Tag Archives: financial advice

Here’s How You Know The Stock Market Is Hugely Overvalued

roller coaster2My Comments: Worrying about your money is a normal activity. At least it is for me.

That being said, to the extent you have money somewhere where your principal is not guaranteed, I think there is a high probability you will soon suffer some losses.

Actually, unless you sell at a loss, you really haven’t ‘lost’ anything. But if your account value drops, and you are old like I am, you may not have the necessary time to wait for it to recover. That’s because you may be using it to pay your bills, and chances are those bills will continue. Unless of course you die, which means it becomes someone else’s problem.

Mark Hulbert – August 16, 2016

The U.S. stock market currently is more overvalued than it was at almost every bull market peak over the past 100 years.

That’s crucial, since it undercuts one of the arguments some exuberant investors currently are using to try to wriggle out from underneath the otherwise bearish message of various valuation indicators. Their argument in effect is “of course current valuation is high; what would you expect when the market is at an all-time high?”

Unfortunately, an equally sobering picture is painted when we compare the current market not to historical averages but to just those past occasions when equities were at the top of a bull market.

In fact, as you can see from the chart (not shown), the current stock market is more overvalued, in terms of the following metrics, than it was at most of the past bull market peaks dating back to 1900.

Giving credence to this message is that it comes from six different ways of measuring valuation. That should make it harder for the bulls to dismiss the data:
1. The price/book ratio, which stands at 2.8 to 1: The book value dataset I was able to obtain extends only back to the 1920s rather than to the beginning of the century, but at 23 of the 29 major market tops since then, the price/book ratio was lower than it is today.

2. The price/sales ratio, which stands at an estimated 1.9 to 1: I was able to access per-share sales data back to the mid 1950s; at 18 of the 19 market tops since, the price/sales ratio was lower than where it stands now.

3. The dividend yield, which currently is 2.1% for the S&P 500: SPX, -0.33% . At 31 of the 36 bull-market peaks since 1900, the dividend yield was higher. (high is good; low is bad)

4. The cyclically adjusted price/earnings ratio, which currently stands at 27.2: This is the ratio championed by Yale University’s Robert Shiller. It was lower than where it is today at 31 of the 36 bull-market highs since 1900.

5. The so-called “q” ratio: Based on research conducted by the late James Tobin, the 1981 Nobel laureate in economics, the ratio is calculated by dividing market value by the replacement cost of assets. According to data compiled by Stephen Wright, an economics professor at the University of London, and Andrew Smithers, founder of the U.K.-based economics-consulting firm Smithers & Co., the market currently is more overvalued than it was at 30 of the 36 bull-market tops since 1900.

6. P/E ratio: This is the valuation indicator that is perhaps most-often quoted in the financial media. Nevertheless, according to data on as-reported earnings compiled by Yale’s Shiller, and based on S&P estimates for the second quarter, this ratio currently stands at 25.2 to 1. That’s higher than at 89% of past bull-market peaks.

To be sure, valuation indicators are not helpful guides to the market’s shorter-term direction. Overvalued markets can stay overvalued for some time, and even become more overvalued. But value eventually wins out.

For example, it was in December 1996 that Yale’s Professor Shiller gave his now-famous lecture to the Federal Reserve about irrational exuberance. His analysis struck many as silly during the subsequent three years in which stocks continued to soar; when the dot-com bubble hit he looked like a genius — and he eventually was awarded the Nobel prize.

A timely analogy comes from Ben Inker, co-head of the asset-allocation team at Boston-based money management firm GMO. He likens the market to a leaf in a hurricane: “You have no idea where the leaf will be a minute or an hour from now. But eventually gravity will win out and it will land on the ground.”

So enjoy the market’s strength — while it lasts.

The case for ETFs in 3 charts

My Comments: As is true in all life, evolution happens. This includes investing your money for the future. A major evolutionary step was the introduction of ETFs. They are as significant a step as was the introduction of mutual funds in the early years of the 20th Century. It’s in your best interest to understand them and employ them when you can.

