Tag Archives: financial advice

Don’t Fight the U.S. Treasury Rally

USA EconomyMy Comments: We’ve been living in a low interest rate environment for some years now. The general consensus has been that they can’t get any lower and that the Fed will push them up if and when the US economy starts to see any inflationary pressure.

I know that clients, who for years depended on bond yield to satisfy their need for monthly income, have suffered. Folks who want the guarantees offered by Certificates of Deposit have despaired when they know they will only generate about 1% per year. Common wisdom tells many of us that safe investments are government issued bonds. And then they look at the S&P500 over the past few years and decide 20% is normal.

Now here is an article by a respected economist that tells us that interest rates can go lower. This is spite of negative interest rates in Japan where the central bank CHARGES you for buying from them. If you know what’s going on, please let me know.

By Scott Minerd, Chairman of Investments and Global CIO

“U.S. Interest Rates Could Head Significantly Lower”

The consensus among market watchers last September was that, with U.S. interest rates so low and the U.S. Federal Reserve (the Fed) about to withdraw stimulus, interest rates would trend higher. I took a different view, writing in a commentary that “10-year rates may be heading back to 2.25 percent or lower.”

When 10-year Treasury yields ended 2013 at 3.02 percent, some may have thought I had taken the wrong end of the bet. But in early August, 10-year Treasury yields went as low as 2.35 percent and I believe the path of least resistance on interest rates is still lower.

A number of factors have helped push Treasury yields lower. With yields on German 10-year Bunds dipping under 1 percent for the first time and Japanese government bonds yielding around 50 basis points, Treasuries look comparatively attractive. Add to that the perception that both the yen and euro are a one-way bet toward depreciation and it is reasonable to expect that international capital will continue flowing toward the U.S., pressuring Treasury yields down as quantitative easing draws to an end.

Tensions from Ukraine to Iraq have added to a flight-to-quality trade, boosting demand for U.S. Treasuries. With the size of incremental U.S. government borrowing also expected to decline because of shrinking federal budget deficits, Treasury yields could move lower.

Reduce Rate Risk

My original forecast of 2.0 to 2.25 percent still seems reasonable. Nevertheless, markets do not move in straight lines, so yields could retrace to 2.5 percent in the near term. Ultimately, as rates head back toward 2 percent portfolio managers should use the rally to reduce interest rate risk.
2014 gov bond rate history

As anyone experienced in investing in the U.S. mortgage market knows there is a phenomenon that traders call the “refi bid.” When interest rates fall, a larger percentage of mortgages become economically attractive to refinance at a lower interest rate.

Whenever a threshold is breached where a large amount of mortgages make attractive refinancing candidates, prepayments spike up dramatically and portfolios that own mortgages have a sudden surge in cash. This causes portfolio duration to shorten and leads to a need to buy longer duration assets in order to maintain the target portfolio duration. This demand surge can result in a sudden and dramatic decline in rates.

Currently, I estimate that the next “refi level” will hit when the 10-year Treasury yield drops to about 2.25 percent.

An unusual feature of this potential wave of mortgage refinancing is that the vast majority of U.S. mortgages are on the cusp of being candidates for refinancing, given the relative stability of mortgage rates over the past year or so. Additionally, there is one dominant holder of these mortgage securities that has vowed to reinvest in new mortgages as prepayments come in—the Fed.

Traditionally, in a refinancing rally, spreads on mortgage-backed securities (MBS) widen due to increased prepayment risk and expected increases in supply. Spreads will not widen on this occasion to the same extent as during previous refi rallies for a number of technical reasons.

Among those reasons is that the Fed, the biggest mortgage investor on the block, has made clear it will reinvest principal repayments dollar for dollar. Normally, the widening in mortgage spreads mutes the impact of the rate decline on mortgage rates, slowing the pace of refinancing.

This time, advertised mortgage rates are likely to fall more rapidly than in prior refi experiences.

10 Helpful Tips About Medicare

My Comments:retirement-exit-2 Medicare has been a life saver for me and my wife. It has allowed us to seek timely and appropriate medical care when problems surfaced.

An argument can be made that it serves to deprive hard working physicians with the compensation they deserve, but from a selfish perspective, that’s their problem.

