Tag Archives: wealth

VLOG: Savvy Social Security Strategies For Maximizing Benefits

Are you closing in on retirement and have questions about social security?

When you begin to collect benefits, how you collect them, and what potentially can impact those payments can be very confusing. Danny Ratliff and Richard Rosso, both highly qualified CFP’s, delve into the many most commonly asked questions about social security and how to maximize the benefits in retirement.

Still have questions? 

No problem.

We at RIA Advisors, a registered investment advisory firm, specialize in preserving and growing investor wealth in times like these. If you are concerned about your financial future, click here to ask a question and find out more.

Two Percent for the One Percent

Gradual inflation has a numbing effect. It impoverishes the lower and middle class, but they don’t notice.”—Andrew Bosomworth, PIMCO Germany, as quoted in Der Spiegel

Media reports and political candidates have been stressing the rising wealth and income inequality gaps in the United States. They do so to advance their agendas, but the problem is real and they are justified in raising it. At the same time, both groups are largely overlooking an important piece of the puzzle in the way they talk about it. To properly diagnose this important problem, we need to understand the role the Federal Reserve plays in managing economic growth and how it contributes to these rising imbalances. This article examines the Federal Reserve’s monetary policy objectives and their stated inflation goals to help you better appreciate the role they play in this troubling and growing problem.  

Populism on the Rise

The political success of Donald Trump, Bernie Sanders and more recently Alexandra Ocasio-Cortez leave scant doubt that populism is on the rise. Voters from both parties are demanding change and going to extremes to achieve it. Much of what is taking place is rooted in the emergence of the greatest wealth inequality gap since the roaring ’20s.

Over the last twenty years, the “1%” have been able to accumulate wealth at an ever-increasing rate. According to the Economic Policy Institute, the top 1% take home 21% of all income in the United States, the largest share since 1928. The graph below, while slightly dated, shows the drastic change in income trends that have occurred over the last 35 years.

Graph Courtesy: New York Times – One Broken Economy, in One Simple Chart

This grab for riches by the few is coming at the expense of the many. There are a variety of social, political and economic factors driving the growing discrepancy, but there is one critical factor that is being ignored.

Enter the Federal Reserve

The Federal Reserve Act, as amended in 1977, contains three mandates dictating the management of monetary policy. They are 1) maximize employment, 2) maintain stable prices, and 3) keep long-term interest rates moderate.

These broadly-worded objectives afford the Federal Reserve great latitude in interpreting the Act. Among these, the Fed’s mandate for stable prices is worth a closer look. The Fed interprets “stable prices” as a consistent rate of price increases or inflation. Per the Federal Reserve Bank of Chicago, “The Committee judges that inflation at the rate of 2 percent, as measured by the annual change in the price index for Personal Consumption Expenditures (PCE), is most consistent over the longer run with the Federal Reserve’s statutory mandate.” 

Understanding why the wealth gap has exploded in recent years requires an appreciation for how this small but consistent rate of inflation harms the poor and middle class while simultaneously enriching the already wealthy.

Wealth is defined as that which is left after consumption and the accumulated results of those savings over time.

With that in mind consider inflation from the standpoint of those living paycheck to paycheck. These citizens are often paid on a bi-weekly basis and spend all of their income throughout the following two weeks. In an inflationary state, one’s purchasing power or the amount of goods and services that can be purchased per dollar declines as time progresses. Said differently, the value of work already completed declines over time.  While the erosion of purchasing power is imperceptible in a low inflation environment, it is real and reduces what little wealth this class of workers earned. Endured over years, it has adverse effects on household wealth.

Now let’s focus on the wealthy. A large portion of their earnings are saved and invested, not predominately used to pay rent or put food on the table. While the value of their wealth is also subject to inflation, they offset the negative effects of inflation and increase real wealth by investing in ways that take advantage of rising inflation. Further, the Fed’s historically low-interest-rate policy, which supports 2% inflation, allows the more efficient use of financial leverage to increase wealth.

Some may counter that daily laborers living week to week get pay raises that offset inflation. That may be true, but it also assumes inflation is measured correctly. The Fed relies upon the Consumer Price Index (CPI) and Personal Consumption Expenditures (PCE) metrics as gauges of inflation. While widely accepted, we all have firsthand experience of the rapid rise in the cost of health care, higher education, rents, and many other essential goods and services that suggests far greater inflation than the Fed’s 2% objective. The truth is that inflation is not measurable with any real accuracy.

John Williams, of Shadow Stats, calculates inflation based on the methods used by the Bureau of Labor Statistics in 1980. Currently, his calculation has CPI running at 9.9% per year, much higher than the latest 2.2% CPI reported. The difference between Williams’ calculation and the BLS’ reported figure is caused by the numerous adjustments the BLS has made to the CPI calculation over the years which has reduced reported inflation. Economists argue that the BLS adjustments provide better accuracy. Maybe, but the record level of wealth inequality and public dissatisfaction offers hard evidence to the contrary. Disagreements notwithstanding, the loss of wealth due to inflation, whether at 2% or 10%, is punishing for those spending everything as it limits their ability to save and accumulate wealth.

