Category Archives: Investment Planning

The First Sign of an Impending Crash

080519_USEconomy1My Comments: Another in a littany of warnings about pending doom. It gets a little tiresome,doesn’t it? Especially when there are others who swear the signs are there for continued gains. My gut tells me this guy is probably right.

By Jeff Clark Thursday, February 12, 2015

Investors have plenty of reasons to be afraid right now…

There’s the rapidly falling price of oil… The big decline in the value of global currencies… The Russian military action in the Ukraine… And the possibility of the European Union falling apart.

It’s unsurprising that many investors are looking for the stock market to crash. And – as I’ll show you today – we’ve seen the first big warning sign.

But here’s the thing…

Stock markets don’t usually crash when everyone is looking for it to happen. And right now, there are far too many people calling for a crash…

Once we get through this current period of short-term weakness that I warned about on Tuesday, the market is likely to make another attempt to rally to new all-time highs.

This will suck investors in from the sidelines… And get folks to stop worrying.

Then, later this year, when nobody is looking for it… the market can crash.

But for now, just to be on the safe side… Keep an eye on the 10-year U.S. Treasury note yield…

The 10-year Treasury note yield bottomed on January 30 at 1.65%. Today, it’s at 2%. That’s a 35-basis-point spike – a jump of 21% – in less than two weeks.

And it’s the first sign of an impending stock market crash.

As I explained last September, the 10-year Treasury note yield has ALWAYS spiked higher prior to an important top in the stock market.

For example, the 10-year yield was just 4.5% in January 1999. One year later, it was 6.75% – a spike of 50%. The dot-com bubble popped two months later.

In 2007, rates bottomed in March at 4.5%. By July, they had risen to 5.5% – a 22% increase. The stock market peaked in September.

Let’s be clear… not every spike in Treasury rates leads to an important top in the stock market. But there has always been a sharp spike in rates a few months before the top.

It’s probably still too early to be concerned about a stock market crash… But keep an eye on the 10-year Treasury note yield. If it continues to rise over the next few months, then you can start to worry.

Good investing,

Jeff Clark

Stock Buybacks Are Killing the American Economy

US economyMy Comments: This is a helpful analysis if you are like me and worried about our financial future.

Retirement planning and what to do with our money so it grows and remains safe for the future is what I do. I’m not sure I like it all the time, but at this stage of my life, doing something else is probably not in the cards.

What caught my attention here is that I had no idea anything was killing the American economy. But a quick read of this caused me to include these thoughts with those I have about income inequality and how, if left unchecked, will lead to social chaos in this country.

By Nick Hanauer / February 8, 2015

President Obama should be lauded for using his State of the Union address to champion policies that would benefit the struggling middle class, ranging from higher wages to child care to paid sick leave. “It’s the right thing to do,” affirmed the president. And it is. But in appealing to Americans’ innate sense of justice and fairness, the president unfortunately missed an opportunity to draw an important connection between rising income inequality and stagnant economic growth.

As economic power has shifted from workers to owners over the past 40 years, corporate profit’s take of the U.S. economy has doubled—from an average of 6 percent of GDP during America’s post-war economic heyday to more than 12 percent today. Yet despite this extra $1 trillion a year in corporate profits, job growth remains anemic, wages are flat, and our nation can no longer seem to afford even its most basic needs. A $3.6 trillion budget shortfall has left many roads, bridges, dams, and other public infrastructure in disrepair. Federal spending on economically crucial research and development has plummeted 40%, from 1.25 percent of GDP in 1977 to only 0.75 percent today. Adjusted for inflation, public university tuition—once mostly covered by the states—has more than doubled over the past 30 years, burying recent graduates under $1.2 trillion in student debt. Many public schools and our police and fire departments are dangerously underfunded.

Where did all this money go?

The answer is as simple as it is surprising: Much of it went to stock buybacks—more than $6.9 trillion of them since 2004, according to data compiled by Mustafa Erdem Sakinç of The Academic-Industry Research Network. Over the past decade, the companies that make up the S&P 500 have spent an astounding 54 percent of profits on stock buybacks. Last year alone, U.S. corporations spent about $700 billion, or roughly 4 percent of GDP, to prop up their share prices by repurchasing their own stock.

