we reduced our weightings in some of our more extended holdings such as Apple (AAPL,) Microsoft (MSFT), United Healthcare (UNH), Johnson & Johnson (JNJ), and Micron (MU.)

In the ETF Sector Rotation Portfolio, we reduced our overweight positions in Technology (XLK), Healthcare (XLV), Mortgage Real Estate (REM), Communications (XLC), Discretionary (XLY) back to portfolio weightings for now.

The important sentence came next:

“We did not ‘sell everything’ and go to cash. We simply reduced our holdings to raise cash, and capture some of the gains we made in 2019. When the market corrects, we will use our cash holdings to either add back to our current positions or add new ones.”

At the time we made those changes, it appeared we were clearly wrong as the market continued to grind higher. As Howard Marks once quipped:

“Being early, even if you are right, is the same as being wrong.” 

You Can’t Time Market Corrections

From a portfolio management, and more particularly, a “risk mitigation” view, our job isn’t necessarily to hit the exact tops or bottoms, just to provide a cushion against losses. This is why we constantly measure risk, and make adjustments accordingly.

Over the last couple of weeks, we have continued to repeatedly note the extreme overbought, overly bullish, and over complacent conditions of the market. This was a point we discussed with our RIAPRO subscribers (Try for 30-days RISK FREE) in last Monday’s technical market update.

“As noted last week: ‘With the market now trading 12% above its 200-dma, and well into 3-standard deviations of the mean, a correction is coming.’ But the belief is currently ‘more stimulus’ will offset the ‘virus.’

This is probably a wrong guess.

Extensions to this degree rarely last long without a correction. Maintain exposures, but tighten up stop-losses.”

That extreme deviation from the long-term mean was unsustainable. What was needed was a catalyst to cause the slide. This past weekend, the realization the “coronavirus was NOT contained,” was the trigger needed to revert that overly stretched condition.

This is the misunderstanding of portfolio management. Risk management decisions are not being “all in” or “all out.” Making extreme movements actually increases your portfolio risk due to the high probability of making a “wrong call.”

For us, risk management is like driving a car. When you drive, you are constantly making a myriad of small adjustments from adjusting your lane position, your speed, and your positioning relative to the other cars. You are also simultaneously assessing the “risks” of other drivers, the weather, unexpected obstacles, and traffic signals and signs. After years of driving, you subconsciously make all these decisions without giving it much thought, but in actuality, you did.

The same goes for portfolio management. Small adjustments made to keep the portfolio moving forward while avoiding the potential of a catastrophic accident is the goal. Sure, it is entirely possible we could get into a “fender bender,” and such should be expected. What we want to make sure of, however, is that in the event of a crash, we will walk away relatively unharmed. This is why we make sure our portfolio has a seat belt (cash), airbags (hedges), strong structural support (bonds), and we drive a little slower than the speed limit (allocation.) 

With the markets pushing into 3-standard deviations above the 200-day moving average, it was only a function of time before a correction occurred. Therefore, while we were early taking profits, the end result was reduced portfolio risk against a pending correction.

“Taking profits, and reducing risks now, may lead to a short-term underperformance in portfolios, but you will likely appreciate the reduced volatility if, and when, the current optimism fades.”

On Monday, that reduced volatility was greatly appreciated.

While our assessment of the market two-weeks ago was that risk versus reward was unbalanced, as we noted then, such can remain the case for extended periods of time.

“The problem with an economy being propped up by artificially appreciated assets is that this pendulum swings both ways. At some point, prices eventually decline. No one knows what will cause the decline:

  • Higher interest rates like in 2018,
  • A presidential tweet, when he launched the “trade war” with China.
  • The ongoing implosion of the Chinese economy is still a threat.
  • It could just be the realization by the markets that asset prices don’t grow to the sky.
  • Or, it could be triggered by an unexpected, exogenous event, which results in the markets “repricing” risk.”

As we have repeatedly stated, it was the impact of the “coronavirus” which the market has failed to account for. To wit:

Given that U.S. exporters have already been under pressure from the impact of the “trade war,” the current outbreak could lead to further deterioration of exports to China. This is not inconsequential as exports make up about 40% of corporate profits in the U.S. With economic growth already struggling to maintain 2% growth currently, the virus could shave another 1% off that number.

Importantly, this decline happened BEFORE the “Wuhan virus” which suggests the virus will only worsen the potential impact.

The impact of the virus has not been factored in by the market.

Remember, it never just starts raining; clouds gather, skies darken, wind speeds pick up, and barometric pressures decline. When you have a consensus of the evidence, you typically carry an umbrella.

Is It Time To “Buy The Dip?”

With the “sell off” on Monday, the immediate reaction by investors is to jump in and “buy the dip?”

Maybe. Maybe not.

The chart below is part of the analysis we use to “onboard” new client portfolios. The purpose of this measure is to avoid transitioning a new client into our portfolio models near a short-term peak of the market. The vertical red lines suggest we avoid adding equity risk to portfolios and vice versa.

With both “sell signals” being triggered short-term, and the market breaking the 50-dma, this is not an opportune point to dramatically increase equity exposure. In other words, be careful “buying the dip,” if you are so inclined.

There are a few important points to denote in the chart above.

  1. The top and bottom signals are essentially relative strength and momentum measures. Both are currently starting to trigger “sell” signals. 
  2. With the market still very deviated above the longer-term 200-dma, and just coming out of 3-standard deviation territory, there is currently more downside risk, than upside reward. 
  3. Note that corrections, once the “sell signals” are triggered, can last from several weeks, to a couple of months. During the correction process there are often multiple opportunities (counter-trend rallies) to reduce risk and raise cash accordingly. 
  4. The last two times the market pushed into 3-standard deviation territory, the resulting corrections were fairly sharp and lasted for a couple of months.

However, with that said, on a VERY short-term basis the market is now oversold enough to elicit a short-term, reflexive, rally. This type of bounce is often termed a “dead cat” bounce, and basically suggests a one, or two, day rise that quickly fails to retest the previous low.

I have also noted that we are in the process of forming a potential “head and shoulder” topping pattern with a very clear “neckline” at yesterday’s closing price. A rally back to resistance at the previous “left shoulder, and a break of the subsequent “neckline,” would entail a decline to the 200-dma, or about 10% from the recent peak.

Given the MACD has registered a “sell signal” from a fairly high level, investors must consider the risk of further downside even if the market rallies over the next couple of days.

Don’t be fooled that a short-term reflexive rally is an “all-clear” for the bull market to resume. With the bulk of our momentum, relative strength, and overbought/sold indicators just starting to correct from recent highs, it is likely short-term rallies will be “selling opportunities” over the next couple of weeks as the market either corrects further or consolidates recent gains.

As we have detailed over the last few missives, due to the rather extreme extension of the market, a correction would likely encompass a 5-10% decline in totality before it is complete. As of today’s close the market is down 4.74% from its recent highs.

As noted in this past weekend’s missive, the Federal Reserve has begun reducing its torrid pace of liquidity, while already weak economic growth, and potentially weaker earnings growth, is at risk from the impact of the coronavirus.

From that perspective, we are continuing to maintain our higher levels of cash, and are opportunistically rebalancing portfolio risks as needed according to our investment discipline.

  1. Tighten up stop-loss levels to current support levels for each position.
  2. Hedge portfolios against major market declines.
  3. Take profits in positions that have been big winners
  4. Sell laggards and losers
  5. Raise cash and rebalance portfolios to target weightings.

Notice, nothing in there says, “sell everything and go to cash.”

By having reduced risk, we can afford to remain patient and wait for the next opportunity.

Like our car driving analogy above, it is always the ones who are sending a text, holding a breakfast burrito with the other, and driving with one knee who always winds up in the worst possible condition.

We prefer to keep two hands on the wheel at all times.

#FPC: Dave Ramsey Is Right & Very Wrong About Permanent Life Insurance (Pt. 2)

Last week’s piece was on why Dave Ramsey is right and wrong about permanent life insurance and some of the reasons you may consider using a permanent life insurance policy. 