Economic growth as measured by Gross Domestic Production (GDP) is the holy grail of all measures of economic advancement. Rising GDP in a debt-based economy depends on credit growth which explains why inflation is so important to policy-makers. The logical conclusion is that the Fed’s primary purpose for running a consistent rate of inflation is to foster credit growth. The growth of credit benefits those who have collateral to borrow against, employ leverage and invest. Again, it is the wealthy that benefit from this. For everyone else, it is a merciless master that makes it difficult if not impossible to maintain one’s standard of living.

The more of one’s wealth that is used for consumption, the more one is subject to the ills of inflation. Additionally, this circumstance also drives a negative feedback loop in that inflation also quietly incents people to consume since goods and services will be more expensive tomorrow than they are today.

While we illustrate the extremes in this article, one can envision how the middle class, which increasingly spend the majority of their wages on consumption and invest little or nothing, also fall into the inflation trap.

Summary

The central banking scheme of supporting economic growth through increasing levels of debt only makes sense if “growth at all cost” uniformly benefits all citizens, but it does not. There is a big difference between growth and prosperity. Furthermore, an inflationary policy that aims to minimize the burden of debt while at the same time aggravating the growth of those burdens is taking a serious toll on global economic and social stability.

As we are finding, the United States is not immune to these disruptions.  The source of these problems are accumulating and compounding as a result of the public’s failure to understand why it is happening. This will ultimately lead to further policy-making errors. Until the Fed’s policies are publicly discussed, re-examined and ultimately reconsidered, the problems will not resolve themselves.

The U.S. Wealth Bubble Created Nearly A Million Millionaires Since 2017

Credit Suisse recently published its annual Global Wealth Report, which found that the United States “added 878,000 new millionaires [since 2017] – representing around 40% of the global increase.” The report also claimed that “The United States has the most members of the top 1% global wealth group, and currently accounts for 41% of the world’s millionaires.”

Credit Suisse Global Wealth Report

While America’s surging wealth may seem like a good thing at first blush, my research has shown that it is actually a dangerous bubble driven by the Fed’s aggressive monetary stimulus since 2008. As I explained in a recent presentation, U.S. household wealth has surged by approximately $46 trillion or 83% since 2009 to an all-time high of $100.8 trillion. Since 1951, household wealth has averaged 379% of the GDP, while the Dot-com bubble peaked at 429%, the housing bubble topped out at 473%, and the current bubble has inflated household wealth to a record 505% of GDP (see the chart below):

Net Worth As Percent Of GDP

Please watch my presentation “Why U.S. Wealth Is In A Bubble” to learn more:

Please read my other recent pieces about how the U.S. wealth bubble is affecting the economy:

How America’s Wealth Bubble Is Boosting Consumer Confidence

Only 28% Of Americans Are “Financially Healthy” During The Largest Wealth Bubble

We at Clarity Financial LLC, a registered investment advisory firm, specialize in preserving and growing investor wealth in times like these. If you are concerned about your financial future, click here to ask me a question and find out more. 

How America’s Wealth Bubble Is Boosting Consumer Confidence

ZeroHedge posted an interesting chart a few days ago showing how affluent Americans (those making over $50,000 a year) have not been more confident since the dot com bubble:

Affluent Consumer Confidence

While strong consumer confidence may seem like a good thing when taken at face value, the contrarian in me sees it as a warning of the kind of over-exuberance seen during bubbles like the dot-com bubble and housing bubble. Unfortunately, I believe that the U.S. is experiencing an unsustainable, artificial household wealth bubble that is causing affluent consumers to be over-optimistic despite the fact that our economic boom is largely driven by cheap credit and is going to end in a painful bust.

As I explained in a recent presentation, U.S. household wealth has surged by approximately $46 trillion or 83% since 2009 to an all-time high of $100.8 trillion. Since 1951, household wealth has averaged 379% of the GDP, while the Dot-com bubble peaked at 429%, the housing bubble topped out at 473%, and the current bubble has inflated household wealth to a record 505% of GDP (see the chart below):

Net Worth As Percent Of GDP

Please watch my presentation “Why U.S. Wealth Is In A Bubble” to learn more:

We at Clarity Financial LLC, a registered investment advisory firm, specialize in preserving and growing investor wealth in times like these. If you are concerned about your financial future, click here to ask me a question and find out more. 

Only 28% Of Americans Are “Financially Healthy” During The Largest Wealth Bubble

MarketWatch published a piece today called “Here is the ‘true state’ of Americans’ financial lives,” which stated that 42% of Americans have no retirement savings at all and that only 28% of Americans are considered “financially healthy”:

The finances of Americans may not be as good as they look from the outside.

Despite optimistic metrics like a nine-year-long bullish, if volatile, stock market, low unemployment levels, and consumer confidence levels nearing record highs, millions of Americans continue to struggle, a study released Thursday from financial consultancy nonprofit the Center for Financial Services Innovation (CFSI) found.

Only 28% of Americans are considered “financially healthy,” according to a CFSI survey of more than 5,000 Americans. “Financial health enables family stability, education, and upward mobility, not just for individuals today but across future generations,” the CFSI says. “Many are dealing with an unhealthy amount of debt, irregular income, and sporadic savings habits.”