Our problem was to find medical answers and find them NOW because the alternative was likely to be dramatic. Maybe not fatal, but… We are able to do this without leaving a financial pall hanging over us. Some people will take unfair advantage of this and perhaps abuse the system. But no one covered by Medicare should avoid timely advice from healthcare providers.

When you couple Medicare with a good supplemental, private health insurance plan designed to cover what Medicare will not cover, you are golden. And alive for a while longer, hopefully enjoying what life has to offer.

by Ann Marsh / AUG 13, 2014

SAN DIEGO — The average couple, at age 65, is likely to need $261,000 to cover all their health care costs for the balance of their lives — and those are just out-of-pocket costs, not those covered by Medicare. To make matters worse, health care costs overall are rising at about 5.8% a year.

Those details emerged during a presentation at LPL Focus in San Diego this week. Joe Moklebust, director of business development at Principal Financial Group, urges planners at the large independent broker-dealer’s annual conference to pay close attention to how and when their clients enroll for Medicare.

Failing to heed certain deadlines for enrollment and failing to evaluate plans can substantially affect clients’ financial lives, Moklebust says.

BRANDED VS. GENERIC DRUGS
One audience member’s own experience illustrated the point. The advisor told the room that he has a medical condition and can’t buy generic versions of the medications he takes.

When it came time to sign up for Medicare Part D, which covers prescription drug medications, he says he and his insurance agent reviewed numerous plans to see how each one would handle his prescription drug needs. Some would not have covered them, he told Moklebust.

“If I were to buy my medications outside, it would be about $1,100 a month,” he said — adding that, with the plan he chose, “It costs me about $300.” That is a big issue for seniors, the planner said.

Moklebust concurs: “They do not investigate the plans,” he said. “It is costing them more money because they do not.” Moklebust offers advisors a series of tips for clients’ Medicare enrollment and usage.

10 TAKEAWAYS TO KNOW ABOUT:

• At 65, the mandatory age when Medicare starts (with exceptions), clients must enroll in the window that starts three months before their birthday month and ends three months afterward. If they don’t, penalties may apply. If those clients are still working and covered by their employers’ qualified group health insurance plans, they can delay. But some people who are laid off and get COBRA coverage make the mistake of thinking that they can wait to enroll in Medicare until after their COBRA period — sometimes as long as two years — has ended. That is not true. “If you don’t sign up within the prescribed enrollment period,” Moklebust says, “for each 12 months when you were eligible and not covered by a group plan, your Medicare part B premium is going to go up 10%. And it will stay up 10% for the rest of your life.” Planners should refer clients who are still working to their employer’s benefits administrator for more detailed information, Moklebust says.

• Clients who are 65 and older but working, with qualified medical plans through their work, may not be ready to enroll for Medicare — but in most cases they should still enroll in Medicare Part B.

• Medicare A and B plans are standardized at the federal level. But Medicare Advantage plans, also known as Medicare Part C, are localized. They can vary greatly in quality not only between states, but also within states — so it pays to shop around.

• If clients are enrolled in Medicare Parts A and B but want additional coverage — for deductibles and co-pays, or for travel abroad — they may wish to add a supplemental Medigap plan. The most common is Medigap Plan F.

• Medicare costs break down as follows: Medicare part A is free unless your client isn’t fully eligible; in that case it can cost as much as $441 a month. The base cost for Medicare part B is $104.90 monthly, although it can range up to $335.70 for wealthier clients. Medigap insurance varies in cost by carrier and by health status, but the average cost ranges from $60 to $200 a month, depending upon what type of plan a client wants. Medicare Part D costs about $40 a month and may carry additional costs for wealthier clients.

• Windfalls from the sale of a home or a large severance can push a client’s Medicare costs into an artificially high bracket. But those higher charges can be appealed and, in some cases, reduced.

• Medicare Part D, the prescription drug coverage, comes with a “donut hole,” which is a gap in coverage. After clients satisfy their deductibles, they then pay a percentage of their prescription drug costs up to $2,850 a year. After that point, they must cover all these costs until they hit $4,550, after which point the insurance kicks in again. While in the “donut hole,” clients receive full credit for the cost of the medication but the actual cost is reduced by 28% for generics and 52.5% for name brands. Under the Affordable Care Act, however, that donut hole is shrinking. By 2020, it is expected to be closed.

• In some cases, clients will need to change their Medicare Advantage coverage if they move.