In the past, this money flowed through the broader economy in the form of higher wages or increased investments in plants and equipment. But today, these buybacks drain trillions of dollars of windfall profits out of the real economy and into a paper-asset bubble, inflating share prices while producing nothing of tangible value. Corporate managers have always felt pressure to grow earnings per share, or EPS, but where once their only option was the hard work of actually growing earnings by selling better products and services, they can now simply manipulate their EPS by reducing the number of shares outstanding.

So what’s changed? Before 1982, when John Shad, a former Wall Street CEO in charge of the Securities and Exchange Commission loosened regulations that define stock manipulation, corporate managers avoided stock buybacks out of fear of prosecution. That rule change, combined with a shift toward stock-based compensation for top executives, has essentially created a gigantic game of financial “keep away,” with CEOs and shareholders tossing a $700-billion ball back and forth over the heads of American workers, whose wages as a share of GDP have fallen in almost exact proportion to profit’s rise.

To be clear: I’ve done stock buybacks too. We all do it. In this era of short-term-focused activist investors, it is nearly impossible to avoid. So at least part of the solution to our current epidemic of business disinvestment must be to discourage this sort of stock manipulation by going back to the pre-1982 rules.

This practice is not only unfair to the American middle class, but is also demonstrably harmful to both individual companies and the American economy as a whole. In a recent white paper titled “The World’s Dumbest Idea,” GMO asset allocation manager James Montier strongly challenges the 40-year obsession with “shareholder value maximization,” or SVM, documenting the many ways that stock buybacks and excessive dividends have reduced business investment and boosted inequality. Almost all investment carried out by firms is financed by retained earnings, Montier points out, so the diversion of cash flow to stock buybacks has inevitably resulted in lower rates of business investment. Defenders of SVM argue that investors efficiently reallocate the profits they reap from repurchased shares by investing the proceeds into more promising enterprises. But Montier shows that since the 1980s, public corporations have actually bought back more equity than they’ve issued, representing a net negative equity flow. Shareholders aren’t providing capital to the corporate sector, they’re extracting it.

Meanwhile, the shift toward stock-based compensation helped drive the rise of the 1 percent by inflating the ratio of CEO-to-worker compensation from twenty-to-one in 1965 to about 300-to-one today. Labor’s steadily falling share of GDP has inevitably depressed consumer demand, resulting in slower economic growth. A new study from the Organization for Economic Co-operation and Development finds that rising inequality knocked six points off U.S. GDP growth between 1990 and 2010 alone.

It is mathematically impossible to make the public- and private-sector investments necessary to sustain America’s global economic competitiveness while flushing away 4 percent of GDP year after year. That is why the federal government must reorient its policies from promoting personal enrichment to promoting national growth. These policies should limit stock buybacks and raise the marginal rate on dividends while providing real incentives to boost investment in R&D, worker training, and business expansion.

If business leaders hope to maintain broad public support for business, they must acknowledge that the purpose of the corporation is not to enrich the few, but to benefit the many. Once America’s CEOs refocus on growing their companies rather than growing their share prices, shareholder value will take care of itself and all Americans will share in the benefits of a renewed era of economic growth.

The Next Great Market Meltdown

My Comments: My hope for the future about this is that I will be wrong. But I’m also aware that hope is not a very effective investment strategy. So, apart from my hope that you and yours have a spectacular 2015, it’s tempered by my expectations of reality. This writer is well known to those of us in this business.

This chart appeared in April of 2013. Meanwhile the market has now exceeded 18,000! What do you think is likely to happen next? I suggest you be prepared.

by Bob Veres / DEC 17, 2014

Ever since Congress and regulators failed to fix the sales incentives that drove us to the epic global meltdown of 2008, I’ve been watching for the next debacle — and I think it’s finally coming into view.

If I’m right, we’re approaching a confluence of failures that will feed on each other. The next great debacle will end up tarnishing (yet again) Wall Street’s reputation. But this time I’m afraid it will also stain the good name of financial planners and advisors.

Let’s start with nontraded REITs, which seem to be imploding right before our eyes. I warned anybody who would listen about recommending opaque illiquid products that use investor dollars to pay huge commissions and generous due diligence fees to broker-dealers.

How could anybody believe that this toxic combination adds up to a viable investment? Unless, of course, the promoter is stuffing money in your shirt pocket.

Now broker-dealers, custodians and investors have all started to back away from the sector; I suspect the stench has become so awful that they have, somewhat belatedly, gotten cautious about taking on the liability associated with selling at least some of this junk.