Meanwhile, 17% of Americans are “financially vulnerable,” meaning they struggle with nearly all financial aspects of their lives, and 55% are “financially coping,” meaning they struggle with some but not all aspects of their financial lives. The recent volatility in the Dow Jones Industrial and S&P 500 has not helped Americans feel secure, experts say.

What I found jaw-dropping about these depressing financial health statistics is that they are this bad even though America is currently experiencing its largest household wealth bubble in history. As I explained in a recent presentation, U.S. household wealth has surged by approximately $46 trillion or 83% since 2009 to an all-time high of $100.8 trillion. Since 1951, household wealth has averaged 379% of the GDP, while the Dot-com bubble peaked at 429%, the housing bubble topped out at 473%, and the current bubble has inflated household wealth to a record 505% of GDP (see the chart below):

Net Worth As Percent Of GDP

Unfortunately, this wealth boom is not a sustainable, permanent wealth increase, but an artificial, Fed-driven bubble that is going to burst with disastrous effects. If America’s personal financial health is this bad right now, just imagine how much worse it will be when our household wealth bubble bursts! (Yes, I know that the 28% who are considered “financially healthy” possess a disproportionate amount of America’s wealth that is currently inflated, but the bursting of this bubble will make these statistics even worse.)

Please watch my presentation “Why U.S. Wealth Is In A Bubble” to learn more:

We at Clarity Financial LLC, a registered investment advisory firm, specialize in preserving and growing investor wealth in times like these. If you are concerned about your financial future, click here to ask me a question and find out more. 

VLOG: Why U.S. Household Wealth Is In A Bubble

Since 2009, the U.S. has been experiencing a household wealth boom due to soaring stock, housing, and bond prices. Unfortunately, this wealth boom is driven by cheap credit and asset bubbles just like the late-1990s and mid-2000s wealth booms before it (both of which ended in a crash).

Jesse Colombo (the creator of this presentation) and Clarity Financial have been very wary of following the overcrowded “buy and hold” strategy when the stock market and household wealth is so inflated (because reversion to the mean is inevitable), which is why we have always employed a very disciplined strategy which follows the trend of the market while it is rising, but protects capital from eventual and inevitable downturns.

After having successfully navigated out of the markets in 2008 and identifying the “buying” opportunity in 2009, we continue to understand the importance of proper asset allocation, sector rotation, value and momentum based investing, and a strong, rule based, “buy/sell” investment discipline.

We at Clarity Financial LLC, a registered investment advisory firm, specialize in preserving and growing investor wealth in times like these. If you are concerned about your financial future, click here to ask me a question and find out more.

U.S. Household Wealth Is In A Bubble – Part 2

U.S. Stocks Are In A Bubble

In Part 1 of this series called “Why U.S. Household Wealth Is In A Bubble,” I explained why America’s post-Great Recession wealth boom is driven by a tremendous bubble that will end in tears.

In Part 2 of this series, I will go into more detail about the U.S. stock market bubble that is a major driver of the overall household wealth bubble. Common stocks – including those held indirectly in mutual funds – are one of the largest components of U.S. household wealth, along with bonds and housing. When stocks are extremely inflated, like they were during the late-1990s Dot-com bubble, they contribute to the inflation of household wealth. Conversely, when stocks experience a bear market, like they did when the Dot-com bubble popped, household wealth falls as well. In this piece, I will show a wide variety of charts and other data that prove beyond a reasonable doubt that the U.S. stock market is excessively inflated and heading for serious pain.

Since the Great Recession bear market bottom in March 2009, the bellwether S&P 500 stock index is up a jaw-dropping 300 percent. In addition, the index is approximately 80 percent higher than its 2007 peak.

SP500 Chart

The more volatile Russell 2000 small cap index and the tech-centric Nasdaq Composite Index are up even more than the S&P 500 – approximately 400 percent and 500 percent respectively:

Percent Increase For U.S. Stock Indices

As discussed in Part 1 of this series, record low interest rates are the primary reason for both the overall U.S. household wealth bubble as well as the U.S. stock market bubble. The chart below shows how U.S. interest rates (the Fed Funds Rate, 10-Year Treasury yields, and Aaa corporate bond yields) have been at record low levels for a record period of time since the 2008 financial crisis. The fact that credit has been so cheap for so long explains why the household wealth bubble is so extreme and why the stock market bubble is so inflated, as valuation indicators later on in this piece will show.

U.S. Interest Rates

Low interest rates contribute to the inflation of asset and credit bubbles in numerous ways:

  • Investors can borrow cheaply to speculate in assets (ex: cheap mortgages for property speculation and low margin costs for trading stocks)
  • By discouraging the holding of cash in the bank versus speculating in riskier asset markets
  • By encouraging higher rates of inflation, which helps to support assets like stocks and real estate
  • By encouraging more borrowing by consumers, businesses, and governments

The chart of real (inflation-adjusted) interest rates below confirms just how loose U.S. monetary policy has been since the Great Recession. In recent decades, the only time the U.S. has experienced negative real interest rates for a significant amount of time was during the mid-2000s housing bubble and during the current “Everything Bubble” period that started after 2009. (Note: “Everything Bubble” is a term that I’ve coined to describe a dangerous bubble that has been inflating across the globe in a wide variety of countries, industries, and assets – please visit my website to learn more.)