• Enrolling in a Medicare Advantage plan may require working with insurers’ PPOs or HMOs, which have their own doctors and hospitals. If your clients want to use their own doctors, advise clients to check to see whether those offices will accept original Medicare.

• If clients under age 65 are receiving Social Security disability insurance, they must have been disabled for two years before they can begin receiving Medicare.

Overall, Medicare covers about 51% of most older Americans’ annual health care costs, Moklebust says. To help clients get the most out of their coverage, he urged planners to go on the Medicare.gov website and get the Medicare & You handbook covering basic details of all Medicare plans.

The Typical Household, Now Worth a Third Less

My Comments: You have read my posts before where I talk about income inequality  (the HAVES vs. the HAVE NOTS) and how if left unchecked, could result in social chaos in this country. Probably not in my lifetime, but definitely affecting the lives of my grandchildren. It’s an issue that demands discussion among ourselves and those who profess to be politically motivated.

Economic inequality in the United States has been receiving a lot of attention. But it’s not merely an issue of the rich getting richer. The typical American household has been getting poorer, too.

The inflation-adjusted net worth for the typical household in 2003 was $87,992. Ten years later, in 2013, it was $56,335. This is a 36 percent decline in very few years, according to a study financed by the Russell Sage Foundation. Those are the figures for a household at the median point in the wealth distribution — the level at which there are an equal number of households whose worth is higher and lower. But during the same period, the net worth of wealthy households increased substantially.

The Russell Sage study also examined net worth at the 95th percentile. (For households at that level, 94 percent of the population had less wealth and 4 percent had more.) It found that for this well-do-do slice of the population, household net worth increased 14 percent over the same 10 years. Other research, by economists like Edward Wolff at New York University, has shown even greater gains in wealth for the richest 1 percent of households.

For households at the median level of net worth, much of the damage has occurred since the start of the last recession in 2007. Until then, net worth had been rising for the typical household, although at a slower pace than for households in higher wealth brackets. But much of the gain for many typical households came from the rising value of their homes. Exclude that housing wealth and the picture is worse: Median net worth began to decline even earlier.

“The housing bubble basically hid a trend of declining financial wealth at the median that began in 2001,” said Fabian T. Pfeffer, the University of Michigan professor who is lead author of the Russell Sage Foundation study.

The reasons for these declines are complex and controversial, but one point seems clear: When only a few people are winning and more than half the population is losing, surely something is amiss

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.

Increased Consumer Spending Driving Strong Economic Growth In USA

USA EconomyMy Comments: On Thursday, July 30 the market dropped 300 points. The blogosphere and media were all a chatter about “was this the start of the correction?”. Who knows ?!?

It illustrates why those of us who profess to be financial advisors are more in the dark than you are. Here we are talking about a looming market correction, one that will happen, and the longer it takes to start the more violent it is likely to be. And here I am this morning, coming to you with good news about the economy. Seems totally weird, doesn’t it?

What has to be remembered is that the markets are always forward looking. I want to invest my money before it goes up, if at all possible. If I think it’s going to crater, I’m taking my money out. At least that’s the plan, unless you use some of the approaches favored by us at Florida Wealth Advisors, LLC.

What this headline tells me is that when the correction happens, it will be relatively short term and though perhaps dramatic, it will not be systemic.

Jul. 31, 2014 / APAC Investment News

Summary
• The Bureau of Economic Analysis is reporting 4 percent growth in the second quarter, a strong rebound from the first quarter.
• Consumer spending in both durable and non-durable goods is up. Both exports and imports also rose, along with most other indicators.
• This economic growth should provide some upward pressure for markets, at least in the short term.

The United States has struggled to fully recover from the 2008 Financial Crisis. While stock markets have rebounded, unemployment has remained high and economic growth has been tepid. New data points to the U.S. economy growing a solid 4 percent in the second quarter, however, propelled by an increase in consumer spending. This should help stabilize markets and perhaps even push them higher.

With consumer spending accounting for roughly 2/3rds of America’s economy, any increase in consumer spending should come as a relief for those concerned of yet another slowdown. Still, stock markets hovered in place following the release of the data on Wednesday, likely over concerns about the Fed’s next move with interest rates and the continued wind down of its asset buying program.