They may be remembering a lesson we all learned in the last go-around with investments like these, during the tax shelter era. The general partner business model for illiquid investments is only sustainable if ever-greater amounts of money are being raised. Once the sales dry up, the sponsors pack their bags and move on to the next opportunity — or retire in luxury with millions of dollars sucked right out of the accounts of workers and retirees.

If I’m right, the next great debacle will see thousands of customers — who put their trust in people who call themselves financial planners and investment advisors — discover that they can no longer afford retirement. The lawsuits over billions of lost investor dollars will, once again, test the viability of the independent broker-dealer industry. Headlines will paint the entire financial planning profession as a bunch of greedy sales agents.

YIELD-BASED APPEAL

Nontraded REITs are sold as a high-yield investment in a yield-starved marketplace. Using essentially the same pitch, a growing number of reps are also selling load-bearing fixed-income mutual funds that offer impressively higher yields than their peers.

Their secret? Load up on the diciest (unrated) private bond issues, BBB-rated or lower investments and higher-duration bonds that are going to get creamed when interest rates tick up.

The Fed has kept rates so low for so long that thousands of questionable issuers have been able to float bonds and rake in money at above-market rates that are low by historical standards. Since the Lehman Brothers collapse, aggregate corporate bond debt has increased an astonishing 53%, according to Bank of America-Merrill Lynch research, with three straight record $3 trillion years of new paper issued.

And emerging market countries set a record for debt issuance last year, at more than three times 2006 levels, according to Thomson Reuters. Kenya issued the largest sovereign bond issue ever by an African nation, equivalent to about a third of its total tax revenues — and the offering was four times oversubscribed.

This is looking like a bond bubble of epic proportions, as the potential default of some Puerto Rican bonds — a prominent holding of many of these yield-chasing funds — is starting to make clear. Any reasonable due diligence effort would question whether Puerto Rico will ever be able to pay back outstanding municipal debt that equals $18,919 per resident of that impoverished island.

Yet last year, an article in The Bond Buyer noted that a Franklin Templeton fund had amassed an astonishing 61% weighting in Puerto Rican debt, while a number of Oppenheimer funds were more than 20% invested in Puerto Rican bonds.

BOND CRASH AHEAD?
It’s not hard to predict that, early in the next great debacle, interest rates will tick up just enough that nobody on the secondary market is going to want to buy dicy paper when they can get equivalent yields from new-issue Treasuries. At current rates, even small shifts could cause risky bond values to fall hard enough to startle lay investors.

Millions of people could see losses on their quarterly statements in a part of a portfolio that their sales rep, masquerading as a financial planner, told them was rock-solid stable — and many of them are going to want to redeem their shares. A run-on-the-bank phenomenon would make the liquidity problem much, much worse.

Imagine the panic reaction if word gets out that certain funds are unable to liquidate and give investors their money back.

I’m going to go out on a limb and predict that at least some of these funds will decide to calculate their NAV using optimistic valuations for bonds that nobody wants at any price. When the regulators step in and demand a repricing, and investors see dramatically higher losses than were being reported, the whole downward spiral will go around one more turn.

In a related scandal, policyholders might discover that the universal life contracts they were sold are nowhere near performing as they were projected when these sales reps sold them the policies. As insurance companies demand new premium payments to keep the policies in force, and investors complain about double-digit losses in their bond funds, the media will have yet another reason to question the value of a financial planning engagement.

ANOTHER BIG SHOE
Somewhere in this mess, I expect another big shoe to drop. Does anybody want to bet that the wirehouses are not selling trillions of dollars worth of undisclosed, unregulated derivatives contracts that allow companies and banks to hedge against higher interest rates?

If rates jump faster than their models predict, I can envision Wall Street firms being on the hook for more than their aggregate net capital holdings — and, given the size of the derivatives market, the liability might actually be comparable to gross global GDP.

I wouldn’t be surprised if, as the next great debacle unfolds, we were to discover that the brokerage firms had also been quietly selling packaged combinations of privately issued bonds to their institutional and highly leveraged hedge fund customers — junk disguised as high-quality paper.

Welcome to the next government bailout.

I hope none of this comes to pass; I really do. But I think the next great debacle that I’ve outlined here is a grimly logical consequence of all the sales incentives that still govern so much of the financial services marketplace. It’s a shadowy world where what you make is infinitely more important than what the customer makes.

