And the Music Keeps Playing…
After the worst start to the year since 2008, the global stock markets staged an amazing reversal in March, thanks to the Federal Reserve and the Central Banks around the world coordinating monetary policy in an effort to boost asset prices and create inflation. Global markets finished roughly flat for the first quarter after being down about 10% through the first month and a half (note, higher asset prices). The benchmark 10 year Treasury yield went from 2.26% to 1.78% so far in 2016, meaning that bond prices went up (note, higher asset prices). Though we don’t have composite housing numbers, anecdotally, I can tell you that inventories seem to be extremely low and, at least in the Seattle area, prices are up considerably through the first quarter (note, higher asset prices).
Ok, enough with the review of what has happened. Let’s turn instead to how we see the world and expand on the higher asset prices theme we have started. Keep in mind this first quarter recap references many discussions we have had with clients over the last couple years - and more. To quote Herbert Stein, well known economist and the father of Ben Stein, “If something can’t go on forever, it will stop.” The one exception that we don’t know yet is if the Universe is ever-expanding, will there be a time that the expansion stops? That one I will leave for all of you Theoretical Physicists. As we quickly close in on $20 trillion in public debt, over 60% of the US government’s budget is going to pay for Social Security and Medicare/Medicaid, plus another 6% to pay the interest on our almost $20 trillion debt, not to mention that the Congressional Budget Office (CBO) projects deficits rising from over $500 Billion (2016) to $1 trillion (2026) and total debt owed to rise to over $29 trillion by 2026. These are current projections that do not include any recession built in for the next 10 years, which would mean 17 years without a recession… Not very likely. – “If something can’t go on forever, it will stop”
Meanwhile, we spend more than we make, our population is getting older, we all know the majority of health care costs happen late in life, and we are heading to two people working for every person collecting benefits through Social Security. “If something can’t go on forever, it will stop”
Let’s try and put this all together. The central banks around the world are trying to prop up asset prices (with debt), so that you feel “wealthier” and are more likely to spend money. At the same time they are keeping interest rates down so you can borrow more money to spend, thus propping up GDP while keeping this charade going. Meanwhile the side effects are that conservative savers can’t invest their money in bonds or CDs that earn a reasonable rate of return, causing those same conservative investors to look for alternatives to make some money and stay ahead of inflation (translation, buy stock or real estate). That then changes the amount of risk in the portfolio and if/when the music stops, the investor is now taking much more risk than they would otherwise desire (translation, your portfolio goes down much further than you are comfortable with).
Ok, so what’s a person to do? As you may know, our allocation model has been waving many yellow flags over the last year, with many more red flags as of late. Accordingly, this has caused us to go to a very conservative allocation in March. Meaning that your portfolio won’t have the dramatic up returns nor will it have the dramatic down returns. We are very much positioned conservatively today. This is not a permanent decision and we will make adjustments as necessary, but based on all the data that we look at, the risks have risen to levels that could bring on dramatic selling in the stock market. Almost to a person, you have told us that, a) you do not want to take that kind of downside risk, and b) if there’s anything we can do to minimize the downside, make the needed changes. This comes in the form of higher fixed income and cash in the portfolio (which is where we stand now). As you are reading this, if you are feeling like you should be fully invested at all times, please let us know.
Just like the game of musical chairs, one never knows when the music will stop. In the investment world, as it relates to central bank policies, we too don’t know when the music will stop. All we can say is “If something can’t go on forever, it will stop”.
To leave you on a positive note, we are all bullish on the long-term future of the United States economy, but we must have common sense policies and spending plans (just like you do in your personal lives). When we tackle these major issues, we will once again be able to leave the country in a better position for our children and grandchildren.
As always, we encourage you to call or email if you wish to have a longer discussion surrounding these, or any topics and we look forward to speaking to you. If you have friends or family that you would like to pass this along to, please do.