Source: http://qz.com/720236

You’re probably familiar with the concept of mutual funds, and may even own at least a few in your 401(k) or other accounts. Yet, you may be less informed about another investment vehicle that has become widely used by many types of investors: exchange-traded funds (ETFs). You may even own them and wonder what they are.

First, a basic definition. ETFs combine familiar features of mutual funds and individual stocks. Like mutual funds, most ETFs are made up of many stocks, bonds or other assets. Like an index fund, an ETF aims to track the performance of a specific market benchmark, like the S&P 500 or the Russell 2000. And like shares of stock, ETFs are traded on an exchange throughout the day.

Want to get grounded in ETFs? Here are three facts to get started.

One: ETFs are not niche products

ETFs have been around for more than two decades, but they’ve really taken off in the past five years or so. Today, investors of all types — from individuals to sophisticated institutions — have helped increase ETF assets to more than $3.1 trillion globally. And while that’s still a fraction of the $21 trillion invested in mutual funds, ETFs are growing at a faster pace, more than doubling in size over the past five years.

Part of the appeal of ETFs is their flexibility. Unlike mutual funds, which can only be bought or sold once a day, at a price established at the market close, ETFs can be traded whenever the market is open, just like stocks. Investors can also trade them in the same way they do stocks, including selling short, or buying on margin, and there is no minimum investment amount required. Learn more about the differences between ETFs and mutual funds here.

Two: Lower costs help you keep more of what you earn

An even bigger draw of ETFs is the bottom line—reducing costs. The fees for most ETFs tend to be much lower than mutual funds, which means more money gets put to work for you.

In fact, iShares Core ETFs average about one-tenth the net expense ratio of most mutual funds.² The impact of these cost savings can be meaningful, particularly over time or when market returns are sluggish.

Here’s another potential benefit. ETFs tend to be relatively tax efficient and incur fewer undesirable capital gains distributions. So you can save up front, over time and on your tax bill.

Source: Chart reflects the hypothetical growth of a fictional investment of $250,000 with an 8% return and assumes the reinvestment of dividends and capital gains. Fund expenses, including management fees and other expenses have been deducted. The graph is for illustrative purposes only and is not indicative of the performance of any actual fund or investment portfolio.

Three: ETFs make it easy to get in—and stay in—the market

Ultimately, of course, pursuing your financial goals is about staying invested. Timing market ups and downs is nearly impossible to get right, and missing out on the rebounds can be costly. In the example here, missing just the five top-performing days over the past 20 years would have cost more than $160,000; missing the top 25 days would have nipped nearly 75% of potential gains.

So instead of trying to outsmart the market, it may make more sense to simply be in the market, smartly.

The graph above shows how a hypothetical $100,000 investment in stocks would have been affected by missing the market’s top-performing days over the 20-year period from January 1, 1996 to December 31, 2015.

Secondary Market Annuities (SMA)

Piggy Bank 1My Thoughts: Last month I posted about having stock positions in your retirement portfolio and how much was appropriate. This post is about another option where there are no stocks at all, only a promise by an insurance company to return all your money to you, over time, at a guaranteed rate of interest. Typically, the rate of return, of ROR, is 4% or more, which in today’s world is pretty good.

The are called SMAs and are discounted receivables. Somebody (an insurance company) has agreed to pay someone else a series of payments for a specified period of time. The contract that makes this happen is an annuity, where the payments are guaranteed. The difference is that the initial recipient of these payments has changed his mind and instead, wants  a lump sum and not monthly payments. So that person sells the future stream of payments to another person in exchange for a lump sum. This new person sees all this as an investment, so he/she in turn finds someone who has a lump sum but would rather have a stream of unbreakable payments. Ergo, Secondary Market Annuities.