Unless those incentives are fixed — and unless the public is given a fair chance to know who is and who is not motivated to sell them junk investments — we’re going to see this same unhappy scenario play out over and over again. The particular investments and shady scams may change from debacle to debacle, but the underlying driver remains the same.

As the next great debacle unfolds, I would ask that both regulators and journalists pay close attention to the fact that those who could trigger this multiheaded scandal — ruining millions of financial lives with self-serving recommendations — were allowed to call themselves financial planners and financial advisors. But that doesn’t mean that they actually were.

Bob Veres, a Financial Planning columnist in San Diego, is publisher of Inside Information, an information service for financial advisors. Follow him on Twitter at @BobVeres.

5 Reasons Why You Should Be Afraid Of A Bear Market

question-markMy Comments: Until I found this, I had never heard of hedgewise.com. I make absolutely no assertion that they know what they are talking about. My personal solution for you is quite different from what you read below, but this part of life is almost always a guessing game.

Oct. 30, 2014 http://www.hedgewise.com/

Summary
• The Fed officially just ended its bond buying program, marking the close of a financial era.
• With the bull market now in its 6th year, stocks may struggle to continue their run without the Fed’s help.
• Many significant warning signs are signaling an oncoming bear market.
• There are smart steps you can take to better hedge your portfolio.

1) There have only been 2 longer bull markets in recent history

Beginning in January 2009, this bull market is now in its 71st month. Only two bull markets have lasted longer in the past century, during the 1920s and the 1990s.


2) Price-to-earnings ratios are approaching 2006 levels

The widely-recognized “Shiller-PE” ratio compares average inflation-adjusted earnings from the previous 10 years to the current price of the S&P 500. This helps to smooth out variance over time caused by natural fluctuations in the business cycle. The current level of the Shiller-PE ratio of over 25 is near that of 2006 and well above the mean of 16.5. While this does not indicate an imminent collapse, history would suggest that the stock market may not be the best investment for the next ten years.


3) The Fed is removing the punch bowl

Interest rates have been at historic lows for the past five years. This has created a sensational environment where stocks are one of the only reasonable investment options. However, the Fed just stopped their bond buying program altogether, and interest rates can only go in one direction. Moving forward, the market faces a cruel double-edged sword. If there is strong growth, it will prompt the Fed to begin raising rates, causing investors to demand higher returns and businesses to cut back. If there is weak growth, it will threaten corporate earnings and spark worries about another recession. Either way, stocks may fall.

4) The volume of the October rally has been light

October was a rollercoaster ride for the markets. While most of the losses have been offset here at month-end, the gains have occurred with relatively light trading volume. This suggests that the major players aren’t the ones buying.


5) Global growth is shaky

As recently studied by Larry Summers, India and China may be on the brink of a major slowdown. China has experienced a 32-year streak of extremely rapid growth, perhaps one of the longest streaks in all of history. Its economy is supported by approximately six trillion dollars of ‘shadow debt’, which may eventually create major systemic issues. While the US may not be the primary source of the next global slowdown, it would still certainly be a victim of the ripple effect.

How to Protect Your Portfolio (by hedgewise.com)

The two most likely scenarios for the economy are a rising interest rate environment with moderate growth, or a continued global slowdown which carries the risk of another recession. Unfortunately, US stocks face an uphill battle in both cases. If the Fed begins to raise rates, it will be a drag on both stocks and bonds. If rates remain low, it will probably only be due to a poor overall economic environment.

If you are seeking alternatives for your portfolio, you may want to consider a few contrarian investment options. When the Fed does raise rates, it will probably be on the heels of stronger growth and higher inflation. In that environment, Treasury-Inflation Protected Bonds (NYSEARCA:TIP) can help keep you safe from the rising price level, and commodities like gold (NYSEARCA:GLD) and oil (NYSEARCA:USO) may outperform due to a weaker dollar and stronger demand. On the other hand, if a significant slowdown occurs, investors may flee back into the safety of Treasury bonds (NYSEARCA:TLT), sending interest rates down yet again. Since it is unclear how the future will unfold, it may be wise to hedge your portfolio with some or all of these investments for the time being.

Wealth Managers Enlist Savvy Spy Software to Map Portfolios

profit-loss-riskMy Comments: I’ve been playing this financial game now for almost 40 years. And like so much in today’s world, it’s very different today than it was then. Technology forces us to embrace new thoughts and ways to deal with so much in life.