Real Fed Funds RateAnother way of determining how excessively loose (or tight) U.S. monetary conditions are is by comparing the Fed Funds Rate to the Taylor Rule model. The Taylor Rule is a proposed guideline created by economist John Taylor to estimate the ideal level for central bank-controlled benchmark interest rates – such as the Fed Funds Rate – for the purpose of maximizing the stability of economic growth. When the Fed Funds Rate is much lower than the Taylor Rule model, it means that interest rates are likely too low relative to economic growth and inflation, which greatly increases the probability of forming a dangerous economic bubble. The chart below shows that the Fed Funds Rate was much lower than the Taylor Rule model during the formation of both the mid-2000s housing bubble as well as the current “Everything Bubble.”

Taylor Rule vs. Fed Funds Rate 1

The chart below plots the difference between the Fed Funds Rate and the Taylor Rule model to show when U.S. monetary policy is likely too tight (when the chart is in positive territory) or too loose (when the chart is in negative territory). Both the U.S. housing bubble and the current “Everything Bubble” formed when the difference between the Fed Funds Rate and the Taylor Rule model was negative (the Fed Funds Rate was lower than the Taylor Rule model).

Fed Funds Rate vs. Taylor Rule 2

Ultra-low interest rates have encouraged corporations to borrow very heavily (via the bond market) since the Global Financial Crisis. Total outstanding non-financial U.S. corporate debt is up by over $2.5 trillion or 40 percent since its 2008 peak, causing the U.S. corporate debt-to-GDP ratio to hit an all-time high of over 45 percent, which is even more extreme than the level reached during the Dot-com bubble and U.S. housing and credit bubble. Click here to read my U.S. corporate debt warning report.

Corporate Debt GDP Ratio

American public corporations have been using their borrowings to boost their stock prices through share buybacks, dividend increases, and mergers & acquisitions. Though these activities make shareholders happy and help increase executive compensation in the shorter-term, they are contrary to the long-term success of these companies. In the past, corporations prioritized long-term business investments and expansions, but pumping stock prices is the name of the game now. The chart below shows the surge in share buybacks and dividends paid. Share buybacks are expected to exceed $1 trillion this year, which would trounce all prior records. The passing of President Donald Trump’s tax reform plan encouraged corporations to further escalate their share buyback plans this year.

Share Buybacks

As discussed in Part 1 of this series, each of the Federal Reserve’s QE programs led to an increase in the Fed’s balance sheet and a corresponding surge in asset prices. The chart below shows how tightly correlated the S&P 500 was to the Fed’s balance sheet from 2009 until 2016. Despite the flat-lining of the Fed’s balance sheet in 2014, the S&P 500 continued to rise again in late-2016 due to optimism over President Trump’s election win and his plans for increased infrastructure spending, tax reform, and greater corporate stock buybacks (a byproduct of the tax reform plan).

Fed Balance Sheet vs. SP500

During bull markets and bubbles, it becomes more popular for traders to borrow money from their brokers in the form of margin loans for the purpose of speculating on rising stock prices. When margin debt levels reach extremes, it is often indicative of overly optimistic market sentiment, which foreshadows a market correction or bear market ahead. During the Dot-com bubble and housing bubble era, margin debt peaked at approximately 2.75 percent of GDP. In the current stock market bubble, margin debt is nearly at 3 percent of GDP, which is a worrisome sign. Another risk of having such large amounts of margin debt in an over-extended bull market is that it exacerbates the eventual downturn by causing powerful liquidation sell-offs as bullish traders are forced to jettison assets to satisfy margin calls.

SP500 vs. Margin As A % of GDP

Another example of overly optimistic market sentiment is the chart below, which shows that retail investors have the highest allocation to stocks (blue line) and the lowest cash holdings (orange line) since the Dot-com bubble. From a contrarian perspective, this is worrisome because small investors tend to be wrong at major market turnings points (example: being too bearish in early-2009 at the very start of the bull market).

Retail Investor Allocation

The CBOE Volatility Index or VIX is a popular fear gauge that is derived from the sentiment of stock option traders. The VIX is usually viewed in a contrarian manner: when fear is very high (typically over 30 to 40), it is often a good time to buy stocks. When fear is very low (usually under 20), however, it is a sign of dangerous market complacency or even euphoria that tends to occur during a bubble. The VIX often remains in complacency territory for a long time before the stock bull market or bubble ends. For the last 7 years or so, the VIX has been acting very similarly to the way it did during the mid-2000s bubble cycle – I believe that this is not a coincidence as it is due to the unusually loose monetary conditions present during each cycle. Loose monetary conditions tend to temporarily backstop the financial markets, artificially suppress volatility, and create dangerous levels of complacency.

Volatility Index (VIX)

The St. Louis Fed Financial Stress Index is another indicator that shows if there are dangerous levels of complacency in the financial markets. Bubbles form during relative troughs in the Financial Stress Index. The Dot-com bubble formed when the index was at a relative low, as did the mid-2000s U.S. housing and credit bubble, and the “Everything Bubble” is forming during the current trough. (Read my piece on the St. Louis Fed Financial Stress Index for more information.)