To reiterate last week’s sentiment-permanent life insurance is not for most, but if you:

  • Max out your retirement savings
  • Make too much to contribute to a Roth
  • Have accumulated a large savings account
  • Want to gain flexibility from taxes
  • Want growth, but would like some protection from high valuations
  • Have a large estate that needs estate tax protection

Keep reading…

Let’s discuss some of the benefits of these policy’s:

  • No 1099’s– your cash value isn’t taxed year to year like most non-qualified investments, in fact if used properly the funds will never be taxed
  • Distributions aren’t considered income (when done properly) so unlike your pre-tax 401K, you’ll be using these funds tax free, which will be a big deal in retirement
  • No Income limitations-that’s right say goodbye to those income limitations most are familiar with on IRA’s
  • No Contribution Limits– it’s difficult to super charge your savings in tax free or tax deferred accounts due to the contribution limits.  In 2020, you can contribute $19,500 to an employer sponsored plan with a catch-up provision of $6,500 for those over 50. In an IRA you’re much more limited. You may contribute up to $6,000 with an additional $1,000 catch up provision for workers 50 or older. Another great tool that’s finally gaining the recognition it deserves is the HAS or Health Savings Account. If you have access to an HSA an individual may contribute $3,550 and a family can contribute $7,100. If you’re maxing out all of these and hopefully utilizing a Roth you’re likely in pretty good shape, but where do those additional funds go?
  • No age requirement for distributions– cash value can be used at any time. Need funds for kid’s college, or retired early prior to 59 1/2-no problem.
  • Likelihood of tax reform impacting your policy is low– this is a little loop-hole that many think may change in the future because of the ability to grow and distribute funds on a tax free basis. With the path the government is on I’m concerned not to have this tool. The 80’s were the last time changes were made to these types of plans and current policy holders were grandfathered to have no changes made to their policies, but only impacting future policy holders. The belief is that the precedent has been set and it would be unfair to materially impact the plans already underway.
  • Creditor Protection-most all states offer some sort of creditor protection some full and some partial. Check with your state to determine how protected you are from potential creditors or judgments.

All these advantageous aspects why don’t we hear more about these types of tools or why do they get a bad wrap?

Dave Ramsey is right. They’re not for everyone. BUT for the few who already know how to save, high income earners or those just looking to be a little more strategic this could be a viable option.

I think many also have an aversion to these products because they are misunderstood or they felt the pressure of someone trying to make a hard sell. Let’s be very clear, a recommendation for such a policy should only come after a thorough financial plan is done. We often say planned, not sold, they are a complex piece to an already complicated puzzle.

Buyer Beware:

Many agents, or “financial advisors,” who sell insurance are held captive to 1 firm and 1 product or are limited in some way. Here I use the term “financial advisors” very loosely, because many are just salesman trying to make a quick buck, not advisors. Have hammer, see nail. Unfortunately, it’s not that easy or at least it shouldn’t be.

I believe any and all financial decisions should be made holistically by looking at the big picture through a telescope and then bringing it back down to each star in your universe with a microscope. Not sparing any detail. After all, each piece of the puzzle must fit and work together. Ideally, you want to work with someone who is independent from working only with one firm so they may scorch the earth to find the best policy for you and your family.

Life insurance, or an annuity, is also not a tool you put all of your funds in and if anyone advises so, RUN!

In the coming weeks we’ll discuss how to use permanent life insurance for cash accumulation or estate planning, what to look for in a policy and the different types of permanent life insurance available.

6 Considerations for Long-Term Care Coverage.

Retirement is a a continuous road; mile markers that represent age may be visualized along the path.

However, if one looks to retire at 67 and in relatively good health, it’s a challenge to comprehend what quality of life may be like at 80. It’s easy to understand how 40 may not look too different from 60 from a quality of health perspective. The stretch from 60 to 90 may be so dramatically different, it’s a challenge to envision.

How does one contemplate their own increasing frailty?

People tend to avoid the topic of long-term care which is defined as financial and caregiver resources required to perform daily activities such as bathing and dressing. Services range from temporary home health services to full-time care through assisted living or memory care. At RIA, we find that investors are hesitant to confront the topic of long-term care. It’s understandable. After all,  the mitigation of long-term care risk is expensive. People barely save enough for retirement, overall. Imagine planning for the possible additional six-figure burden of long-term care services.

Also, consumers don’t understand how coverage works, premiums have the ability to skyrocket every few years which can break constrained budgets, and insurance underwriting can be a challenge. It’s reported that over 30% of those who apply for traditional long-term care coverage are rejected for health reasons. Realistically, after age 62, premiums become cost prohibitive for consumers. It’s in their mid-sixties we find people scramble to put together some patchwork plan. We call long-term care the ‘financial elephant in the room.’ You can try to lift it, move it to another area of your financial house however, wherever you go, there it is! 

As we lament at workshops, on the radio, to clients at face-to-face meetings – heck, to anybody who’ll listen! – Long-term care expenses are the greatest threat to a secure retirement. Confounding about this specific study is that over 53% of Boomers are confident about managing long-term care costs yet the majority have nothing set aside. The results lead me to conclude there’s a strong and dangerous case of DENIAL going on here. Is there more to the story? Since 50% of middle-income Boomers maintain less than $5,000 in emergency reserves, saving for retirement AND retirement care is most likely too burdensome.

Don’t ignore the elephant. Prepare for it. If traditional long-term care insurance isn’t in your future, hope isn’t lost. Consider these alternatives.

Bankers Life Center for Secure Retirement in a study conducted by Blackstone Group in October 2018, discovered that middle-income Baby Boomers (those with an annual household income between $30 and $100,000 and have less than $1 million in investable assets), are increasingly concerned about staying healthy enough to enjoy retirement (56%). Yet, an astounding 4 in 5 (79%) of Boomers sampled have no money set aside specifically for retirement care needs.

First Step: Don’t Ignore the Elephant!

Your rightful concern, if I got you thinking, is to take a deep breath and find a Certified Financial Planner® who is also a fiduciary. In other words, your interests above all else. Financial plans laud strengths; plans also expose financial vulnerabilities that require remedy.

Per the Center For A Secure Retirement® study, six out of ten Baby Boomers have a plan for how they will fund retirement. Only one-third have a retirement long-term care strategy which leads me to believe this group is not undertaking holistic financial planning which considers every facet of a fiscal life including the possible need for long-term care from custodial to skilled nursing. I’m not surprised that 88% of Boomers who have included a retirement care strategy reported a positive impact to their overall plan.

Second Step: Cover the Spouse Who’ll Most Likely Live Longest.

I’m not going to lie; the mitigation of long-term care risk using insurance isn’t cheap.  According to the American Association for Long-Term Care Insurance, the best age to apply is in your mid-fifties. To obtain coverage, the current condition of your health matters or you may not qualify. Only 38% of those age 60-69 make the cut. Even if healthy, at a point in life, especially around the mid-sixties, premiums are known to be household budget nightmare. For example, a couple both age 60 in a preferred health class can wind up paying close to $5,000 a year in premiums and will likely experience premium increases over time.

The number of insurance carriers is shrinking – down to less than 12 from more than 100. Recently, Genworth, one of the heavy hitter providers of long-term care insurance temporarily suspended sales of traditional individual policies and an annuity product designed to provide income to cover long-term costs such as nursing home stays.

If you’re astute enough to plan for retirement care and concerned about the impact of dual premiums on the household budget including saving for other goals, work with a Certified Financial Planner to create a scenario to consider at least partial coverage for the spouse with a greater probability of longevity. For example, on average, women outlive men by 7 years.

If single and do not have a reason to leave a legacy to children or grandchildren, it’s likely that asset liquidation can adequately cover a long-term care event. Again, it’s best to work with a CFP Fiduciary who can help create a liquidation strategy.

Third Step: Take the Kids Out of It. 

I’m shocked by parents who assume their adult children will take care of them or ‘take them in’ in the case of a long-term care event. Personally, I find it too painful to interrupt my daughter’s life and impact her physical, emotional and financial health by providing long-term assistance to her dad.

According to www.caregiver.org, 44 million Americans provide $37 billion hours of unpaid informal care for adult family members and friends with chronic illnesses and conditions. Women provide over 75% of caregiving support. Caregiving roles are going to do nothing but blossom in importance as the 65+ age cohort is expected to double by 2030. There will be a tremendous negative impact, financial as well as emotional, on family caregivers who will possibly need to suspend employment, dramatically interrupt their own lives to assist loved ones who require assistance with activities of daily living.

Parents must begin a dialogue with adult children to determine if or how they may become caregivers. Armed with information learned from discussion, I have helped children prepare for some form of caregiving for parents.

A 47-year-old client has added financial support for parents as a specific needs-based goal in her plan; another recently purchased a larger one-story home with an additional and easily accessible bedroom and bath. Yet another has commenced building a granny pod on his property for his elderly (and still independent), mother. All these actions have taken place due to open, continuous dialogue with parents and siblings.

In addition, elder parents have been receptive to allocating financial resources to aid caregiver children. Siblings who reside too far away to provide day-to-day support have been willing to offer financial support as well. However, these initiatives weren’t pushed on children. Children weren’t forced into a situation based on an assumption. If you’re a parent, ask children if they’d be willing to provide care. As an adult child, don’t be afraid to ask parents how they plan to cover long-term care expenses.

Fourth Step: Get Creative. 

Three out of every five financial plans I create reflect deficiencies to meet long-term care expenses. Medical insurance like Medicare does not cover long-term care expenses – a common misperception. Close to 56% of people surveyed in the Bankers Life Center study are under the false impression that Medicare covers long-term care expenses.