When it comes to managing your money, my role as an investment advisor and financial planner causes me to try and stay at least near the front of the line, otherwise I’ll get left behind.

Much better returns on investment (ROI) can be had today, hypothetically, than we could have hoped for 30 years ago. Do you remember when interest rates less than 10% were thought to be ridiculous? Now we are living with interest rates near zero and have been for some time. So how is it possible to predict that a 10% ROI is reasonable today?

The following article talks about people of wealth that no one around here fully understands. And so for the rest of us, it’s kind of meaningless. Except when they talk about technology and how far its come so that mere mortals like us can benefit. Having access to these technologies can make a huge difference in your life.

Posted by Steven Maimes, Contributor – on August 5th, 2014
NYT article by Quentin Hardy

Some of the engineers who used to help the Central Intelligence Agency solve problems have moved on to another challenge: determining the value of every conceivable investment in the world.

Five years ago, they started a company called Addepar, with the aim of providing clear and reliable information about the increasingly complex assets inside pensions, investment funds and family fortunes. In much the way spies diagram a communications network, Addepar filters and weighs the relationships among billions of dollars of holdings to figure out whether a portfolio is about to crash.

Professional wealth managers are going to be seeing a lot more of big data. Last spring, Addepar raised a substantial sum to take this mainstream, and although it is not the only one bringing big data to a portfolio statement, its cast of characters sets it apart.

“One of the most foundational questions in finance is ‘What do I own, and what is all of this worth?’ ” said Eric Poirier, the chief executive of Addepar. “ ‘What is my risk?’ turns out to be an almost intractable problem.”

Although the list of wealth managers who use Addepar is confidential, Mr. Poirier says it has already grown from people like Joe Lonsdale, its tech-billionaire founder, and Iconiq Capital, which manages some of the Facebook co-founder Mark Zuckerberg’s money, to include family offices, banks and investment managers at pension funds.

“In this state, some people are just getting wealthier,” said Joseph J. Piazza, chairman and chief executive of Robertson Stephens L.L.C., a San Francisco investment adviser that manages about $500 million using software from Addepar. Ten years ago, he said, “it might be a young entrepreneur with $50 million. Now it could be 10 times that, and they are thoughtful, bigger risk-takers.”

Investing used to be a relatively simple world of stocks, bonds and cash, with perhaps some real estate. But deregulation, globalization and computers have meant more choices. For a wealthy person, this could mean derivatives, private equity, venture capital, overseas markets and a host of other choices, like collectibles and Bitcoin.

And for all the computers on Wall Street’s trading floors, a lot of money management is surprisingly old-fashioned. Venture capitalists may invest in cutting-edge technology, but they sometimes still send out quarterly reports on paper. Financial custodians, which hold securities for people, often have custom-built computer systems. That makes it hard to compare a trade at one with a trade at another.

“The market is much more complicated than it used to be,” said David G. Tittsworth, president and chief executive of the Investment Adviser Association, a trade group of 550 registered firms. “The rich have bigger appetites for futures, commodities, alternative investments. There’s a lot of demand for helping them keep track of what their holdings actually are.”

Mr. Poirier, 32, a New Hampshire native who started a coding business at 14 before heading to Columbia University, worked on analyzing fixed-income products at Lehman Brothers from 2003 to 2006, before that Wall Street firm collapsed from mismanagement of its own risk. “Trying to figure out a yield, I’d work with a dozen different computer systems, with different interactions that people didn’t understand well,” he said.

He then took a job with Palantir Technologies, a company founded to enable military and intelligence agencies to make sense of disparate and incomplete data. He went on to build out Palantir’s commercial business, managing risk for things like JPMorgan Chase’s portfolio of subprime mortgages.

There were plenty of parallels between the two worlds, but instead of agencies, spies and eavesdropping satellites, finance has markets, investment advisers and portfolios. Both worlds are full of custom software, making each analysis of a data set unique. It is hard to get a single picture of anything like the truth.

Even a simple question like “How many shares of Apple do I own?” can be complicated, if some shares are held outright, some are inside a venture fund where the wealthy person is an investor and some are locked up in a company that Apple acquired.

Finance “was the same curve I encountered in the intelligence community,” Mr. Poirier said. “How do you make sense of diverse information from diverse sources, when the answer depends on who is asking the question?”