Consumer Spending On The Rise
According to the Bureau of Economic Analysis consumer spending increased a solid 2.5 percent in the second quarter, up from 1.2 percent in the first quarter. Durable goods, which includes automobiles, appliances, and other similar goods, increased by an astounding 14 percent, compared with an increase of just 3.2 percent in the first quarter. Non-durable goods, which includes food and clothing, increased by 2.5 percent. The BEA presents its numbers in seasonally adjusted annual rates.

Automobiles have been performing particularly well as of late, even while General Motors is still feeling the fallout from a major scandal and many automakers are suffering a rash of recalls. There were some fears of a major slowdown following the economic contraction in the first quarter, but for now it appears that the feared slow down hasn’t materialized.

Ford did suffer a decline in sales in June, falling some 5.8 percent YOY. While this may not seem like good news, the drop was not as bad as expected. Meanwhile, General Motors sales rose 1 percent even in spite of the bad publicity from the ignition scandal, and Chrysler posted a solid 9.2 gain.

Growth Being Driven By Other Factors
Besides consumer spending, other areas of the economy have also performed well. Exports rose by 9.5 percent, following a sharp decline of 9.2 percent in the first quarter. This suggests that the global economy may also be growing. Imports also rose 11.7 percent, compared with an increase of only 2.2 percent in the first quarter.

Investment in equipment rose 7 percent, while investments in non-residential structures rose by 5.3 percent.

Interestingly, federal government consumption actually decreased by .8 percent, suggesting that the rise in spending is being driven by private businesses and consumers. This should come as a welcome sign given the government’s high debt burden. Simply put, the American government likely couldn’t afford to drive up consumption even if it wanted to.

Strong Economic Growth Should Re-enforce Markets
For now, strong economic growth should keep markets buoyant even with many factors exerting downward pressures. Sanctions on Russia, tensions in the South China Seas, political infighting in Congress, the possible fallout of the Fed curtailment of its asset buying program, and numerous other factors have created jitters. Strong economic growth can counteract these downward pressures, at the very least.

Meanwhile, as stock indexes have surged to all time highs, there have been some concerns that a bubble may be building. While stock markets have been performing well, the economy in general seemed to be suffering from sluggish growth, suggesting that something besides actual economic performance has been driving stock prices upwards. Now, however, economic growth finally appears to be in line with the rising stock market indexes.

So long as the economy continues to grow, markets should remain stable. Of course, the economy itself could quickly swing back into contraction. Government debt levels remain high, profits can evaporate over night, and consumer sentiments can change quickly.

Further, as the economy continues to grow, the Fed will almost certainly continue to cut back its stimulus measures, and eventually even raise interest rates. This, in turn, could slow economic growth. Meanwhile, stagnant wages, continued high unemployment, high debt levels, and other factors could eventually pose a threat.

THOUGHT FOR THE WEEK – July 30, 2014

house and pigMy Comments: I’m involved in a philosophical conflict these days between those on one side who believe there is a universal truth that says investment skill trumps traditional permanent life insurance every time.

On the other side is someone who believes permanent life insurance trumps traditional investment methodologies. They argue vehemently that permanent life insurance will result in a better outcome for everyone. Both sides of this argument have a built in bias that is difficult for the average consumer to recognize and compensate for.

I’m loath to attribute “universal truth” status to either position. Life insurance and credible investment strategies have roles to play in almost everyone’s life. It’s only when you fully understand a client’s thought process, value system, and where they are in life are you able to help them determine whether life insurance is appropriate, what kind to buy if it is, and how much coverage is enough.

Here is a thought from a trusted colleague with a valid perspective on this question.

By Gene A. Pastula, CFP

When compared to other investment options for liquid assets for medical emergencies, the creation of a large asset from small deposits (life insurance) is a most desirable alternative.

Those who say that life insurance is a bad investment are not relating to real life.

Since everyone dies, we know exactly what the end result of a life insurance program is going to be. Because we don’t know when any individual will die, we don’t know how efficient the program will be.

* Walt purchased a $1,000,000 life insurance policy at the age of 47 and died from a brain tumor at age 53. Does anyone disagree that, no matter what Walt paid for it, he made a good “investment” buying that policy… an IRR of about 92% per year?

* Sharon purchased the same kind of policy at the age of 63 and died at the age of 93. After 30 years of paying premiums… an IRR of about 4.5% per year. Should have put her money in a mutual fund. Who knew?