The Genworth Cost of Care Survey has been tracking long-term care costs across 440 regions across the United States since 2004.

Genworth’s results assume an annual 3% inflation rate. In today’s dollars a home-health aide who assists with cleaning, cooking, and other responsibilities for those who seek to age in place or require temporary assistance with activities of daily living, can cost over $45,000 a year in the Houston area. On average, these services may be required for 3 years – a hefty sum of $137,000. We use a 4.25-4.5% inflation rate for financial planning purposes to reflect recent median annual costs for assisted living and nursing home care.

As I examine long-term care policies issued recently vs. those 10 years or later, it’s glaringly obvious that coverage isn’t as comprehensive and costs more prohibitive. It will require unorthodox thinking to get the job done.

One option is to consider a reverse mortgage, specifically a home equity conversion mortgage. The horror stories about these products are way overblown. The most astute of planners and academics study and understand how for those who seek to age in place, incorporating the equity from a primary residence in a retirement income strategy or as a method to meet long-term care costs can no longer be ignored. Those who talk down these products are speaking out of lack of knowledge and falling easily for overblown, pervasive false narratives.

Reverse mortgages have several layers of costs (nothing like they were in the past), and it pays for consumers to shop around for the best deals. Understand to qualify for a reverse mortgage, the homeowner must be 62, the home must be a primary residence and the debt limited to mortgage debt. There are several ways to receive payouts.

One of the smartest strategies is to establish a reverse mortgage line of credit at age 62, leave it untapped and allowed to grow along with the value of the home. The line may be tapped for long-term care expenses if needed or to mitigate sequence of poor return risk in portfolios. Simply, in years where portfolios are down, the reverse mortgage line can be used for income thus buying time for the portfolio to recover. Once assets do recover, rebalancing proceeds or gains may be used to pay back the reverse mortgage loan consequently restoring the line of credit.

Our planning software allows our team to consider a reverse mortgage in the analysis. Those plans have a high probability of success. We explain that income is as necessary as water when it comes to retirement. For many retirees, converting the glacier of a home into the water of income using a reverse mortgage is going to be required for retirement survival and especially long-term care expenses.

American College Professor Wade Pfau along with Bob French, CFA are thought leaders on reverse mortgage education and have created the best reverse mortgage calculator I’ve studied. To access the calculator and invaluable analysis of reverse mortgages click here.

Insurance companies are currently creating products that have similar benefits of current long-term care policies along with features that allow beneficiaries to receive a policy’s full death benefit equal to or greater than the premiums paid. The long-term care coverage which is linked to a fixed-premium universal life policy, allows for payments to informal caregivers such as family or friends, does not require you to submit monthly bills and receipts, have less stringent underwriting criteria and allow an option to recover premiums paid if services are not rendered (after a specified period).

Unfortunately, to purchase these policies you’ll need to come up with a policy premium of $50,000 either in a lump sum or paid over five to ten years. However, for example, paying monthly for 10 years can be more cost effective than traditional long-term care policies, payments remain fixed throughout the period (a big plus), and there’s an opportunity to have premiums returned to you if long-term care isn’t necessary (usually five years from the time your $50,000 premium is paid in full). Benefit periods can range from 3-7 years and provide two to five times worth of premium paid for qualified long-term care expenses. As a benchmark, keep in mind the average nursing home stay is three years.

I personally went with this hybrid strategy. For a total of $60,000 in premium, I purchased six years of coverage, indexed for inflation, for a total benefit of close to $190,000.

Also,  pay closer attention to your employers’ benefits open enrollment. It’s amazing to discover how many people have bypassed or didn’t realize their employers offer long-term care insurance coverage. Those with health issues and possibly ineligible for coverage in the open marketplace will find employer-offered long-term care insurance their best deal.

Fifth Step: Formalize a Liquidation/Downsize Plan. 

Consider a liquidation/downsizing hierarchy to subsidize long-term care costs. According to a Deutsche Bank report from January 2018 titled US Wealth and Income Inequality,  a record high 30% of Americans hold no wealth outside their primary residences which makes me wonder how that group is going to fund retirement, let alone long-term care expenses.

We partner with clients who can’t afford premiums or not able to pass long-term care insurance underwriting with liquidation strategies which look to begin 3-5 years before retirement.  Liquidation of a primary residence can be a workable option especially if an individual is widowed or living alone.  Empty-nesters can aspire to sell and move into one-story smaller digs early into or before retirement to lower overall fixed costs. They include in their plan home improvements such as ramps, easy access baths, kitchen cabinets and the cost of caregiver services which complement a spouse or life partner’s long-term care responsibilities. 

Per the Center for Retirement Research from their analysis dated February 11, 2020, most older Americans prefer to age in their homes. However, it’s important to decide whether a current residence is appropriate for the task. In other words, many older Baby Boomers look to remain in large homes with empty rooms and two stories which is absolutely not practical – Especially in the face of property taxes that increase annually, sometimes dramatically! 

The Center’s paper discovered that:

  • Seventy percent of households have very stable homeownership patterns, even over several decades. They either stay in the home they own in their 50s (53 percent) or purchase a new home around retirement and stay for the rest of their life (17 percent).
  • The 30 percent of households that do move consist of two distinct subgroups. Frequent movers (14 percent) appear to face labor market challenges.  Late movers (16 percent) look like a slightly more affluent version of the households that never move, but then face a health shock that forces them out of the home that they owned into a rental unit or a long-term services and supports facility.
  • Overall, the findings largely support the narrative from prior research that most people want to age in place and move only in response to a shock.

Sixth Step: Consider Long-Term Care Riders for Permanent Life Insurance.

Permanent life insurance unlike term, builds cash value. Policies can be ‘over funded’ above the cost of insurance to allocate to a fixed interest sleeve and other investment choices attached through various calculations, to stock indexes such as the S&P 500. There is no chance of loss in cash-value accumulation therefore balances have the true opportunity to compound. 

A living benefits rider allows the insured to accelerate access to death benefits due to certain conditions such as long-term care needs and terminal illness.  There are benefits to utilizing permanent life insurance to subsidize long-term care needs. Premiums remain level (unlike long-term care insurance premiums that tend to increase on a regular basis, sometimes dramatically), second, of course unlike long-term care insurance, at least there’s life insurance or dollars at the end of the road for heirs.

In addition, underwriting for morbidity risk (long-term care) can be draconian compared to mortality risk (life insurance). In other words, medical issues that have potential to affect activities of daily living may not have the same effect on life expectancy; consumers who don’t qualify for long-term care insurance may still qualify for life insurance.  There are a couple of drawbacks to these life insurance riders:  Funds accessed during a lifetime will inevitably reduce the face value or death benefit of a life insurance policy. Second, riders cost money. So, before adding a living benefits rider, through holistic financial planning be certain you require insurance to mitigate long-term care risk. Through proper planning, we discover that four out of every ten clients have assets to liquidate or are able to self-insure.

Retirement care analysis is a deep dive into the overall retirement planning process. Unlike income planning, retirement care planning requires us to face our inevitable physical limitations and the toll it can have on personal finances along with the negative ripple effects on wealth and health of loved ones.

It’s best to expose vulnerability and plan accordingly while there’s precious time to do so.

Technically Speaking: Chasing The Market? Warnings Are Everywhere

This past weekend, we discussed the breakout to all-time highs as the belief the market is immune to risks, due to the Federal Reserve, has become pervasive. As I quoted:

“Yet as a major economic problem looms on the horizon, the cognitive disconnect between current asset prices and reality feels like the market equivalent of ‘peace for our time.’ 

For those investors who perceive the disconnect between risk assets which are priced for a rosy outcome, and the reality of the looming risks to growth and earnings, any attempt to reduce risk leads to underperformance. It is a mind-numbing exercise for investors who see the cognitive dissonance. The frantic race to accumulate securities has cast price discovery to the side.

I have never in my career seen anything as crazy as what’s going on right now, this will eventually end badly.“ – Scott Minerd, CIO of Guggenheim Investments

The current environment remind s me of when I was growing up. My father, probably much like yours, had pearls of wisdom that he would drop along the way. It wasn’t until much later in life that I learned that such knowledge did not come from books, but through experience. One of my favorite pieces of “wisdom” was:

“Exactly how many warnings do need before you figure out that something bad is about to happen?”

Of course, back then, he was mostly referring to warnings he issued for me “not” to do something I was determined to do. Generally, it involved something like trying to replicate Evil Knievel’s jump at Caesar’s Palace using a homemade ramp and a collection of the neighbor’s trash cans.

However, I always based my arguments on sound logic and data analysis:

“But Dad, everyone else is doing it.”

After I had broken my wrist, I understood what he meant.

Likewise, investors are currently rushing to get back into the market with a near reckless disregard for the consequences.

Simply because “everyone else is doing it.” 

So, before you go “hit the ramp”, there are some warning signs to consider.

