Plan for a Changing Investing Climate

By Lee Bellinger / March 26, 2015

In order to grow your wealth, your investments must be wellsuited to the economic and investing climate. (Fighting reality is rarely profitable.) Your investments must also be suitable for your particular investing objectives and life circumstances. Unfortunately, all too many investors hold portfolios that are either mismatched for the times or a poor fit for their goals and circumstances.

Only you can assess your own financial situation, time horizon, risk tolerance, and personal preferences. A financial advisor may be able to help, but don’t expect a great deal of customized advice. Financial advisors typically steer all their clients into some variation of a pre-packaged, conventionally iversified portfolio. One that regulators say is appropriate for the typical investor under the Prudent Man Rule.

Problems With Most Financial Advisors

A financial advisor would likely consider the portfolios of the world’s richest and most successful investors to be unsuitable! Do you think people like Warren Buffett and Carl Icahn are basing their investment decisions off some textbook financial planning formula? Of course they aren’t.

Despite being well into “retirement age,” billionaires Buffett and Icahn continue to invest with an eye to long-term capital appreciation. Buffett has more than 98% of his net worth invested in Berkshire Hathaway, the company he runs.

A financial advisor would reject their portfolios as too aggressive. Of course, they have the luxury of being billionaires. If they were to lose half their net worth in a crashing stock market, they’d still be billionaires. For most folks in their 70s and 80s,seeing their portfolios fall by half would result in more tangible and more painful consequences. Such as not being able to retire in comfort.

Rethinking Conservative

Investing Precepts

So the standard advice that you should be more conservative with your investments as you age isn’t altogether wrong. It just doesn’t apply to everyone equally.

Moreover, what constitutes “conservative” investments depends on the investment climate. Bonds aren’t conservative if default risk rises. Cash isn’t conservative if the value of the currency is plummeting. Just ask recent holders of Russian rubles or Ukrainian hryvnia!

In terms of rubles and hryvnia, real assets including gold are soaring. Gold is also making gains against sinking euros. Gold has struggled in terms of U.S. dollars, however. Silver has been hit especially hard.

When a currency is strong, you don’t need precious metals in your portfolio. But when a currency is weak, gold and silver are safe havens that function as superior forms of cash. This was proven out from 2001- 2011. Over that decade-long span, gold and silver were the premier assets – outperforming stocks, bonds, and all world currencies.

You need a sizeable allocation to precious metals in order to provide a counterweight to the paper assets in your portfolio. Yet as Kipinger’s Retirement Report noted a few years back, “Most experts suggest no more than 1% to 2% of your portfolio should be invested in gold.”

Most experts are wrong. A tiny allocation of 2% or less to gold is scarcely worth the trouble. It won’t be enough to provide balance to a portfolio that is allocated 98%+ to financial assets.

Gold and Silver Still At Play
in This Chaotic Environment

Gold and silver will reemerge as go-to assets when the broader economic climate in the U.S. shifts in their favor. Back in spring 2011, silver prices peaked at $49 per ounce. In these pages we urged caution toward silver as prices climbed into the $40s. We specifically suggested an opportunity to sell silver and buy it back later at a cheaper price.

Prices did indeed get cheaper. They got even cheaper than we expected and have stayed cheap for longer than we expected. Some precious metals promoters who are permanently bullish have been in denial this whole time, refusing to admit that the climate for precious metals changed.

Some of the hard money gurus I track are still talking as if real inflation is running at 8%, 9%, or 10%. That’s what they expected as the Fed kept printing currency and holding rates down. Instead, the Fed’s money machinations have mostly inflated Wall Street, government bonds, and the banking sector. The real economy has been little helped or much affected since the announcement of QE2.

Global Deflationary Pull Is
Sinking Demand for Real Goods

You don’t get high rates of inflation when wages are stagnant and oil and commodity prices are falling. The year-over-year Consumer Price Index is actually slightly negative. Yes, the CPI understates real inflation over time. But right now not much in the real economy (save healthcare) is going up a whole lot in price.

The Baltic Dry Index is showing global economic weakness driving deflationary, rather than inflationary, pressures. The Baltic Dry Index tracks shipping rates for dry bulk goods such as base metals, coal, and grains. The Index serves as somewhat of a barometer for global economic demand. And right now it’s signaling weakness. The Index recently hit a 30-year low.

Obviously, that means it’s below 2008 financial crisis levels. Yet hardly anyone in the mainstream media is expressing alarm at the extraordinary divergence between plunging bulk shipping rates and soaring U.S. stock prices. It’s just another indication of the fundamental disconnect between the stock market and reality.