If you, for example, own your house and have some money sitting in a bank somewhere that is earning very little, you might consider using that money to buy a favorable stream of future payments, where the return on investment (ROI) is much better than what the bank is paying you.

How Do SMAs Work?
Secondary Market Annuities are not what you would normally associate with the term, “annuities.” Annuities tend to be more complicated – involving contracts with riders, contractual terms, guaranteed rates, variable indices, and a host of other terms. By comparison, the purchase of an SMA is quite simple.

The easiest way to explain SMAs is with an example case.

Using today’s SMA yields, you can purchase a 10 year SMA case for $91,656 that begins to pay $1,000 per month for 120 months beginning on June 1, 2016 and ending on May 1, 2026. This SMA offers a guaranteed payment stream with definite dates of payment. To determine the purchase price, SMA Hub, the provider of choice, applies a discount rate to those payments, and the result is the purchase price today.

Comparing Apples To Apples
The real value of an SMA comes to light when you compare this SMA to a period certain annuity, such as a 10 year Single Premium Immediate Annuity (SPIA).

If your goal as a member of the public is to have a check every month of $1,000, you’ll find that if you purchase a SPIA with the same 10 year guaranteed income stream, it will cost about $110,254 based in today’s rates.

In our example here, if you can find an SMA to provide $1000 per month for 10 years, would you rather spend $91,656 or $110,254 to achieve the same outcome? You’ll pay roughly 20% less, provide you with the exact same income stream, and comes to you from a very high credit quality insurance carrier.

Each SMA case is like a unique, rare gem. While they are not too good to be true, they are one of a kind. Each case is offered for sale and once sold, it is gone. I have access to a weekly inventory of what is available. Talk with me if you want to further explore this idea.

A 34-Year Tailwind For Stock Market Returns Has Run Out Of Steam

bear-market--My Comments: Many in my profession have been waiting for a market correction of significance for at least the past 18 months. Obviously it hasn’t happened yet, but unless you expect the sun to rise in the west, it will happen, and probably sooner rather than later.

More and more commentary surfaces every day that suggests a reversal will happen soon. Just when, how severe it will be, what will be the trigger, and how long it lasts is a total unknown. But happen it will.

I’m taking steps with my money and I hope you are doing the same.

Chuck Jones, June 13, 2016

One component investors consider when investing in the stock market is what rate of return they can get in alternative investments such as fixed income securities. Historically as interest rates have fallen, stock market valuations have increased. And when rates rise, it negatively impacts stock prices and valuations. When you look at the past 16 years compared to the previous 40 it looks like this relationship has not just run out of steam but has been broken.

Starting in 1960 the S&P 500 was at 58 and over the next 56 plus years to this past Friday it increased to 2,096 for a compounded annual growth rate (CAGR) of 7.3%. While it would be wonderful if the stock market increased by the same amount every year it doesn’t and one factor is interest rates. I have broken down the past 56 years into four timeframes.

1960 to 1970: The first spike in interest rates
At the beginning of 1960 the S&P 500 was at 58 and the US 10 year Treasury was 4.72%. At the beginning of the 70’s the 10 year Treasury increased to 7.79% while the S&P 500 climbed to 90 which is a 4.5% compounded annual growth rate (CAGR) which was significantly below the 56 year average of 7.3%.

During that timeframe the S&P 500’s PE ratio decreased from 17.1x to 15.8x a decline of 8%. While the 65% increase in interest rates may not have been the only reason the PE multiple contracted slightly the PE multiple decline did impact the stock markets return.

1970 to 1982: Interest rates continue to rise

Interest rates dropped some in the early 70’s but continued their rise from 7.79% to a high of 14.76% on June 25, 1982. Over that 12 and a half year period the S&P 500 only rose 1.5% a year to 109 which was significantly below the 56 year average. For the 22 and a half years since 1960 when the 10 year increased from 4.72% to 14.76% the market only increased 2.9% a year.