Warning 1: Deviations From The Mean

There is a funny story about a “defensive driving” class where the instructor asks the class how many thought they were “above average drivers.” About 80% of the class raised their hands. The funny thing is that all of them were in the class because of traffic violations or accidents. But more to the point, 80% of drivers cannot be above average. It is mathematically impossible.

Likewise, in investing, prices must be both above, and below, the “average price” over a set period for an average to exist. To many degrees, “price” is bound by the laws of physics, the farther from the “average price” the current price becomes, the greater the reversion to, and generally beyond, the average. This is shown in the daily chart below.

Currently, the market is more than 11% above its longer-term daily average price. These more extreme deviations tend not to last an extraordinarily long time. Furthermore, reversions from these more extreme deviations tend to be rather quick.

If we view a weekly basis, we see the same warning.

At more than 12% above the long-term weekly moving average, the market is currently pushing the upper end of historical deviations. There have been higher extremes for certain, but discounting risk often doesn’t end well.

On a monthly basis, the almost 17.5% deviation is hitting levels more associated with drawdowns of 20% of more.

The important point to take away from this data is that “mean reverting” events are commonplace within the context of annual market movements. 

Currently, investors have become extremely complacent with the rally from the beginning of the year and are discounting the potential global-supply shock from the “coronavirus.” The assumption that any disruption will be met by more Central Bank intervention, and higher stock prices, is a likely a risky proposition this late into an economic cycle.

In every given year, there are drawdowns that have wiped out some, most, or all of the previous gains. While the market has ended the year higher, more often than not, the declines have often shaken out many an investor along the way.

Let’s take a look at what happened the last time the market finished a year up nearly 30%. Over the next two years, the market consolidated with a near-zero rate of return.

From a portfolio management standpoint, the markets are very extended, and a correction over the next couple of months is highly likely. While it is quite likely the year will end positive, particularly given the current momentum push, taking some profits now, rebalancing risks, and using the coming correction to add exposure as needed will yield a better result.

Warning 2 – Technical Warnings

The technical warnings also confirm our concerns about a near-term correction.

Each week, we post the chart below for our RIA PRO (Try Risk-Free for 30-days) subscribers, which is a composite index of our weekly technical measures including RSI, Williams %R, Stochastics, etc. Currently, the overbought condition of the market is near points which have denoted more significant corrections.

The market/sector analysis, which is also exclusive to RIA PRO members, shows the rather extreme price deviation in Technology, Real Estate, & Utilities. Also, relative performance shows that it has primarily been those three sectors providing a bulk of the “alpha” year-to-date.  (Also, note the lower left-hand panel which shows virtually every sector back to extreme overbought.)

These are abnormalities that tend not to last long in isolation, and rotations tend to occur rather quickly.

Warning 3 – Economic Concerns

Just recently, Barbara Kolmeyer via MarketWatch discussed thoughts from Julien Bittel of Pictet Asset Management. He gives a pretty stern warning to the litany of economic bulls. To wit:

He sees a lot of similarities between what is happening now and the year 2000—the market peaked in the front half of the year, followed by a recession. Bittel has lots of charts to back up his case, such as this one showing Jolts job openings (which measures U.S. job vacancies), at the lowest since the Global Financial Crisis, often a bad omen for employment:”

“He also highlighted trouble for the U.S. long-term business cycle, ‘linked to the less-cyclical areas of the economy so it’s the credit cycle, consumer confidence and the labor markets…these dynamics are all slowing,’ he said.”

He said what makes his call so contrarian is that most economists see a 25% recession possibility, while equity markets are factoring in only a 2% chance.

‘I think investors are a bit naive going into this year, thinking that the gravy trains or rainbows will continue, but in order for that to happen earnings need to come back in a big way. A sustained move in equity markets that’s driven by multiple expansion cannot maintain itself unless you get a huge recovery in earnings.” – Julien Bittel

Speaking of an earnings recovery, that is unlikely to happen.

Warning 4 – Earnings

It is highly unlikely you are going to get a massive surge in earnings to support lofty asset prices and valuations particularly when you have a global supply-chain shock in progress. While the media has been fawning over the latest earnings season, it really isn’t what it seems.

As noted by FactSet:

“ For Q4 2019 (with 77% of the companies in the S&P 500 reporting actual results), 71% of S&P 500 companies have reported a positive EPS surprise and 67% of S&P 500 companies have reported a positive revenue surprise.”

Wow…that’s impressive and certainly would seem to be the reason behind surging asset prices.

The problem is that “beat rate” was simply due to the consistent “lowering of the bar” as shown in the chart below:

Pay attention to the two charts above.

  1. Earnings declined in 2019 and are projected to continue to decline into 2021. 
  2. Investors are not discounting the decline in earnings, and rising valuations, which will eventually become problematic.

Importantly, as I noted this past weekend:

“With equities now more than 30% higher than they were then, the Fed mostly on hold in terms of rate cuts, and “repo” operations starting to slow, it certainly seems that expectations for substantially higher market values may be a bit optimistic.

Furthermore, as noted above, earnings expectations declined for the entirety of 2019, as shown in the chart below. However, the impact of the “coronavirus” has not been adopted into these reduced estimates as of yet. These estimates WILL fall, and likely markedly so, which as stated above, is going to make justifying record asset prices more problematic.”

“Conversely, if by some miracle, the economy does show actual improvement, it could result in yields rising on the long-end of the curve, which would also make stocks less attractive.

This is the problem of overpaying for value. The current environment is so richly priced there is little opportunity for investors to extract additional gains from risk-based investments.”

If They Don’t “Buy & Hold” – Why Should You?

Here is the market for you, year to date:

  • S&P 500 +4.62%
    • Alphabet +13.74%
    • Microsoft +17.53%
    • Apple +10.92%
    • Amazon +15.53%
    • Tesla +91.24%

(Disclosure: We are long Apple, Amazon, and Microsoft in our equity portfolio.)

These “warning signs” are just that. None them suggest the markets, or the economy, are immediately plunging into the next recession-driven market reversion.

But as David Rosenberg previously noted:

“The equity market stopped being a leading indicator, or an economic barometer, a long time ago. Central banks looked after that. This entire cycle saw the weakest economic growth of all time coupled with the mother of all bull markets.”

There will be payback for the misalignment of funds.

Past experience suggests that future returns will be far less than historical averages suggest. Furthermore, there is a dramatic difference between investing for 30-years, and whatever time you personally have left to your financial goals. As noted yesterday, many investors are just now getting back to even.

While much of the mainstream media suggests that you should “invest for the long-term,” and “buy and hold” regardless of what the market brings, that is not what professional investors are doing.

The point here is simple.

No professional, or successful investor, every bought and held for the long-term without regard, or respect, for the risks that are undertaken. If professionals are looking at “risk,” and planning on protecting capital from mean-reverting events, then why aren’t you?

After A Decade, Investors Are Finally Back to Even

I recently discussed putting market corrections into perspective, in which we looked at the financial impact of a 10-60% correction. But what happens afterward?

During strongly advancing, and very long bull markets, investors become overly complacent about the potential risks of investing. This “complacency” shows up in the resurgence of “couch potato,” “buy and hold,” and “passive indexing” portfolios. While such ideas work as long as markets are relentlessly rising, when the inevitable reversion occurs, things go “sideways” very quickly.

“While the current belief is that such declines are no longer a possibility, due to Central Bank interventions, we had two 50% declines just since the turn of the century. The cause was different, but the result was the same. The next major market decline will be fueled by the massive levels of corporate debt, underfunded pensions, and evaporation of ‘stock buybacks,’ which have accounted for almost 100% of net purchases since 2018.

Market downturns are a historical constant for the financial markets. Whether they are minor or major, the impacts go beyond just the price decline when it comes to investors.”

It is the last sentence I want to focus on today, as it is one of the most important and overlooked consequences of market corrections as it relates to long-term investment goals.

There are a litany of articles touting the massive bull market advance from the 2009 lows, and that if investors had just held onto the portfolios during the 2008 decline, or better yet, bought the March 2009 low, you would have hit the “bull market jackpot.” 

Unfortunately, a vast majority of investors sold out of the markets during the tail end of the financial crisis, and then compounded their financial problems by not reinvesting until years later. It is still not uncommon to find individuals who are still out of the market entirely, even after a decade long advance.

This is what brutal bear markets due to investors psychologically. 

“Bear markets” push investors into making critical mistakes:

  1. They paid premium prices, or rather excessive prices, for the companies they are investing in during the “bull market.” Ultimately, overpaying for value has a cost of lower future returns, as “buying high” inevitably turns into “selling low.” 
  2. Investors Panic as market values decline. It is easy to forget during sharply rising markets the money we invest is the “savings” we are dependent on for our family’s future. Many investors who claim to be “buy and hold” change their mind after large losses. There is a point, for every investors, where they are willing to “get out at any price.”
  3. Volatility is ignored. Volatility is not always a bad word, but rising volatility coupled with large declines, eventually feeds into investor “fear and panic.”
  4. Ignoring Market Analysis. When markets are trending strongly upwards, investors start to “rationalize” why they are overpaying for value in the market. By looking for “confirmation bias,” they tend to ignore any “market analysis” which contradicts their “hope” for higher prices. The phrase “this time is different” is typically a hallmark.