The parallel was also evident to Mr. Lonsdale, a Palantir co-founder. From an earlier stint at PayPal, he had millions in cash and on paper is a billionaire from his Palantir holdings. He also knew lots of other young people in tech who could not make sense of what was happening to their money. “Wealth management is designed for the 1950s, not this century,” he said.

Mr. Lonsdale left Palantir in 2009, starting Addepar with Jason Mirra, another Palantir employee, in 2009. “It didn’t make sense for Palantir to hire 20 or 30 people to work in an area like this,” Mr. Lonsdale said. Mr. Mirra is Addepar’s chief technical officer. Mr. Poirier joined in early 2013 and became chief executive later that year.

Besides Mr. Lonsdale, early investors in Addepar included Peter Thiel, a founder of both PayPal and Palantir. More money came from Palantir’s connections to hedge fund investors. Addepar’s $50 million funding round last May was led by David O. Sacks — another PayPal veteran, who sold a company called Yammer to Microsoft for $1.2 billion in 2012 — and Valor Equity Partners, a Chicago firm that has also invested in PayPal, SpaceX and Tesla Motors, among other companies.

Despite the pedigree, Mr. Lonsdale says Addepar, which has 109 employees, is not meant just as a tool for rich tech executives or family money. They are, he said, “just the early adopters.”
Karen White, Addepar’s president and chief operating officer, says a typical customer has investments at five to 15 banks, stockbrokers or other investment custodians.

Addepar charges based on how much data it is reviewing. Ms. White said Addepar’s service typically started at $50,000, but can go well over $1 million, depending on the money and investment variables involved.

And in much the way Palantir seeks to find common espionage themes, like social connections and bomb-making techniques, among its data sources, Mr. Lonsdale has sought to reduce financial information to a dozen discrete parts, like price changes and what percentage of something a person holds.

As a computer system learns the behavior of a certain asset, it begins to build a database of probable relationships, like what a bond market crisis might mean for European equities. “A lot of computer science, machine learning, can be applied to that,” Mr. Lonsdale said. “There are lessons from Palantir about how to do this.”

A number of other firms are also trying to map what everything in a diverse portfolio is worth. One of the largest, Advent Software, in 2011 paid $73 million for Black Diamond, a company that, like Addepar, uses cloud technology to increase its computing power and more easily draw from several databases at once.

“We’ve been chipping at the problem for 30 years,” said Peter Hess, Advent’s president and chief executive. “There is a lot more complexity now, and the modernization of expectations about how things should work is led by the new tech money. But because of Apple and Google, even my parents have expectations about how easy tech ought to be.”

3 Market Warning Signs Predict 20% Stock Tumble

My Comments: No need for any commentary from me. Just draw your own conclusions, and hope that if the author is right, you’ve talked with me about how to make money when everyone around you is losing theirs.

On the other hand, essentially this same argument was made last April and yet the crash has not happened. Yet.  Another example of the boogyman creating uncertainty. All you can do is be prepared, which I hope you are.

MarketWatch commentary by Mark Hulbert / August 3, 2014

Over the past 45 years, the stock market has lost more than 20% each time three warning signs flashed simultaneously.

After a selloff this past week dragged the Dow Jones Industrial Average into negative territory for the year, it’s worth noting that all three are flashing today.

The signals are excessive levels of bullish enthusiasm; significant overvaluation, based on measures like price/earnings ratios; and extreme divergences in the performances of different market sectors.

They have gone off in unison six times since 1970, according to Hayes Martin, president of Market Extremes, an investment consulting firm in New York whose research focus is major market turning points.

Bear in the air

The S&P 500’s average subsequent decline on those earlier occasions was 38%, with the smallest drop at 22%. A bear market is considered a selloff of at least 20%, with bull markets defined as rallies of at least 20%.

In fact, no bear market has occurred without these three signs flashing at the same time. Once they do, the average length of time to the beginning of a decline is about one month, according to Martin.

The first two of these three market indicators — an overabundance of bulls and overvaluation of stocks — have been present for several months. Back in December, for example, the percentage of advisers who described themselves as bullish rose above 60%, a level Investors Intelligence, an investment service, considers “danger territory.” Its latest reading, as of Wednesday, was 56%.