The PE multiple took a big hit when interest rates increased dramatically. As interest rates almost doubled (they increased 89%) the S&P 500’s PE went from 15.8x to 7.7x, down 51%. While the PE drop doesn’t exactly match the interest rate increase in percentage terms it is awfully close.

1982 to 2000: Interest rates start their 34 year decline

I remember in the early 1980’s you could get double-digit returns for two and three year Guaranteed Investment Contracts (GICs) in 401k plans since inflation was running in the 11% to 14% range. Over the next 18 years when the 10 year Treasury dropped from 14.76% to 6.66% the S&P rose from 109 to 1,426 or 15.8% on a yearly basis, significantly outperforming the 7.3% average.

While interest rates declined 52% the market’s PE multiple exploded from 7.7x to 29.0x towards the peak of the tech bubble. The 275% increase in the PE multiple far outpaced the decline in interest rates and helped to set up low returns going forward.

2000 to 2016: Interest rates continue to decline but returns are miniscule

As can be seen in the logarithmic graph of the S&P 500 below its price hasn’t moved much over the past 16 years (CAGR of 2.4%) even though the market increased almost 50% from 1,426 to 2,096.

While interest rates have continued to decline from 6.66% to 1.73% PE multiples have also dropped going from 29.0x to 24.2x (down 17%) which is not the typical relationship. It appears that PE multiples overshot so much where they should have been in the late 1990’s even lower interest rates can’t make up for the extended PE multiples.

What John Oliver Got Right (and Wrong) About the DOL Fiduciary Rule

My Comments: The financial services industry is starting to come to terms with what is known as the DOL Fiduciary Rule. Some of us embrace this new standard and others think the world is about to end.

In short, it institutionalizes the idea that if you are providing financial advice to the consuming public, you are bound to act in your client’s best interests. While many believe this has been the case all along, it’s been largely a myth. If push comes to shove, the companies for whom the large majority of brokers and advisers work for do not want to be held accountable for the recommendations and offerings made by their sales people. They have argued vehemently against this new standard and with the help of millions of dollars spent on lobbyists, the new rules are a watered down version of what was originally proposed.

But in my opinion, it’s a good first step. If those in my profession are ever going to achieve the professional status of Certified Public Accountants (CPAs) and attorneys, we’re going to have to, in every respect, conform to a fiduciary standard.

June 17, 2016

The Department of Labor’s fiduciary rule has been a battle for our industry for about six years now, and consumers rarely know about or understand the potential changes. But last week, the rule took on a new audience: the viewers of “Last Week Tonight with John Oliver.”

I spend almost every day reading something about this rule, whether it be about lawsuits, what advisors should do about it or how the industry should embrace it. The rule itself is extremely complicated and so are the things advisors managing retirement accounts must do. As Oliver explains, “for the average person saving for retirement … [it] doesn’t need to be this confusing.”

Oliver does a decent job of explaining why the rule came about, but he also sways in favor of the DOL, which doesn’t seem to be the opinion of our industry.
I see how many of our industry’s people are worried and furious about the harm it could cause, but I also see why the DOL and consumers think the rule is important to protect Americans and their money. Just take a look at this Reddit thread where consumers are concerned about the “hidden fees” their accounts may be facing. Here’s a look at hits and misses of the video:

What he got right:

In the beginning of the video, Oliver begins to discuss how the term “financial advisor” is not a credential but rather just a job title. Although he may have angered advisors for mocking their job titles, it’s true that consumers may not know these are not reflective of the advisor’s credentials.

Oliver goes on to explain how the fiduciary rule is good for consumers because they should have someone acting in their best interests. This makes sense because in order to create a successful retirement plan, many different products and investments will most likely be needed to make sure a client will have enough income for as long as they live. It only makes sense for advisors to be fiduciaries, right?

Where Oliver was wrong:

Although he was right to state that the titles “financial advisor, financial analyst, etc.” virtually mean nothing, he failed to mention that consumers bear part of that burden. When hiring someone to manage your money, one would think the consumer would do some research on the people chosen to manage that money. Really, it comes down to the lack of financial education our country faces.