Financial Stress Index

High-yield (or “junk”) bond spreads are another effective market complacency indicator. In central bank-manipulated environments like we’ve had for several decades, very low high-yield bond spreads indicate the formation of a dangerous bubble.The high-yield spread was unusually low during the Dot-com bubble and housing bubble, as well as during the current “Everything Bubble.” (Read my pieceJunk Bond Spreads Reveal Complacency” to learn more about this indicator.)

Junk Bond Spread

Another class of indicators measure the overall market’s valuation to help determine if it is undervalued, fairly valued, or overvalued relative to fundamentals such as earnings, sales, and book value. The cyclically-adjusted price-to-earnings ratio (aka CAPE or Shiller P/E) is basically a smoothed price-to-earnings ratio (learn more here). According to CAPE, the U.S. stock market is currently more overvalued than it was in 1929, right before the stock market crash and Great Depression. While the market was more overvalued during the Dot-com bubble, it should not automatically be assumed that the market will reach those levels again. Just because it can happen doesn’t mean that it must happen. When market valuations reach extremes, reversion to the mean is inevitable, and it’s going to happen again to this market – it’s just a matter of time.

Cyclically-Adjusted P/E Ratio (CAPE)

The long-term chart of the S&P 500’s dividend yield also confirms the market overvaluation thesis. When stock market valuations are very high, dividend yields are low, and vice versa. For the past two decades or so, dividend yields have been at their lowest levels in well over a century. This is a result of the Fed-caused market overvaluation since the late-1990s. (Note: while I am aware that dividend payout ratios have been declining over time as well, this only partly explains why dividend yields are so low. Extremely high market valuations are the other rarely-discussed reason why yields are so low.)

S&P500 Dividend YieldThe U.S. stock market capitalization-to-GDP ratio (the total value of the U.S. stock market divided by the GDP) also shows that the stock market has gotten far ahead of the underlying economy, just as it did in the prior two bubbles. Unfortunately, it’s even worse this time around. This ratio is often nicknamed “Warren Buffett’s favorite indicator” because he described it as “probably the best single measure of where valuations stand at any given moment.

Market Cap To GDP Ratio

Tobin’s Q ratio (the total U.S. stock market value divided by the total replacement cost of assets) is another valuable market valuation indicator. When the ratio is under .40, the broad market is undervalued and worth buying into. Conversely, when the ratio is over 1.0, it means that the market is overvalued and heading for a correction or mean reversion soon. Conservative investors may want to consider selling stocks and staying in cash when Tobin’s Q ratio is over 1.0. The majority of the most important historic stock market peaks occurred when the ratio was over 1.0. Right now, the ratio is even higher than it was in 1929 before the stock market crash and Great Depression (which confirms the warning given by the cyclically-adjusted P/E ratio discussed earlier).

Tobin's Q Ratio

The next chart below shows U.S. after-tax corporate profits as a percentage of the gross national product (GNP). This is not a valuation measure like the last several charts, but a measure of how profitable American corporations are. This chart is highly correlated with the S&P 500’s net profit margin and is used as a proxy for that because long-term S&P 500 profit margin data is very hard to find. American corporations have been unusually profitable since the early-to-mid-2000s: profit margins have averaged approximately 9 percent versus the 6.6 percent average since 1947.

While above-average corporate profitability may sound like a good thing when taken at face value, I view it as another worrisome sign because it’s further evidence of an economy and financial markets that are being juiced by cheap credit and financial engineering. Ultra-low interest rates help to boost corporate profitability by reducing borrowing costs. Cheap credit also gives consumer spending a strong boost, which has a significant effect on our economy that is heavily driven by consumer spending. Low interest rate environments allow the government (federal, state, and local) to borrow more cheaply in the bond market and use it to boost spending, which gives the overall economy a shot in the arm. In addition, artificially-inflated financial markets boost the profitability of the financial sector.

A major risk for the stock market is the mean reversion of corporate profitability, which is a nightmarish prospect when considering how overpriced stocks currently are relative to earnings. This mean reversion is likely to occur as the result of the ending of ultra-cheap credit conditions (when corporate bonds fall back to earth) and through increased competition, which is what Milton Friedman warned about. (Note: critics may try to rebut my assertions by claiming that U.S. corporate profitability is unusually high due to corporations earning a higher percentage of earnings overseas. I’ve accounted for this by using gross national product as the denominator instead of the more commonly used GDP.)

Corporate Profit Margins vs GNP

What is particularly alarming about the current U.S. stock market bubble is the fact that it’s driven by a very narrow group of stocks, which means that there isn’t a healthy breadth, or broad strength, behind the bull market. In general, tech stocks have been leading the way – in particular, a group of stocks known as FAANG, which is an acronym for Facebook, Apple, Amazon, Netflix, and Google. The chart below compares the performance of the FAANG stocks to the S&P 500 during the bull market that began in March 2009. While the S&P 500 is up approximately 300 percent, the FAANGs are up significantly more, with Apple rising by over 1,000 percent, Amazon rising more than 2,000 percent, and Netflix surging by over 6,000 percent.