When you sell life insurance for a living, you must concentrate on the “need”. That is what all the critics of insurance focus on. How expensive is it, and do you really “neeeed” it? You will sell only to those clients to whom you can effectively point out that the individuals untimely death will leave a significant deficiency in the financial condition of those he/she leaves behind. Then you must be convincing, and good at motivating them to take action to “purchase” the policy so the money will be there “in case” they die.

On the other hand, if you are a financial planner or investment advisor you can clearly see the value in your clients’ portfolio and to their family of having a portion of their assets “invested” in a life insurance policy. And the way you can tell if it is a good value is to know when the insured will die. Only then can you calculate the rate of return. In most cases the tax free rate of return is about 4.5% if one dies at age 93 and much greater (8.5%/yr.) if you are lucky enough to die at 85 and EVEN GREATER (24%/yr.) if you are EVEN LUCKIER and die at 75… well, hopefully you get my point.

Now consider the risks of Critical, and Chronic Illness that (in many cases) occur before death. Just think of the rate of return on your money if you are lucky enough to have a heart attack or kidney failure or need a lung transplant after only 10 or 15 years of owning and paying for that policy. That is assuming your advisor was wise enough to make sure the insurance you were “investing in” contained an acceleration rider to access a portion of the death benefit while you are still alive and needed some big bucks to cover the cost of that lung transplant.

An additional comment from TK: Among my resources at Florida Wealth Advisors, LLC, are people like Gene Pastula, and his company, Westland Financial Services. They believe in the value of committing a portion of their clients’ portfolio to an insurance policy that creates large assets just at the time it is needed, no matter when that may be. And yet… if it is never needed, the heirs will think of them as a hero for doing such a good job of protecting the portfolio. Life does not move in a straight line; it has ups and downs. Who knows what is going to happen next. Whatever it is, a major health issue could cause great damage to their portfolio just when it was about to make great gains in the upcoming bull market.

Stocks Will Rise And The 3 Trades You Can’t Make

My Comments: Once again, the question of a market crash raises its ugly head. And once again, no one has a clue when it will happen.

And once again, as I tell my clients and prospective clients, it really doesn’t matter if you have your money where it can grow regardless of when and how severe the coming crash.

The author includes among his 3 Trades… something you CAN participate in if you have access to the tactical approach to investing that I recommend for all my clients. Some of you know what I’m talking about. The rest of you will have to call or send me an email.

By Lance Roberts   Jul. 18, 2014

I wrote recently that stocks spend 5% of their time hitting new highs while the other 95% of the time investors spend in the market has been making up losses. This is shown in the chart below.
I make this point as I saw a flashing banner across the bottom of the TV screen stating the markets have hit 14 new highs this year alone. While this sounds like an amazing feat, it is actually just a function of being in record territory. For example, assume a dragster sets a record in the 1/4 mile of 7 seconds. The next driver that runs the same strip at 6.999 seconds sets a new record. So forth, and so on. There are two important points to take away from this:
1. When the markets are at a record level, it only takes infinitesimal advances to set new records.
2. Records are attained when previous extremes have been breached which is generally a later stage event.

However, while logic would suggest that current market levels are getting extreme, the “exuberance” created by current price momentum fuels additional gains. As the ongoing “bullish meme” from mainstream media sources and analysts continue to feed individual’s “confirmation biases” the “fear” of “missing out” blinds individuals of the rising risk.

Dr. Robert Shiller recently penned an interesting piece at Project Syndicate stating:
“In recent months, concern has intensified among the world’s financial experts and news media that overheated asset markets – real estate, equities, and long-term bonds – could lead to a major correction and another economic crisis. The general public seems unbothered: Google Trends shows some pickup in the search term “stock market bubble,” but it is not at its peak 2007 levels, and “housing bubble” searches are relatively infrequent.”

Dr. Shiller is correct. The general public seems “unbothered” by the rising risks in the markets despite a variety of warnings recently:

Janet Yellen during in the Federal Reserve’s Semiannual Monetary Policy Report to the Congress: “The Committee recognizes that low interest rates may provide incentives for some investors to ‘reach for yield,’ and those actions could increase vulnerabilities in the financial system to adverse events…In some sectors, such as lower-rated corporate debt, valuations appear stretched and issuance has been brisk.”