“The underlying theory of buy and hold investing denies that stocks are ever expensive, or inexpensive for that matter, investors are encouraged to always buy stocks, no matter what the value characteristics of the stock market happen to be at the time.” – Ken Solow

The primary problem with “buy and hold” investing is ultimately, YOU!

The Pension Problem

During raging bull markets, individuals do two things which ultimately lead to their financial distress.

  1. Start treating the market like a casino in hopes to “getting rich quick,” and
  2. Reduce their “contributions” given expectations that high returns will “fill the gap.” 

Unfortunately, this is the same problem that plagues pension funds all across America today.

As I discussed in “Pension Crisis Is Worse Than You Think,”  it has been unrealistic return assumptions used by pension managers over the last 30-years, which has become problematic.

“Pension computations are performed by actuaries using assumptions regarding current and future demographics, life expectancy, investment returns, levels of contributions or taxation, and payouts to beneficiaries, among other variables. The biggest problem, following two major bear markets, and sub-par annualized returns since the turn of the century, is the expected investment return rate.

Using faulty assumptions is the linchpin to the inability to meet future obligations. By over-estimating returns, it has artificially inflated future pension values and reduced the required contribution amounts by individuals and governments paying into the pension system

Pensions STILL have annual investment return assumptions ranging between 7–8% even after years of underperformance.”

However, why do pension funds continue to have high investment return assumptions despite years of underperformance? It is only for one reason:

To reduce the contribution (savings) requirement by their members.

This is the same problem for the average American faces when planning for 6-8% average annual returns on their investment strategy. Why should you save money if the market can do the work for you? Right?

This is a common theme in much of the mainstream advice. To wit:

“Suze Orman explained that if a 25-year-old puts $100 into a Roth IRA each month, they could have $1 million by retirement.” 

The problem with Ms. Orman’s statement is that it requires the 25-year old to achieve an 11.25% annual rate of return (adjusting for inflation) every single year for the next 40-years.

That certainly isn’t very realistic.

However, under-saving is one of the primary problems which leaves investors well short of their financial goals by retirement.

The other problem, as noted above, is the most important part of the analysis overlooked by promoters of “buy and hold” investing.

Let me explain.

Getting Back To Even, Isn’t Even

Here is the common mainstream advice.

“If you had invested $100,000 at the market at the peak of the market in 2000, or in 2007, your portfolio would have gotten back to even in 2013. Since then, your portfolio would have grown to more than $200,000.

Here is the relative chart proving that statement is correct. (Real, inflation-adjusted, total return of a $100,000 investment.)

No one talks much about investors who have been in the market since the turn of the century, but it is one of the problems why so many Americans are underfunded for retirement. While Wall Street claims the market delivers 6% annual returns, or more, the annual rate of return since 2000, on an inflation-adjusted, total return basis, is just shy of 4%.

However, since most analysis used to support the “buy and hold” thesis starts with the peak of the market in 2007, that average return does indeed come in at 6.64%.

Here is the problem.

While your portfolio got back to even, on a total return basis, 6 or 13-years after your initial investment, depending on your start date, you DID NOT get back to even.

Remember your investment plan? Yes, that plan touted by the mainstream media, which says to assume a return of 6% annually?

The chart below shows $100,000 invested at 6% annually from 2000 or 2007.

So, what’s wrong with that?

An investor tripled their money from 2000 and doubled it from 2007.

Unfortunately, you didn’t get that.

Let’s overlay our two charts.

If your financial plan was based on reduced saving rates, and high rates of return, you are well short of you goals for retirement if you started in 2000. Fortunately, for investors who started in 2007, congratulations, you are now back to even.

Unfortunately, there are few investors who actually saw market returns over the last 12-years. As noted, a vast majority of investors who were fully invested into the market in 2007, were out of the market by the end of 2008. After such a brutal beating, it took years before they returned to the markets. Their returns are vastly different than what the mainstream media claims.

While there is a case to be made for “buy and hold” investing during rising markets, the opposite is true in falling markets. The destruction of capital eventually pushes all investors into making critical investment mistakes, which impairs the ability to obtain long-term financial goals. 

You may think you have the fortitude to ride it out. You probably don’t.

But even if you do, getting back to even isn’t really an investment strategy to reach your retirement goals.

Unfortunately, for many investors today who have now reached their financial goals, it may be worth revisiting what happened in 2000 and 2007. We are exceedingly in the current bull market, valuations are elevated, and there is a rising belief “this time is different.” 

It may be worth analyzing the risk you are taking today, and the cost it may have on “your tomorrow.” 

#FPC: Dave Ramsey Is Right & Very Wrong About Permanent Life Insurance (Pt. 1)

Let’s start with the basics, Dave Ramsey is great at a couple of things, budgeting, helping people get out of debt, prioritizing material things and/or putting things in perspective. 


There are some things where good ole Dave isn’t so great. I know this is going to surprise many of you, but you need to hear this.


Allow me to give you some additional context. Dave is good at helping people get out of debt and make better financial decisions, in fact he’s really good. His Financial Peace University has helped so many people get on track to a better life. I’m a really big fan of Dave for the work he does, but my clients and most of our readers have graduated beyond Dave’s philosophy’s to needing more sophisticated planning and advice.

Dave Ramsey believes you should buy term life insurance and invest the rest. In theory it sounds great. For example, if you were to spend $1,000 a month on a permanent life insurance policy- according to Dave you should buy a term policy and invest the rest.

And from a RISK MANAGEMENT mindset I love the idea.

In fact, this is where you should start. Buy a term policy to protect your family. There are many factors to consider when purchasing a term policy and how much you need here are a few:

  • Loss of Income
  • Debt
  • Expenses
  • Children
  • Lifestyle
  • Age
  • Do you have insurance through work? Is it portable if you leave?

The rule of thumb is 7 to 10 times your annual salary-BUT we believe each individual should go through a thorough analysis to help determine what’s right for their family.

Now that you have your bases covered to protecting your family what’s next?

I’m making an assumption that you already have an emergency fund, established a “financial vulnerability cushion” and are wondering where to put additional funds.

Here’s what I hear often-

  • I make too much to put into a Roth IRA
  • I make too much to put into a Roth 401(k)- (no you don’t there are no income limitations)
  • I can’t make tax deductible contributions to a Traditional IRA
  • Where do I put funds?
  • Savings aren’t earning much interest,
  • I’m missing out on returns in the markets (High Yield Savings) No FOMO.
  • Or alternatively, Markets are too high to put funds to work

The list goes on and on.

What has the Financial Industry beat into our brains year after year?

 Tax Deferred Savings, Tax Deferred Savings, Tax Deferred Savings!

Times are changing. With the new Secure Act we just saw the death of the Stretch IRA and are in one of the lowest tax brackets we’ve seen in years. Not to mention the TCJA (current tax code) sunsets in 2026 and there is also a political party dead set on raising taxes if elected.  In regard to debt and taxes neither Democrat or Republican party understands a budget or how to truly curtail deficit spending. U.S. Government let me introduce you to Dave. It’s a match made in Heaven-until it causes a massive recession, but that’s beside the point. I’d expect higher taxes, not austerity.

So how will you prepare for higher taxes?

When helping clients prepare for retirement we look for not only the low hanging fruit or the obvious feel good propositions, but also some of the harder ones. Like paying taxes now.  

Right now we’re the bearers of bad news.

You don’t always retire in a lower tax bracket.

AND, most aren’t prepared for the additional stealth taxes Uncle Sam surprises you with.

Stay with me, I know I’m walking you through a dark tunnel. The light is near.

Envision yourself on a 3-legged stool. Each leg represents a different tax ramification.

  • Leg 1-Fully Taxable
  • Leg 2-Partially Taxable
  • Leg 3-Tax Free

If you could put all of your eggs in one leg where would they be?

Exactly, Leg 3-but why are so many stools so wobbly? I’ll go one step further.

  • Leg 1- 401(k)’s, 403(b)’s, Traditional IRA’s (the feel good’s)
  • Leg 2- Saving’s, Brokerage Accounts, After tax investment Vehicles

We focus on so many other things first.  The typical sequence of savings is:

  • 401(k)
  • Savings
  • Investments

What do these all have in common? Taxes

What do we want to get away from? Taxes

Here’s how I want you to look at Leg 1- it’s not all yours. Treat these funds like a business, but you don’t own all of it Uncle Sam has some ownership in your business. However, this partnership is unlike any other-they can increase their ownership at any time therefore decreasing your probability of success in retirement.