FAANG Stocks vs. SP500

The disproportionate amount of influence that this small group of top-performing stocks currently have on the overall market cannot be overstated. Here are some recent statistics that have been making the rounds:

  • 10 stocks (including the FAANGs) have accounted for 100 percent of the S&P 500’s year to date returns. (Source)
  • Excluding the FAANGs, the S&P 500’s first half returns would have been negative (Source)
  • The top 20 stocks in the S&P 500 make up more of the overall index than the bottom 400 combined (Source)
  • The combined market capitalization of Facebook, Google, Amazon, Microsoft, and Apple increased $260B in just 11 trading days in mid-July 2018 alone (Source)
  • The combined market capitalization of Facebook, Google, Amazon, Microsoft, and Apple increased an incredible $812B since the start of 2018 (that’s the size of a company like Microsoft or Google) (Source)

Today’s FAANG phenomenon is reminiscent of the Nifty Fifty group of stocks that dominated the 1960s and early-1970s bull market. The Nifty Fifty were fast-growing blue chip stocks that led the overall market and were seen as “one decision” stocks (the only decision necessary was to buy) because investors thought they would keep rising up, up, and away as a function of time. Unfortunately, the Nifty Fifty proved as fallible as any other investment when they sank during the 1973-1974 bear market. Many investors view today’s FAANGs as “can’t lose” stocks just like their counterparts did during the Nifty Fifty boom and are going to be taught the same lesson when the market ultimately turns.

Another important development that is contributing to the current runaway U.S. stock market bubble is the rise of passive investing (or passive indexing). Passive investing is a style of investing that eschews active portfolio management or trading in favor of buying and holding an index like the S&P 500. Passive investors often utilize exchange traded funds (ETFs) to construct portfolios instead of investing in individual stocks. The proponents of passive investing point out that the passive approach is much cheaper than the active approach in terms of management fees, brokerage commissions, and other costs. They also posit that few active investment managers consistently beat the major stock indices over the long run, so investors are better off holding index funds or ETFs.

While the proponents of passive investing make some valid points, they are ignoring a glaring risk of their approach: they never sell out of the market, even when it is extremely overvalued as it is currently. This issue should not be taken lightly because, as my boss Lance Roberts has shown, it takes an average of twenty-two years for investors just to break even if they start investing at high valuations like we have today. Twenty-two years is a very high percentage of the time most investors have to build up a retirement fund, which is usually a few decades at most. Investing in stocks at the wrong time can completely ruin one’s retirement plans.

As the Fed-driven stock market bubbled up 300 percent with barely a pullback since 2009, over $2 trillion has flowed out of actively managed funds and into passive investment vehicles. Many of today’s passive investors seem to think (whether explicitly or implicitly), “why should we pay an active investment manager a fee when the market just keeps rising year after year? You can’t lose in this market – it always goes back up after every pullback!” Thanks to the Fed’s ultra-low interest rates and QE programs, it has conditioned investors to believe that it will always backstop the financial markets and swoop in to save the day each time a bit of volatility appears.  After nearly a decade of supporting the markets and economy, the Fed has created an extremely dangerous moral hazard and has artificially suppressed market volatility. This market has become too easy for investors and has created a false sense of security that has led to overly aggressive risk-taking. As Lance has said many times before, the risk with this passive investing boom is that it will result in active selling once the current market bubble bursts. When investors see their portfolio down ten, twenty, or thirty percent, their previous convictions (“I’m in it for the long run!”) fly out the window and they emotionally slam the “sell” button. Passive investing-turned-active selling will greatly exacerbate the coming downturn.

How The U.S. Stock Market Bubble Will Burst

Now I get to address the question that has been on everyone’s minds: “so, how and when will this bubble pop?!” Though I wish I was clairvoyant and could pinpoint a specific date in the future that this bubble will pop such as “April 3rd, 2019,” that is simply impossible – not only for me, but also for the likes of George Soros, Fed chairman Jerome Powell, and Warren Buffett. Fortunately, it is not necessary to predict the market with that kind of accuracy to be a successful investor or preserve your wealth when the bubble pops. We do have tools that allow us to estimate in general when the bubble is much likelier to pop, when we should start cutting our risk exposure, and if a market breakdown is likely to lead to even more bearish action.

To put it simply, the stock market bubble will pop due to the removal of its fuel: cheap credit. Fed-driven economic booms, bull markets, and bubbles end after the central bank raises interest rates to a high enough level. How high do rates have to go to pop the current bubble? There is no mathematical formula to determine that, but as hedge fund manager Jeff Gundlach put it, the Fed will keep hiking until “something breaks.” In 2007, it was the subprime mortgage industry that broke first, and this time around, there is a very high probability that it will be corporate bonds, which would then spill over into the U.S. stock market (a scenario I discussed in my corporate debt report). It could also be energy junk bonds or hot tech stocks like the FAANGs that break first, for example. Because of the growing debt burden in our economy, the interest rate threshold that is necessary to end economic cycles keeps getting lower and lower.

The chart below shows how the last two recessions and bubble bursts occurred after Fed rate hike cycles. It’s virtually a guarantee that the current rate hike cycle will also lead to a strong recession and bear market.

Fed Funds Rate Chart

One very valuable tool for determining where we are in the economic cycle is the 10-Year/2-Year U.S. Treasury yield spread. To create this chart (see chart below), the current two-year Treasury note yield is subtracted from the current ten-year Treasury note yield and plotted over time. When the spread is between 0 percent and 1 percent, it is in the “recession warning zone” because it signifies that the economic cycle is reaching maturity and that a recession is likely to occur within a few years. When the spread falls into negative territory, that’s when the yield curve is inverted, which means that a recession is imminent within the next year or so. The yield curve inverted before every U.S. recession in the past half-century, which is why it is worth paying close attention to. (Read my piece about the Treasury yield spread to learn more.)