Oliver also suggests people should be investing in low-cost index funds, which the show seems to imply is a good investment for any and every person. From my experience though, every portfolio and client situation is different, which is why financial advisors are important in the first place; suggesting one type of investment as a be-all, end-all for investors could create a sticky situation in the long run.

In case you missed it (or if you didn’t make it to the last two minutes of the video), here are the five retirement saving tips the show gives to its viewers:
1. Start saving now.
2. Invest in low-cost index funds.
3. Ask if your advisor if they’re a fiduciary.
4. As you get older gradually shift your assets from stocks to bonds.
5. Try to keep your fees under 1%.

One more thing to point out is that Oliver seems to think that annuities are almost always a bad investment decision. Annuities have been the subject of the “bad” in our industry according to Elizabeth Warren and Suze Orman (both of which he cites as fighting against the investment products).

To me, what this video tells consumers is that they should be aware of exactly how their money is being invested. Advisors should be clear to their clients about how they’re being compensated, and in turn, clients should communicate any concerns they have with their advisors.

My hope is that this video helps educate consumers at least on the importance of saving for retirement and that it sparks conversation.

How To Talk to Your Family About Your Estate Plan

Family and fenceMy Comments: In days past, estate planning was associated with having lots of money. This was because the IRS had their fingers in your financial pie if you died owning what is today considered a modest estate, anything more than $550,000.

Since that existential threat has largely diminished for almost all of us, estate planning is about making sure our stuff goes where we want it to go. And with a minimum of fuss and costs associated with the legal transfer of ownership rights.

This is a good place to start with this process.

By Tim Habbershon, Fidelity Advisors, 03/09/2015

One of the potential benefits of wealth planning is the opportunity for families to have meaningful conversations about their hopes, dreams, legacy wishes, and more. These types of planning discussions can not only help to create family intimacy, but may also help build relationship capital for the future.

In my first Viewpoints article, If money talks, so should you, I defined relationship capital as “the relational reserve of goodwill that allows families to talk about anything,” and I gave four guiding principles for building it. In this article, I outline what I consider the three outcomes that we strive for in order to have effective family communication—and how these goals can help lay the foundation for sensitive and complex estate planning decisions.

Defining your goals

Most people assume that the goal of effective communication is mutual agreement. This can be a dangerous assumption, particularly when it comes to estate planning. Here’s why.

When agreement is the goal, people often fight for their view, and try to force others to agree with them. Entering a complex, emotionally charged conversation with this mindset is always counterproductive.

Seeking agreement can also get confused with needing consensus before a decision is made. Consensus seeking can constrain decision making, and let one or a few people hold the process hostage by saying “I’m not proceeding unless everyone agrees.”

Sometimes, the mere fear of not getting agreement can keep people from entering into difficult conversations. Some people may be conflict-averse and equate disagreement with conflict. Others may never have had the experience of having effective conversations that include disagreement, or of ending without full agreement.

While you don’t need to have agreement as the frame for effective conversation, you do need to have decision-making clarity. In other words, who has the power and the right to make the final decision, and how will it be made?

For example, if assets under discussion are owned by a senior generation member, a healthy conversation doesn’t mean successors have a vote, but I believe they should at least have a voice.

So, if vote and agreement are not the outcome goals, what are? Why even give people a voice in the process? The overarching answer is to remember that we are building relationship capital within the family, and not just doing estate and wealth planning. With that point in mind, here are three goals I would encourage people to strive for in their conversations.

Goal 1: Understanding

How many conversations have you ended by saying, “You just don’t understand”? Or, how often have you stopped trying to talk to someone because they only voice their opinions and make no attempt to understand yours? We all know the feeling of someone coming across as uninterested, disengaged, arrogant, indifferent, or controlling, simply because they don’t try to understand our point of view.