Institutional Investing

Drives the Herd Now

We live in a time when central bankers and concentrated institutional buyers exert overwhelming influence. The market advance since 2009 has been driven almost entirely by institutional buying. The retail investors have remained largely on the sidelines. The economic recovery underpinning corporate earnings has been anemic.

Corporations are using cheap financing that trickles down to them from the Fed less to invest in research and development and more to buy back their own shares. Corporate share buybacks are at record levels. This doesn’t boost actual business profitability, but it does boost earnings per share by reducing the number of shares outstanding and generates more demand for the shares themselves.

According to Bloomberg, corporate stock repurchasing is now the biggest source of new capital into U.S. equity markets. Corporations have spent over $2 trillion buying their own shares since 2009. Some bull market!

Recent Headlines Eerily Harkin
Back to Late, Great Tech Bubble

Glancing at some recent headlines may give you a sense of déjà vu:

  • These five stocks are in the Nasdaq driver’s seat (CNBC, Feb 24, 2015)
  • The new ‘Horsemen of the Nasdaq’ – how long will they ride? (Reuters, Mar 5, 2015)
  • What Tech Stocks Are You Getting In to? (CNBC, March 1, 2015)
  • Forget the S&P 500, Buy the Nasdaq 100, Goldman Sachs Says (Barron’s, March 6, 2015)
  • Three Reasons Why the Nasdaq Will Hit a Record (Wall Street Daily, Mar 6, 2015
  • Dot-Com Deja Vu: Nasdaq Tops 5000, Approaching Record High (ABC News, March 2, 2015)

After all it was in March of 2000 that the Nasdaq last hit the 5,000 mark. It didn’t stay there long. In terms of valuations, share prices today are quite extended, though not as extended as in the 2000 tech mania peak. The Nasdaq would still need to rise an additional 40% above its former nominal high in 2000 to achieve a real, inflation-adjusted new high.

How Big and Long Can a
Fed-Generated Bull Market Go?

A long-term investment is justified when the potential reward greatly outweighs the risk. That’s almost always the case near market bottoms. It’s less often the case 6 years into a bull market that is near nominal new highs and is diverging from fundamental economic realities.

So far the Nasdaq has been unable to break decisively to new all-time highs, even though the Dow and S&P 500 have done so. In 2011, when gold made new record highs, silver stalled right near its old 1980 peak and then turned down. Could the Nasdaq be heading for a similar fate as silver?

Time will tell. But at some point the favorable climate for the Nasdaq will reverse. We can see some storm clouds gathering for stocks. And some signs of a new dawn for precious metals. But until the tremendous recent strength in the U.S. dollar abates, gold and silver will have difficulty sustaining any big rallies.

What’s Going on With the Dollar?

The dollar has benefited from the fact that its major rivals are in turmoil. Negative interest rates have spread from Japan to Europe. We see severe economic contraction in Russia and a near total economic collapse in Ukraine, combined with runaway inflation. Currency wars are leading to episodes of both deflation and inflation.

Deflation is ultimately unsustainable under a fiat monetary regime. Regardless of whether the Federal Reserve raises interest rates later this year, it will aim to generate a positive inflation rate of around 2%. And it will eventually overshoot. The dollar may be the last major currency standing, but it will eventually fall, too.

Yes, Climate Change Is Real,
At Least as a Political Force

As an investor, you must accept the reality of climate change with regard to geopolitics, the economy, and markets. The investing climate will never be static. And not all the ways in which the investing climate changes will be predictable in advance (though some may be).

Global warming promoters have seized upon the truism that the climate changes to re-brand their theory. They no longer say something specific about the direction of the climate (“global warming”). They now refer to something vague and meaningless (“climate change”).

Only a complete idiot would deny that the climate has changed, is changing, and will change over time.

But global warming theorists have so far been unable to predict how and when the climate will change. In fact, most of their recent predictions have been dead wrong. No one has perfect knowledge of all the inputs that go into driving climate trends. So predictions are, at best, educated guesses.
At worst, they are baseless speculations masquerading as settled science.

Similarly, no one knows for sure how the investing climate will change (though there are plenty of liars who claim certainty with regard to their forecasts). But change it will. You as an investor must be positioned not only for the conditions that prevail at present. You must also prepare for changing conditions.

Lots of Hype, Lots of Liars, Too
Much Behind the Curve Investing

That means not basing your investments on the current hype or the most recent headlines. Too many wellinformed people who read
newspapers and watch cable TV news end up following yesterday’s trends and being perpetually behind the curve when it comes to changing
market environments.

Whether you expect the investment climate to be inflationary, deflationary, or expansionary, you need to prepare for change.

It won’t always come when you expect it. Those betting on a perpetually rising stock market or a perpetually rising dollar may soon be in for a nasty surprise.

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