According to the 10-Year/2-Year U.S. Treasury bond spread, we are currently in the “recession warning zone,” but not the “recession zone” just yet. At the rate the yield curve is currently flattening, the yield curve may actually invert as soon as late-2018. According to my research, during the last six economic cycles that culminated in a recession, an average of 9.7 months elapsed between the time that the yield curve first inverted and the peak of the stock market. Recessions began an average of 5 months after the stock market peaked or 14.7 months after the yield curve inverted. According to this logic, if the current cycle follows the average of the past six cycles, the yield curve would invert in December 2018, the stock market would peak in September 2019, and the recession would begin in February 2020. Please realize that this is a not a prediction, but just an estimate based on historic economic cycles. The bear market and recession could occur even sooner than that or later. One thing is certain: with the market as overvalued as it is, the time to worry and start preparing is now – not tomorrow or in a year from now.

10-Year 2-Year Spread

At this point, a significant portion of readers are probably thinking “but how can this market crash?! President Donald Trump is making America great again! That’s why this market is soaring.” Let me preface my views by saying that I actually err on the conservative/libertarian side, but I do not believe that President Trump can prevent the inevitable popping of the “Everything Bubble” that I’m warning about. First of all, this bubble is truly worldwide, so the U.S. President has no jurisdiction over the economies of China, Australia, Canada, emerging markets, etc. I believe that the popping of a massive global bubble outside of the U.S. is enough to create a bear market and recession within the U.S.

In addition, this bubble was inflating years before Trump even decided to run for office, let alone actually became President. Due to the extreme debt buildup and asset overvaluation, this bubble was destined to pop no matter who was in office – I’d be singing the same tune if Hillary Clinton had won. It’s just math. In September 2016, before the election, Donald Trump himself called the stock market a “big, fat, ugly bubble,” yet that very same bubble is now 30 percent larger (and Trump is no longer calling it a “bubble,” but is actually praising it…hmm).

Many economic bulls and Trump supporters expect the President’s tax reform plan to usher in a powerful economic boom that creates millions of new jobs and causes corporate earnings to soar, which would help to justify today’s lofty stock market levels. Unfortunately, this is more wishful thinking than reality. As Lance Roberts has explained in great detail earlier this year, “there will be no economic boom” (Part 1, Part 2) due to how saturated with debt our economy has become (among many other factors). So far, this view is being proven correct as the U.S. economy has actually started to slow down rather than accelerate. Lance also warned that the tax cuts were likely to result in more stock buybacks, with little trickle-down to the middle class or poor – another view that is being confirmed.

Summary – Part 2

To summarize, the U.S. stock market is at extremely lofty levels due to aggressive actions on the part of the Federal Reserve rather than an organic, sustainable economic boom. Booms that are created through the brute force of monetary stimulus never end well despite appearing to be normal economic booms during the good times.

Please stay tuned for Part III, where I will discuss U.S. Housing Bubble 2.0 and how it is contributing to the U.S. household wealth bubble.

If you are like most investors, the U.S. household wealth bubble means that your own investments, wealth, and retirement fund are extremely inflated and exposed to grave risk of another crash. Most investment firms have absolutely no clue that another storm is coming, let alone how to navigate it. Clarity Financial LLC, my employer, is a registered investment advisor firm that specializes in preserving and growing investor wealth in precarious times like these.

Please click here to contact us so that we can help protect your hard-earned wealth.


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U.S. Household Wealth Is In A Bubble – Part 1

This article is Part I of a series that explains why U.S. household wealth is experiencing a dangerous bubble, why this bubble is heading for a powerful bust, and how to preserve and grow your wealth when this bubble inevitably bursts.

This series of articles will cover the following key points:

  • How inflated household wealth currently is compared to historic levels
  • What forces are driving household wealth to such extreme levels
  • A look at the underlying components of household wealth and why they are inflated
  • A look at the growing bubbles in equities, housing, and bonds
  • How the household wealth bubble is driving consumer spending 
  • How the wealth bubble contributes to our artificial economic recovery
  • How the wealth bubble is creating a temporary surge of inequality 
  • How the wealth bubble will burst
  • How to preserve your wealth when the wealth bubble bursts

Part I: U.S. Household Wealth Is In A Bubble

In most people’s minds, any increase in wealth is a good thing. Surely, only a misanthrope would argue otherwise, right? Well, in this article series, I’m going to make the unpopular argument that America’s post-Great Recession household wealth boom is actually a very dangerous phenomenon.

Since the financial crisis in early-2009, household wealth has surged by nearly $46 trillion or 83 percent to a record $100.8 trillion. As the chart below shows, the powerful increase in household wealth (blue line) has far exceeded the growth of the underlying economy, as measured by the GDP (orange line). Household wealth should closely track the economy, as it did during the 20th century until the extreme boom-bust era that started in the mid-to-late 1990s.