Leg 2- the principal is yours (you’ve already paid the taxes,) but any realized growth, interest and dividends are taxable at either ordinary income levels or capital gains tax rates.

Leg 3- like leg 2 you’ve already paid the taxes, but the earning’s when all the rules are followed are tax free. For obvious reasons this is the more difficult leg to stabilize. It’s not easy, it takes some proper planning and it takes some work.

I believe everyone needs to strengthen leg 3. Most people will do it by utilizing a Roth 401k or a Roth IRA, but a few will use a permanent life insurance policy.

This is where Dave is right- for most people.

Buying term and investing the difference if you are diligent enough to do so is a great strategy for the majority of Americans living paycheck to paycheck or the saver who is doing all they can to make the sacrifices for their family, but they just can’t do much more. 

This is where Dave is wrong?

What about our typical client? These are the people who are doing all the right things, maxing out retirement contributions, maxing out their HSA’s, putting funds into their savings accounts regularly with little to no debt. Do they just keep plugging away putting additional funds into accounts that are taxable?

What about our clients who have a true estate tax problem? These are people who’ve built businesses, acquired land, built wealth with hard work, blood, sweat and tears. Do their heirs liquidate assets just to pay the tax bill?

No, no they don’t they use insurance properly.

Is permanent life insurance wrong for them, Dave?

No, they use insurance as one leg of their 3-legged stool. These are people who take a big picture holistic view, have a financial plan and have planned for these events.

Insurance is something that must be planned, not sold.

I know and hear of too many insurance agents who say everyone needs a Variable Universal Life Policy aka (VUL.) Unfortunately, many of these guys primarily sell property and casualty and are looking for a big-ticket item, the VUL. Which typically carry higher fee’s little or no guarantee’s and premiums that can change. The majority of the time a realistic plan wasn’t done, illustrations are done to show only the best case scenarios and many times the agents themselves are captive to one or two carriers and/or don’t quite know what to look for in an insurance policy or how to choose one that really fits your needs. This is the have hammer, everything is a nail syndrome.

Permanent Life Insurance when done right can play a vital role in a retiree’s financial plan, it can help provide tax free income, some provide guarantee’s to principal and offer low fee’s which help with accumulation of cash value when overfunding the contract.

Which is why we believe insurance should be planned, it’s a solution to a sophisticated problem. Insurance is also a sophisticated product, that deserves a better reputation than many give it.

  • Who doesn’t want some guarantee’s?
  • Who doesn’t want to pay 0% in taxes on distributions?
  • Who doesn’t want protection from the governments stealth taxes?
  • Who doesn’t want creditor protection?
  • Who doesn’t want to protect their family and their hard-earned funds?

I hope this post has opened your eyes to another potential avenue to explore in your plan.

Next week in Part 2, we’ll get into the nitty-gritty of different types of permanent life insurance, how to use them, what to look for in a policy and also what to stay away from.

Market Downturn? Putting Corrections Into Perspective

Shawn Langlois recently penned an interesting article:

“Despite a few notable hiccups along the way, the bull market continues to prove insanely resilient.”

What was most interesting, however, was the following quote:

“Current hyper-valued extremes are likely to be followed by market losses on the order of two-thirds of the value of the S&P 500.” 

The immediate response by most individuals is a 60%+ decline is an outlandish and impossible event given ongoing Central Bank interventions.

But is it really?

The risk of a larger mean reverting event is a possibility even though such is entirely dismissed by the mainstream media under the guise of “this time is different.”  With the market trading more than 3-standard deviations above the 50-week moving average, historical reversions have tended to be more brutal. 

The chart below uses key support levels as potential reversion levels. The lows of 2018. The highs and lows of 2015-2016, and the 2007 highs.

At this juncture, a correction back to the 2018 lows would entail a 25% decline. However, if a “bear market” growls, the 2015-16 highs become the target, which is 34% lower. The lows of 2016 would require a 43% draft, with the 2008 highs posting a 52% “crash.” 

Those levels are still short of the 67% decline discussed above.

Such a level certainly seems preposterous, as Shawn quoted:

I recognize that the notion of a two-thirds market loss seems preposterous. Then again, so did similar projections before the 2000-2002 and 2007-09 collapses.”

While the current belief is that such declines are no longer a possibility, due to Central Bank interventions, we had two 50% declines just since the turn of the century. The cause was different, but the end result was the same. The next major market decline will be fueled by the massive levels of corporate debt, underfunded pensions, and evaporation of “stock buybacks,” which have accounted for almost 100% of net purchases since 2018.

Market downturns are a historical constant for the financial markets. Whether they are minor, or major, the impacts go beyond just the price decline when it comes to investors. This was a discussion I had in more detail in “Retired, Or Retiring Soon? Yes, Worry About A Correction.”

“In 2000, the average ‘baby boomer’ was around 45-years of age. The ‘dot.com’ crash was painful, but with 20-years to go before retirement, there was time to recover. In 2010, following the financial crisis, the time to retirement for the oldest boomers was depleted, and the average boomer only had 10-years to recover. During both of these previous periods, portfolios were still in accumulation mode. However, today, ONLY the youngest tranche of ‘boomers,’ have the luxury of ‘time\ to work through the next major market reversion. (This also explains why the share of workers over the age of 65 is at historical highs.) 

With the majority of ‘boomers’ now faced with the implications of a transition into the distribution phase of the investment cycle, such has important ramifications during market declines. The following example shows a $1 million portfolio with, and without, an annualized 4% withdrawal rate.”

“While a 10% decline in the market will reduce a portfolio from $1 million to $900,000, when combined with an assumed monthly withdrawal rate, the portfolio value is reduced by almost 14%. This is the result of taking distributions during a period of declining market values. Importantly, while it ONLY requires a non-withdrawal portfolio an 11.1% return to break even, it requires nearly a 20% return for a portfolio in the distribution phase to attain the same level.

Impairments to capital are the biggest challenges facing pre- and post-retirees currently. 

This is an important distinction. Most articles written about retirees, or those ready to retire, is an unrealized assumption of an indefinite timeline.

While the market may not be different than in the past, YOU ARE!”

This is an important point.

Investing is about growing your savings over time, and controlling the risk which could lead to a significant loss of principal. Taking on excruciating losses is not investing, nor is it financially feasible to do so, and still reach your retirement goals successfully. 

Putting Corrections Into Perspective

The real problem with discussing corrections is three-fold:

  1. It is has been so long since we have had a correction of magnitude, many investors have forgotten what happens, and more importantly, how they reacted previously.
  2. The majority of mainstream media advice is written or prognosticated by individuals who don’t manage money for a living, have substantial investment  capital at risk, and have never actually been through a bear market. 
  3. Given the extremely long market expansion, many investors have truly come to believe “this time is different.” 

If we put corrections into a bit of perspective, it becomes easier to visualize that damage which could, and most likely will, eventually occur.

10% Correction 

A correction of 10% is entirely normal for a market in any given year. While a 10% decline in a bit painful, such a decline from current levels would only set the market back October of 2019 when the Federal Reserve started their latest liquidity interventions.

20% Correction

A 20% correction from the recent highs is a bit more serious. The last time we came close to a 20% reset was in December, 2018. Try and remember how you felt during that decline.

Currently, a 20% decline would reset your portfolio back to where it was in December 2017, wiping out all the gains of the past two-years. While not the end of the world, your retirement is now set back by almost 4-years as you will have to make up the 30% gain from 2019 plus two-more years of lost growth.

30% Correction

A 30% correction gets much more serious. A decline of this magnitude takes you back to the beginning of 2017. While losing just 3-years of growth may not seem that bad, assuming you need 6% a year to reach your retirement goal, you will need almost 9-years to recover. (Remember, it takes 42.9% to recover the 30% loss, plus you have to make up the 6% annual gains you needed, but didn’t accrue, during each year of recovering the previous loss.)

40% Correction

Okay, this is starting to get a bit uglier. A 40% decline takes the market back to 2014 levels and has now wiped out 6-years of your gains. While a 40% decline requires a 66.7% recovery to breakeven, (10 years at 6%,) the lost accrual years are going to make it very difficult to meet retirement goals.

50% Correction

I know…I know…this can’t happen. (It just happened twice the century already.)

A 50% decline is effectively “game over” for investors at this point. A decline of this magnitude will reset the market essentially back to the market highs of 2000 and 2007. For individuals who were close to retirement in 2000, their portfolio, on an inflation-adjusted basis, will have been completely reset.

At this point, retiring is no longer an option for most.

60% Correction

A 60% correction is not entirely out of the question. As I have discussed previously, the next mean reverting event will likely be the last. Corrections of such a magnitude would reset portfolios back to 1999 levels. The devastation will be greater than investors can currently imagine and retirement goals would be erased entirely.