Understanding is the intellectual dimension of a conversation and is essential for gaining both insight and engagement from others. In a research study I conducted several years ago, participants who felt that the group at large tried to understand their views reported higher levels of trust, satisfaction, and enlistment in the outcome—even when the decision did not go their way. Without understanding a person’s point of view, we can make assumptions, which may lead us to miss the particular planning point under discussion.

Let’s look at a hypothetical scenario. “Bruce” made a wrong assumption when discussing his stepchildren’s inheritance with his biological children. At one point during the meeting, his biological children made a statement that the way he was treating them in relation to the stepchildren wasn’t fair. Without understanding what his children meant by “fair,” he immediately reacted in anger. The only point they were making was that he was trying hard to treat them all as equals, rather than dealing with each of them as individuals—regardless of whether they were a child or a stepchild.

Goal 2: Congruence

Congruence is the emotional dimension of a conversation, which focuses on each person’s feelings. It should be recognized that effective communication is not emotionless.

Many people believe that conversations are safer without emotions because an individual’s feelings are often expressed in destructive ways. Behavior such as anger or shouting can create distance, not congruence. Even if shouting is an “acceptable” family pattern, it can still create distance. This is because those who are being shouted at are forced to “get over it” in order to get back into equilibrium.

In order to create congruence, emotions have to be expressed in a way by which they can be heard. We are emotional creatures, and unless we intentionally and effectively share feelings during a conversation, those feelings go underground, fester, and often come out at inopportune times—perhaps right when you have to discuss a difficult wealth transference issue.

Let’s look at an example. When a father and daughter started pounding their fists on the table and shouting during one of our planning meetings, it actually had nothing to do with the topic at hand. In reality, “Sandy” was feeling judged and unsupported by her father, “David,” and “David” was feeling very let down by “Sandy.” Had they talked about these feelings prior to or as part of the larger conversation, it is my belief the derailing explosion would not have occurred.

Goal 3: Mutuality

I believe conversations that build relationship capital must give people a sense of mutuality. This dimension requires a level of “peership” between people in the conversation. Peership is a concept that conveys respect, engagement, and belongingness, and cuts across people’s position, power, intellect, or moral authority in a conversation.

For example, during a recent planning conversation I led, “Bill” tried to end an uncomfortable conversation with his children by saying, “It is my money and I will do what I want. You kids should be grateful you are getting anything.” Need I say that there wasn’t much mutuality or peership in that statement? Bill was feeling threatened by the views of his adult children and he reverted to a strong parent-child mode of communication. It shut down the conversation, and destroyed any hope of creating intimacy or building relationship capital from the process.

Peership, however, does not mean that everyone in the conversation is equal in terms of input or decision making. It does mean that people leave the conversation (no matter what their age, knowledge level, gender, role, or decision authority) feeling as if they had an appropriate voice, felt part of the group, and were considered in the outcome. In other words, the goal is to have everyone involved leave the conversation with a feeling of mutuality.

By making understanding, congruence, and mutuality the outcome goals of family communication, it is possible to build relationship capital as well as achieve your estate planning goals.

The Next Bear Market Will Be Ruthless

bear-market--My Comments: This might put you to sleep. Or the next bear market might cause you to leap from a tall building. You choose.

If you have money invested in the markets, and your time horizon for a full recovery is limited, you should read this to the end.


by Eric Parnell, CFA,  June 10, 2016

• It has been almost nine years since the outbreak of the financial crisis. And it has been more than seven years since the start of the most recent bull market.
• The Fed has created a bubble not only in asset prices but also in the investor belief that the value of their investments will be protected no matter what.
• Unfortunately, the next bear market will eventually come, and it is likely to be ruthless once it finally arrives.
• Investors who recognize such an eventual reality can stand at the ready to capitalize once the time finally arrives.