Also beginning late last year, the price/earnings ratio for the Russell 2000 index of smaller-cap stocks, after excluding negative earnings, rose to its highest level since the benchmark was created in 1984 — higher even than at the October 2007 bull-market high or the March 2000 top of the Internet bubble.

Three strikes and you’re out

The third of Martin’s trio of bearish omens emerged just recently, which is why in late July he advised clients to sell stocks and hold cash. That’s when the fraction of stocks participating in the bull market, which already had been slipping, declined markedly.

One measure of this waning participation is the percentage of stocks trading above an average of their prices over the previous four weeks. Among stocks listed on the New York Stock Exchange, this proportion fell from 82% at the beginning of July to just 50% on the day the S&P 500 hit its all-time high.

It was one of “the sharpest breakdowns in market breadth that I’ve ever seen in so short a period of time,” Martin says.

Another sign of diverging market sectors: When the S&P 500 hit its closing high on July 24, it was ahead 1.4% for the month, in contrast to a 3.1% decline for the Russell 2000.

Expect up to a 20% S&P 500 decline

How big of a decline is likely? Martin’s best guess is a loss of between 13% and 20% for the S&P 500, less than the 38% average decline following past occasions when his triad of unfavorable indicators was present. The reason? He expects the Federal Reserve to quickly “step in to provide extreme liquidity to blunt the decline.”

To be sure, Martin focuses on a small sample, which makes it difficult to draw robust statistical conclusions. But David Aronson, a former finance professor at Baruch College in New York who now runs a website that makes complex statistical tests available to investors, says that this limitation is unavoidable when focusing on past market tops, since “by definition it will involve a small sample.”

He says that he has closely analyzed Martin’s research and takes his forecast of a market drop “very seriously.”

Martin says that expanding his sample isn’t possible because most of his current indicators didn’t exist before the 1970s and “the comparative math gets very unreliable.” But he says he does use several statistical techniques for dealing with small samples that increase his confidence in the conclusions that his research draws.

Russell 2000 could take 30% hit

He says stocks with smaller market capitalizations will be the hardest hit in the decline he is anticipating, in part because they currently are so overvalued. He forecasts that the Russell 2000 will fall by as much as 30%.

Also among the hardest-hit stocks during a decline will be those with the highest “betas” — that is, those with the most pronounced historical tendencies to rise or fall by more than the overall market. Martin singles out semiconductors in particular — and technology stocks generally — as high-beta sectors.

He predicts that blue-chip stocks, particularly those that pay a large dividend, will lose the least in any decline. One exchange-traded fund that invests in such stocks is iShares Select Dividend, which charges annual expenses of 0.40%, or $40 per $10,000 invested.

The average dividend yield of the stocks the fund owns is 3%; that yield is calculated by dividing a company’s annual dividend by its stock price. Though the fund’s yield is higher than the S&P 500’s 2% yield, it nevertheless pursues a defensive strategy. It invests in the highest-dividend-paying blue-chip stocks only after excluding firms whose five-year dividend growth rate is negative, those whose dividends as a percentage of earnings per share exceed 60% and those whose average daily trading volume is less than 200,000 shares.

The consumer-staples sector has also held up relatively well during past declines. The Consumer Staples Select Sector SPDR ETF currently has a dividend yield of 2.5% and an annual expense ratio of 0.16%.

If the broad market’s loss is in the 13%-to-20% range that Martin anticipates, and you have a large amount of unrealized capital gains in your taxable portfolio, you could lose in taxes what you gain by selling to sidestep the decline. But the larger losses he anticipates for smaller-cap stocks could be big enough to justify selling and paying the taxes on your gains.

5 QLAC Questions and Answers

My Comments: QLAC? What the heck is a QLAC?

By Jeffrey Levine / July 18, 2014

On July 1, 2014 the Treasury Department released the long-awaited final regulations for Qualifying Longevity Annuity Contracts (QLACs). These new annuities will offer advisors a unique tool to help clients avoid outliving their money.

The QLAC rules, however, are a complicated mash-up of IRA and annuity rules, and clients may need substantial help in understanding their key provisions. To help advisors break down the most important aspects of QLACs, below are 5 critical QLAC questions and their answers.

1) Question: What are QLACs?
Answer: QLACs, or qualifying longevity annuity contracts, are a new type of fixed longevity annuity that is held in a retirement account and has special tax attributes. Although the value of a QLAC is excluded from a client’s RMD calculation, distributions from QLAC don’t have to begin until a client reaches age 85, well beyond the age at which RMDs normally begin.