There are numerous catalysts which could pressure such a downturn in the equity markets:

  • An exogenous geopolitical event
  • A credit-related event
  • Failure of a major financial institution
  • Recession
  • Falling profits and earnings
  • A loss of confidence by corporations which contacts share buybacks

Whatever the event is, which is currently unexpected and unanticipated, the decline in asset prices will initiate a “chain reaction.”

  • Investors will begin to panic as asset prices drop, curtailing economic activity, and further pressuring economic growth.
  • The pressure on asset prices and weaker economic growth, which impairs corporate earnings, shifts corporate views from “share repurchases” to “liquidity preservation.” This removes a major support of asset prices.
  • As asset prices decline further, and economic growth deteriorates, credit defaults begin triggering a near $5 Trillion corporate bond market problem.
  • The bond market decline will pressure asset prices lower, which triggers an aging demographic who fears the loss of pension benefits, sparks the $6 trillion pension problem. 
  • As the market continues to cascade lower at this point, the Fed is monetizing nearly 100% of all debt issuance, and has to resort to even more drastic measures to stem selling and defaults. 
  • Those actions lead to a further loss of confidence and pressures markets even further. 

The Federal Reserve can not fix this problem, and the next “bear market” will NOT be like that last.

It will be worse.

None of this will happen, you say?

Maybe? I certainly hope not.

But are you actually willing to bet your retirement on it?

MacroView: The Next “Minsky Moment” Is Inevitable

In 2007, I was at a conference where Paul McCulley, who was with PIMCO at the time, was discussing the idea of a “Minsky Moment.”  At that time, this idea fell on “deaf ears” as the markets, and economy, were in full swing.

However, it wasn’t too long before the 2008 “Financial Crisis” brought the “Minsky Moment” thesis to the forefront. What was revealed, of course, was the dangers of profligacy which resulted in the triggering of a wave of margin calls, a massive selloff in assets to cover debts, and higher default rates.

So, what exactly is a “Minskey Moment?”

Economist Hyman Minsky argued that the economic cycle is driven more by surges in the banking system, and in the supply of credit than by the relationship which is traditionally thought more important, between companies and workers in the labor market.

In other words, during periods of bullish speculation, if they last long enough, the excesses generated by reckless, speculative, activity will eventually lead to a crisis. Of course, the longer the speculation occurs, the more severe the crisis will be.

Hyman Minsky argued there is an inherent instability in financial markets. He postulated that an abnormally long bullish economic growth cycle would spur an asymmetric rise in market speculation which would eventually result in market instability and collapse. A “Minsky Moment” crisis follows a prolonged period of bullish speculation which is also associated with high amounts of debt taken on by both retail and institutional investors.

One way to look at “leverage,” as it relates to the financial markets, is through “margin debt,” and in particular, the level of “free cash” investors have to deploy. In periods of “high speculation,” investors are likely to be levered (borrow money) to invest, which leaves them with “negative” cash balances.

While margin balances did decline in 2018, as the markets fell due to the Federal Reserve hiking rates and reducing their balance sheet, it is notable that current levels of “leverage” are still excessively higher than they were either in 1999, or 2007.

This is also seen by looking at the S&P 500 versus the growth rate of margin debt.

The mainstream analysis dismisses margin debt under the assumption that it is the reflection of “bullish attitudes” in the market. Leverage fuels the market rise. In the early stages of an advance, this is correct. However, in the later stages of an advance, when bullish optimism and speculative behaviors are at the peaks, leverage has a “dark side” to it. As I discussed previously:

“At some point, a reversion process will take hold. It is when investor ‘psychology collides with ‘leverage and the problems associated with market liquidity. It will be the equivalent of striking a match, lighting a stick of dynamite, and throwing it into a tanker full of gasoline.”

That moment is the “Minsky Moment.”

As noted, these reversion of “bullish excess” are not a new thing. In the book, The Cost of Capitalism, Robert Barbera’s discussed previous periods in history:

The last five major global cyclical events were the early 1990s recession — largely occasioned by the U.S. Savings & Loan crisis, the collapse of Japan Inc. after the stock market crash of 1990, the Asian crisis of the mid-1990s, the fabulous technology boom/bust cycle at the turn of the millennium and the unprecedented rise and then collapse for U.S. residential real estate in 2007-2008.

All five episodes delivered recessions, either global or regional. In no case was there as significant prior acceleration of wages and general prices. In each case, an investment boom and an associated asset market ran to improbably heights and then collapsed. From 1945 to 1985 there was no recession caused by the instability of investment prompted by financial speculation — and since 1985 there has been no recession that has not been caused by these factors. 

Read that last sentence again.

Interestingly, it was post-1970 the Federal Reserve became active in trying to control interest rates and inflation through monetary policy.

As noted in “The Fed & The Stability Instability Paradox:”

“In the U.S., the Federal Reserve has been the catalyst behind every preceding financial event since they became ‘active,’ monetarily policy-wise, in the late 70’s. As shown in the chart below, when the Fed has lifted the short-term lending rates to a level higher than the 2-year rate, bad ‘stuff’ has historically followed.”

The Fed Is Doing It Again

As noted above, “Minsky Moment” crises occur because investors, engaging in excessively aggressive speculation, take on additional credit risk during prosperous times, or bull markets. The longer a bull market lasts, the more investors borrow to try and capitalize on market moves.

However, it hasn’t just been investors tapping into debt to capitalize on the bull market advance, but corporations have gorged on debt for unproductive spending, dividend issuance, and share buybacks. As I noted in last week’s MacroView:

“Since the economy is driven by consumption, and theoretically, companies should be taking on debt for productive purposes to meet rising demand, analyzing corporate debt relative to underlying economic growth gives us a view on leverage levels.”

“The problem with debt, of course, is it is leverage that has to be serviced by underlying cash flows of the business. While asset prices have surged to historic highs, corporate profits for the entirety of U.S. business have remained flat since 2014. Such doesn’t suggest the addition of leverage is being done to ‘grow’ profits, but rather to ‘sustain’ them.”

Over the last decade, the Federal Reserve’s ongoing liquidity interventions, zero interest-rates, and maintaining extremely “accommodative” policies, has led to substantial increases in speculative investment. Such was driven by the belief that if “something breaks,” the Fed will be there to fix to it.

Despite a decade long economic expansion, record stock market prices, and record low unemployment, the Fed continues to support financial speculation through ongoing interventions.

John Authers recently penned an excellent piece on this issue for Bloomberg:

“Why does liquidity look quite so bullish? As ever, we can thank central banks and particularly the Federal Reserve. Twelve months ago, the U.S. central bank intended to restrict liquidity steadily by shrinking the assets on its balance sheet on “auto-pilot.” That changed, though. It reversed course and then cut rates three times. And most importantly, it started to build its balance sheet again in an attempt to shore up the repo market — which banks use to access short-term finance — when it suddenly froze up  in September. In terms of the increase in U.S. liquidity over 12 months, by CrossBorder’s measures, this was the biggest liquidity boost ever:”

While John believes we are early in the global liquidity cycle, I personally am not so sure given the magnitude of the increase Central Bank balance sheets over the last decade.

Currently, global Central Bank balance sheets have grown from roughly $5 Trillion in 2007, to $21 Trillion currently. In other words, Central Bank balance sheets are equivalent to the size of the entire U.S. economy.

In 2007, the global stock market capitalization was $65 Trillion. In 2019, the global stock market capitalization hit $85 Trillion, which was an increase of $20 Trillion, or roughly equivalent to the expansion of the Central Bank balance sheets.

In the U.S., there has been a clear correlation between the Fed’s balance sheet expansions, and speculative risk-taking in the financial markets.

Is Another Minsky Moment Looming?

The International Monetary Fund (IMF) has been issuing global warnings of high debt levels and slowing global economic growth, which has the potential to result in Minsky Moment crises around the globe.

While this has not come to fruition yet, the warning signs are there. Globally, there is roughly $15 Trillion in negative-yielding debt with asset prices fundamentally detached for corporate profitability, and excessive valuations on multiple levels.

As Desmond Lachman wrote:

“How else can one explain that the risky U.S. leveraged loan market has increased to more than $1.3 trillion and that the size of today’s global leveraged loan market is some two and a half times the size of the U.S. subprime market in 2008? Or how else can one explain that in 2017 Argentina was able to place a 100-year bond? Or that European high yield borrowers can place their debt at negative interest rates? Or that as dysfunctional and heavily indebted government as that of Italy can borrow at a lower interest rate than that of the United States? Or that the government of Greece can borrow at negative interest rates?

These are all clear indications that speculative excess is present in the markets currently.

However, there is one other prime ingredient needed to complete the environment for a “Minsky Moment” to occur.

That ingredient is complacency.

Yet despite the clearest signs that global credit has been grossly misallocated and that global credit risk has been seriously mispriced, both markets and policymakers seem to be remarkably sanguine. It would seem that the furthest thing from their minds is that once again we could experience a Minsky moment involving a violent repricing of risky assets that could cause real strains in the financial markets.”