When household wealth tracks the growth of the economy, it’s a sign that the wealth increase is likely organic, healthy, and sustainable. When household wealth far outpaces the growth of the underlying economy, however, that is a tell-tale sign that the boom is artificial and unsustainable. The last two times household wealth growth exceeded GDP growth by a large degree was during the late-1990s dot-com bubble and the mid-2000s housing bubble, both of which ended in tears. The gap between household wealth and the economy is far larger today than it was in the last two bubbles, which means that the coming reversion or crash is going to be even more painful, unfortunately.

U.S. Household Net Worth vs. GDP

Another way of visualizing the household wealth bubble is to plot it as a percent of GDP, which paints the same picture as the chart above. U.S. household wealth is currently 505 percent of the GDP, which is even more extreme than the housing bubble’s peak at 473 percent, and the dot-com bubble’s peak at 429 percent. Household wealth has averaged 379 percent of the GDP since 1951, so the current 505 percent figure is completely out of line, which means that a violent reversion to the mean (aka, another crash) is inevitable. To make matters even worse, the 379 percent average figure is skewed upward by the anomalous boom-bust period that began in the mid-to-late 1990s. When U.S. household wealth comes crashing down again, there is a very good chance that it will overshoot below its historic average due to how stretched it has become during the current bubble.

Household Net Worth As A Percent Of GDP

What is driving the current U.S. household wealth bubble and why is it happening? The answer lies squarely with the U.S. Federal Reserve and its actions during and after the Global Financial Crisis. During the Crisis, household wealth plunged as stocks, housing prices, and bonds (aside from Treasuries) cratered. These aforementioned assets make up the bulk of household wealth, so bull markets in stocks, housing, and bonds lead to bull markets in household wealth and vice versa. When household wealth plunges as it did in 2008 and 2009, consumers pare back their spending dramatically, which leads to even more economic pain.

In an attempt to pull the economy and financial markets out of their deep-freeze, the Federal Reserve cut interest rates to record low levels and launched emergency monetary stimulus policies known as quantitative easing or QE. QE basically entails creating new money out of thin air (this is done digitally) and using the proceeds to buy mortgage-backed securities and Treasury bonds with the idea that the massive influx of liquidity into the financial system would indirectly find its way into riskier assets such as stocks. Even though the Fed only has two official mandates (maximizing employment and maintaining price stability), boosting asset prices essentially became their unspoken third mandate after the 2008 financial crisis.

As former Fed chairman Ben Bernanke wrote in a 2010 op-ed in which he explained (what he claimed to be) the virtues of the Fed’s new, unconventional monetary policies:

And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.

While the idea of having a central bank like the Federal Reserve boost asset prices to create an economic recovery may seem clever and admirable, it is terribly misguided because asset booms driven by central bank intervention are overwhelmingly likely to be unsustainable bubbles rather than genuine booms. Central bank-driven booms are very similar to sugar highs or highs from hard drugs – a crash is inevitable once the substance wears off. When central banks interfere in markets, they create mass distortions and false signals that trick investors into believing that the boom is legitimate, even though it’s not.

The chart below shows the Fed Funds Rate, which is the interest rate that the Fed raises and lowers in order to steer the economy. When the Fed holds rates at very low levels (which keeps borrowing costs in the economy low), dangerous bubbles form in asset prices and the overall economy. When the Fed ultimately raises rates, the bubble pops, which results in stock bear markets and recessions. The dot-com and housing bubbles formed during periods of low interest rates and popped when interest rates were raised.

What is terrifying is the fact that interest rates have remained at record low levels for a record length of time since the financial crisis, which means that the current market distortion and coming crisis will be even more extreme than the last two. Remember how extreme the current household wealth bubble looked in the two charts shown earlier in this piece? Well, that is certainly no coincidence: it is a direct result of the extremely loose monetary conditions over the last decade.

Fed Funds Rate

This next chart shows the Federal Reserve’s balance sheet, which shows the assets purchased by the central bank during its QE programs. Each QE program led to an increase in the Fed’s balance sheet and corresponding surge in asset prices. The three QE programs caused the Fed’s balance sheet to expand by over $3.5 trillion to a peak of approximately $4.5 trillion. Since late-2017, the Fed has been attempting to shrink its balance sheet (this is known as quantitative tightening or QT), which has roiled the financial markets.

Fed Balance Sheet

Summary – Part I

To summarize, we are currently experiencing an explosion of wealth on a scale that has never been seen before. Unfortunately, it’s not the good kind of wealth explosion, but the bad kind – the kind that precedes wealth implosions that lead to deep economic recessions and depressions. While most people are cheering this boom on and are delighted by the return to prosperous times, they have absolutely no clue what is driving it or the fact that it will prove to be fleeting and ephemeral.

Please stay tuned for Part II, where I will discuss the underlying components of U.S. household wealth (stocks, bonds, etc.) and provide even more evidence that they are experiencing speculative bubbles in their own right.

If you are like most investors, the U.S. household wealth bubble means that your own investments, wealth, and retirement fund are extremely inflated and exposed to grave risk of another crash. Most investment firms have absolutely no clue that another storm is coming, let alone how to navigate it. Clarity Financial LLC, my employer, is a registered investment advisor firm that specializes in preserving and growing investor wealth in precarious times like these.

Please click here to contact us so that we can help protect your hard-earned wealth.