Stanley Druckenmiller and Carl Icahn via the CNBC Delivering Alpha conference:
“I am fearful that today our obsession with what will happen to markets and the economy in the near term is causing us to misjudge the accumulation of much greater long-term risks to our economy” – Druckenmiller

“You have to worry about the excessive printing of money. You have to be worried about the markets.” – Icahn

Yet, despite these warnings individuals, as shown below, are as heavily allocated to the markets currently as they were prior to the financial crisis. (Note: there are more charts in the original article which I am not adding here. If you need to see them, here is a link to the original text: http://seekingalpha.com/article/2322275-stocks-will-rise-and-the-3-trades-you-cant-make )

Furthermore, while individual investors are fully allocated to the equity markets, professional investor sentiment has rocketed in recent weeks to astronomically high levels.

While excessive bullish sentiment, low volatility, and a perceived blindness to risk are certainly noteworthy; “irrational exuberance” can drive markets higher in the short term for much longer than most expect.

There is currently a belief that there is no recession on the horizon, that markets are “fairly valued” based on the current interest rate environment, and there is “no other option but stocks.” While these views certainly bolster the near term perspective of being long the equities, which will continue to drive asset prices higher, it is important to remember that each of these dynamics can, and do, change much more rapidly than investors can generally react to.

The chart below shows the annual change in GDP, 10-year interest rates and the S&P 500. It is important to note that prior to every recession that was an instilled belief that “no recession” was on the horizon. It is worth remembering that Alan Greenspan and Ben Bernanke both stated that the economy was doing well…just before it wasn’t.

It was in 1996 that Alan Greenspan first uttered the words ‘irrational exuberance’ but it was four more years before the ‘bull mania’ was completed. The ‘mania’ of crowds can last far longer than logic would dictate and especially when that mania is supported by artificial supports.

The statistical data suggests that the next economic recession will likely begin in 2016 with a negative market shock occurring late that year, or in 2017. This would also correspond with the historical precedent of when recessions tend to begin during the decennial cycle. As shown in the chart below the 3rd, 7th and 10th years of the cycle have the highest occurrence of recession starts.

With the Fed’s artificial interventions suppressing interest rates and inflation it is likely that the bullish mania will continue into 2015 as the ‘herd’ mentality is sucked into the bullish vortex. This is already underway as shown recently in ‘Charts All Market Bulls Should Consider’ which showed individuals are once again piling into stocks and depleting cash reserves in the hopes of ‘getting rich quick.

The 3 Trades You Can’t Make
As a money manager, my portfolio model remains currently fully invested. The problem is that I am grossly uncomfortable with that allocation given the risks that currently prevail. However, as I have stated many times previously, I must follow the trend of the market or I will suffer “career risk” as clients move money elsewhere to chase market returns. This is what I call the “investor duration mismatch.” While investors are supposed to be investing for long-term returns, buying low and selling high, the reality is that their emotional biases make them extremely myopic to short-term market movements. The problem with short-term market movements is that they have NOTHING to do with underlying fundamentals. (Read more on why fundamentals don’t matter.)

The problem for investors today is that the “easy money” is no longer available by betting on stocks going up. Which means there is an opportunity brewing in three areas which, unfortunately, investors cannot actually make.

• Long Volatility (NYSEARCA:VXX)
• Long Bonds (Investment Grade Corporates)
• Short Stocks

The reason I say that you can’t make these trades is that they are a bet on the eventual market reversion. When the reversion occurs volatility will significantly rise, interest rates will decline stock prices drop markedly. The problem is that most investors do not have the patience to let such a “bet” mature. The pressure of betting against a rising market will eventually lead to selling at painful losses.

The current low-volume market, combined with excessive bullish sentiment, sets up a potential for asset prices to be inflated further. As stated, the risks in the markets have clearly risen, but the next major reversion could be many months away. The problem for most, particularly those touting “investing for the long term,” is when the “dip” turns into a full-fledged “decline” the panic to exit the markets will become overwhelming.

Dr. Shiller’s final paragraph summed things up well:
“Those who warn of grave dangers if speculative price increases are allowed to continue unimpeded are right to do so, even if they cannot prove that there is any cause for concern. The warnings might help prevent the booms that we are now seeing from continuing much longer and becoming more dangerous.”

Our memories tend to be much shorter than the damage done to portfolios by failing to recognize risk and managing accordingly.

(My final note: Risk is not something to be avoided; it is something to be understood and managed. If you want to know how this is done, call me or send me an email. – TK )