Desmond is correct. Currently, despite record asset prices, leverage, debt, combined with slowing economic growth, the level of complacency is extraordinarily high. Given that no one currently believes another “credit-related crisis” can occur is what is needed to allow one to happen.

Professor Minsky taught that markets have short memories, and that they repeatedly delude themselves into believing that this time will be different. Sadly, judging by today’s market exuberance in the face of mounting economic and political risks, once again, Minsky is likely to be proved correct.

At this point in the cycle, the next “Minsky Moment” is inevitable.

All that is missing is the catalyst to start the ball rolling.

An unexpected recession would more than likely due to trick.

#FPC: 5-Things You Aren’t Being Told About HSA’s.

With the passage of the SECURE ACT and the death of the STRETCH IRA 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, but not anymore. In 2020, we are finally seeing a shift in financial advice to find ways to put funds aside and avoid taxes altogether down the road.

Health Savings Accounts are becoming common place now that employers are shifting more of the burden of Health Insurance to the employees with the use of 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.

Not everyone is eligible for a Health Savings Account, to have access to an HSA you must be in a High-Deductible Health Plan. This means your out of pocket deductibles must be at minimum $1,400 and your max out of pocket can be no greater than $6,900 for a single insured and for a family the minimum deductible can be no less than $2,800 and maximum out of pocket expenses can be no greater than $13,800 for a family in 2020.

If your health insurance plan meets those parameters you can contribute to a Health Savings Account.

The annual 2020 contribution limit, (employer+employee) is $3,550 for a single insured and $7,100 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. 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. Other more recent studies show the employer contributions typically varies by the size of the company, but varying between $750 and $1250.

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

Flexible Spending Accounts are much different from HAS’s. They are offered through an employer-established benefit plan.  Unlike the HSA if you are self-employed, you aren’t eligible for an FSA.  A Flexible Spending Account will allow participants to put up to $2,750 annually in their account. FSA’s also provide you 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 in the account each year-even if you don’t use them.
  • An FSA may allow for a rollover of unused funds of up to $500, but only if your company agrees to it and anything remaining over the $500 will go back to the company’s coffers.
  • The HSA’s ability to make tax free contributions, allow the funds to grow tax free year after year and then make tax free withdrawals when used for medical expenses make this a great tool to utilize as part of diversifying the type of accounts in your financial plan.
  • The HSA also allows employees to retain their funds long after their employment.
  • Contributions to an HSA should stop permanently 6 months prior to starting Medicare. Medicare enrollment can be delayed past 65 if you’re still covered under an employer plan, but one should be familiar with the system and potential penalties if not enrolled properly and on time.
  • 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 RIA Financial Guardrails, the cost of health care is growing twice as fast as the typical Cost of Living Adjustment in Social Security benefits.

Healthview Services put’s out an annual report on the trends and costs of health care. In their 2018 Retirement Healthcare Costs Data Report they found that health care expenses are projected to rise at an annual rate of 4.22%. The report also found that the average healthy 65 year old couple who is retiring this year should expect to spend $363,946 in today’s dollars in health care premiums, deductibles and out-of-pocket expenses.

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?

In your financial plan what is your health care expense and at what % is it inflated each year?

Time and time again financial plans use unrealistic return numbers, little or no inflation and health care considerations have been either missed or an altogether after-thought. 

If you don’t know-ask your advisor what type of assumption’s 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.

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 a 2018 Economic News Release by the Bureau of Labor Statistics the median number of years an employee stays at one job is 4.2 years. Now that number is even smaller (2.8 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 2019 National Compensation study shows that of the only 64% of employers who offer a 401k plan and on average 74% take advantage of those plans. Out of the 64% who do offer a plan around half of them don’t even offer a match.  As labor markets continue to tighten hopefully we’ll see employers begin to sweeten the pot on 401(k) plans as they try to retain and entice 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 regard 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: 

  1. Employee contributions are tax deductible,
  2. Interest is allowed to grow tax free; and,
  3. 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 at minimum 2 years of deductibles and premiums saved in a very low risk allocation 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 Shiller’s 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.

Where’s the Adult Merit Badge for Super Savers?

Super Savers are a special breed.

They are not concerned about keeping up impressions; they exist outside the mainstream of seductive consumerism.

Call it a mindset, call it walking a different path; perhaps it’s an offbeat childhood money script. Whatever it is, those who fall into this category or save 20% or more of their income on a consistent basis are members of an elite group who strive for early financial independence.

Speaking of independence: At RIA we believe households should maintain 3-6 months of living expenses in a savings account for emergencies like car and house repairs.  They should also maintain an additional 6 months of living expenses as a “Financial Vulnerability Cushion,”  whereby cash is set aside for the big, life-changing stuff like extended job loss especially as we believe the economy is in a late-stage expansionary cycle. Job security isn’t what it used to be; best to think ahead.

In 2018, TD Ameritrade in conjunction with Harris Poll, completed a survey among 1,503 U.S. adults 45 and older to understand the habits that set Super Savers apart from the pack. The results are not surprising. However, they do validate habits all of us should adopt regardless of age.

Like a physical exercise regimen, shifting into Super Saver mode takes small, consistent efforts that build on each other.

So, what lessons can be learned from this elite breed?

First, on average, Super Savers sock away 29% of their income compared to non-super savers. 

Super Savers place saving and investing over housing and household expenses.

Keep in mind, the Personal Saving Rate as of December 2019 according to the Federal Reserve Bank of St. Louis was a paltry 7.6%.  How does this group manage to accomplish such an arduous task? They abhor the thought of being house poor. They focus attention on the reduction of spending on the big stuff, or the fixed costs that make a huge impact to cash flow. Candidly, they’re not concerned about cutting out lattes as a viable strategy to save money. Super Savers spend 14% on housing, 16% on essential household expenses compared to non-supers who spend 23% and 21%, respectively. Any way you cut it, that’s impressive!

Perhaps it’s because Super Savers think backwards, always with a financially beneficial endgame in mind. There is great importance placed on financial security, peace of mind and freedom to do what they want at a younger age. They consider the cumulative impact of monthly payments on their bottom line, which is not common nature for the masses.  They internalize the opportunity cost of every large or recurring expenditure.

Super Savers weigh the outcome of every significant purchase, especially discretionary items, which invariably increases their hesitancy to spend. This manner of thought provides breathing room to deliberate less expensive alternatives and thoroughly investigate the pros and cons of their decisions.

Tip for the Super Saver in training: Sever the mental connection between monthly payments and affordability. How? First, calculate the interest cost of a purchase. For example, let’s say you’re looking to purchase an automobile. First, never go further than 36 months if you must make payments. Why? Because longer loan terms like 48 to 72 months is a payment mentality that will undoubtedly increase interest costs.

For example, let’s say an auto purchase is financed for $23,000. At 3.49% for 36 months, the payment is roughly $674 with total loan interest of $1,258. For 72 months, naturally there’s a lower monthly obligation – $354. However, total loan interest amounts to $2,525.

A Super Saver’s consideration would be on the interest incurred over the life of a loan, not the affordability of monthly payments. An important difference between this manner of thinking and most, is to meet a lifestyle, it’s common for households to go for the lowest monthly payment with little regard to overall interest paid. Super savers will either consider a less expensive option or adjust household budgets to meet higher payments just to pay less interest in the long run.

Second, Super Savers live enriching lives; they don’t deprive themselves.

Members of the super crowd don’t live small lives -a big misnomer. I think people are quick to spread this narrative to ease personal guilt or envy. Certainly, a fiscal discomfort mindset is part of who they are when they believe personal financial boundaries are breached. However, the TD Ameritrade survey shows that both super and non-super savers spend the same 7% of their income on vacations!

Third, starting early is key for Super Savers.

Per the study, more than half of Super Savers started investing by age 30 (54%).  I’m not a fan of personal finance dogma. Many of the stale tenets preached by the brokerage industry are part of a self-serving agenda to direct retail investor cash into cookie-cutter asset allocation portfolios; all to appease shareholders.

However, one rule I’m happily a complete sucker for is Pay Yourself First. It’s not just a good one. It’s the core, the very foundation, of every strong financial discipline. Why? Paying yourself first, whereby dollars are directed to savings or investments before anything else, reflects a commitment to delayed gratification. An honorable trait that allows the mental breathing room to avoid impulse buys, raise the bar on savings rates and minimize the addition of debt.

Per Ilene Strauss Cohen, Ph.D. for Psychology Today, people who learn how to manage their need to be satisfied in the moment thrive more in their careers, relationships, health and finances when compared to those who immediately give in to gratification. Again, the root of Pay Yourself First is delayed gratification; the concept goes back further than some of the concepts the financial industry has distorted just to part you from your money.