2) Question: Why did the Treasury Department create QLACs?

Answer: Prior to the establishment of QLACs, there were significant challenges to purchasing longevity annuities with IRA money. The rules required that unless an annuity held within an IRA had been annuitized, its fair market value needed to be included in the prior year’s year-end balance when calculating a client’s IRA RMD. This left clients with non-annuitized IRA annuities with an inconvenient choice to make after reaching the age at which RMDs begin. At that time, they needed to either:
1) Begin taking distributions from their non-annuitized IRA annuities, reducing their potential future benefit, or
2) Annuitize their annuities, which would obviously produce a lower income stream than if they were annuitized at a more advanced age, or
3) “Make-up” the non-annuitized annuity’s RMD from other IRA assets, drawing down those assets at an accelerated rate.

None of these options was particularly attractive and now, thanks to QLACs, clients will no longer be forced to make such decisions.

3) Question: How much money can a client invest in a QLAC?

Answer: The final regulations limit the amount of money a client can invest in a QLAC in two ways: a percentage limit; and an overall limit. First, a client may not invest more than 25 percent of retirement account funds in a QLAC.

For IRAs, the 25 percent limit is based on the total fair market of all non-Roth IRAs, including SEP and SIMPLE IRAs, as of December 31st of the year prior to the year the QLAC is purchased. The fair market value of a QLAC held in an IRA will also be included in that total, even though it won’t be for RMD purposes.

The 25 percent limit is applied in a slightly different manner to 401(k)s and similar plans. For starters, the 25 percent limit is applied separately to each plan balance. In addition, instead of applying the 25 percent limit to the prior year-end balance of the plan, the 25 percent limit is applied to the balance on the last valuation date.

In addition, that balance is further adjusted by adding in contributions made between the last valuation and the time the QLAC premium is made, and by subtracting from that balance distributions made during the same time frame.

In addition to the 25 percent limits described above, there is also a $125,000 limit on total QLAC purchases by a client. When looked at in concert with the 25 percent limit, the $125,000 limit becomes a “lesser of” rule. In other words, a client can invest no more than the lesser of 25 percent of retirement funds or $125,000 in QLACs.

4) Question: What death benefit options can a QLAC offer?
Answer: A QLAC may offer a return of premium death benefit option, whether or not a client has begun to receive distributions. Any QLAC offering a return of premium death benefit must pay that amount in a single, lump-sum, to the QLAC beneficiary by December 31st of the year following the year of death.

Such a feature is available for both spouse and non-spouse beneficiaries. In addition, the final regulations allow this feature to be added regardless of whether the QLAC is payable over the life of the QLAC owner only, or whether the QLAC will be payable over the joint lives of the QLAC owner and their spouse.

QLACs may also offer life annuity death benefit options. In general, a spousal QLAC beneficiary can receive a life annuity with payments equal to or less than what a deceased spouse was receiving or would have received if the latter died prior to receiving benefits under the contract. An exception to this rule is available, however, to satisfy ERISA preretirement survivor annuity rules.

If the QLAC beneficiary is a non-spouse, the rules are more complicated. First, clients must choose between two options, one in which there is no guarantee a non-spouse beneficiary will receive anything; but if payments are received, they will generally be higher than the second option.

The second option is a choice that will guarantee payments to a non-spouse beneficiary, but those payments will be comparatively smaller than if payments were received by a non-spouse beneficiary under the first option. Put in simplest terms, a non-spouse beneficiary receiving a life annuity death benefit will generally fare better with the first option if the QLAC owner dies after beginning to receive benefits whereas, if the QLAC owner dies before beginning to receive benefits, they will generally fare better with the second method.

5) Question: Are QLACs available now
Answer: Yes…and no. Quite simply, the QLAC regulations are in effect already, but that doesn’t mean that insurance carriers already have products that conform to the new IRS specifications.

To the best of my knowledge, and as of this writing, QLACs exist in theory only.
It’s likely, however, that in the not too distant future, QLACs will go from tax code theory to client reality. Exactly which carriers will offer them and exactly which features those carriers will choose to incorporate into their products remains to be seen.

But make no mistake: QLACs are coming (or here, depending on your point of view). If such products may make sense for clients, it probably makes sense to reach out to them now and begin the discussion.