It has been almost nine years since the outbreak of the financial crisis. And it has been more than seven years since the start of the most recent bull market. Stocks have been impressively resilient in the face of every test during the post-crisis period thanks in large part to the seemingly endless support from monetary policymakers including the U.S. Federal Reserve. This has helped foster an environment where many investors are not only comfortable but have swagger about owning stocks at historically high valuations despite chronically slow growth. As a result, the Fed has helped create bubbles not only in asset prices but investor expectations that the principal value of their investments will be upheld no matter what challenges befall the economy. Unfortunately, just like the bursting of the tech bubble and the onset of the financial crisis, the next recession will finally come. And when it does, it has the potential to be absolutely ruthless for investors.

Let’s Get This Out Of The Way

I can already hear the bulls sharpening their knives for the comment section of this article, and I very much look forward to reading and responding to all points of view including those that strongly disagree with my article, but let me get out in front with a few observations.

Indeed, I have been bearish for some time, but this does not mean that I’m predicting that everything is going to go up in smoke tomorrow. Just as the tech bubble went about four years longer than it probably should have, the same could definitely be said for today’s market. Moreover, we could see the S&P 500 Index (NYSEARCA:SPY) continue to rally for the next several months or couple of years. Then again, we could already be one year into a new bear market. Only time will tell. But what’s important to note is that the higher and longer today’s market continues to rise, the longer and harder it is likely to fall on the backside. In the meantime and until we start to definitely roll down the other side of the mountain, I have and will continue to hold a meaningful allocation to stocks.

But isn’t my holding stocks a contradiction to my bearish view? Absolutely not. For just as being bullish does not mean that one should be all in and 100% allocated to equities, being bearish does not imply that one should be completely out of stocks and hide away in a bunker waiting for the world to end. Bear markets slowly evolve over long-term periods of time, and selected segments of the stock market have historically demonstrated the ability to perform well during different stages of bear market cycles. For example, consumer staples (NYSEARCA:XLP), utilities (NYSEARCA:XLU) and healthcare (NYSEARCA:XLV) stocks all typically perform well during the early stages of a bear market, and selected specific stocks of various styles and sizes such as Wal-Mart (NYSE:WMT), Village Super Market (NASDAQ:VLGEA), Community Bank System (NYSE:CBU) and Southern Company (NYSE:SO) have demonstrated the ability to perform well throughout the entirety of two of the worst bear markets in history in the bursting of the tech bubble and the financial crisis. So while I may not be loaded up on the SPY, the market offers a solid menu of stocks that one can hold through the worst of a market storm. I also own a lot of other things outside of stocks that are performing well today and I expect will perform even better during any future bear market in stocks.

Also, isn’t my making a statement that the next bear market could be “absolutely ruthless” for investors nothing more than fear mongering? No, it is not. Instead, it is trying to increase investor awareness of a view that they may not otherwise be hearing. After all, one only has to tune into one of the major financial news networks to hear a cornucopia of bullish views on the market, many from analysts that have a direct vested interest in promoting such bullish views and reassuring the audience that despite any short-term rough patch that “stocks will be trading higher by the end of the year.” Conversely, those expressing a bearish view are often met with heavy pushback and scowling derision. As a result, this leaves many that may be less experienced with investment markets exposed to the risk of wondering “why didn’t I see this coming” when they eventually find themselves locked in the jaws of the next bear market.

In the end, it is up to individual investors to decide how they wish to proceed with their own portfolio allocation. But by sharing this more bearish perspective on today’s markets – it at a minimum provides investors with a viewpoint to consider that they may not be hearing elsewhere. Now that we’ve got that out of the way, let’s get down to it.

The Economic/Market Disconnect

The next bear market is setting up to be ruthless for investors. But this does not mean that it will be ruthless for the U.S. economy. In fact, it would not be surprising at all to see a prolonged and significant decline in stocks accompanied by what amounts to a somewhat longer than normal but otherwise relatively mild economic recession. How can this be the case? Simple. Since Main Street (NYSE:MAIN) hardly participated in the glorious ascent that has been Wall Street via the stock market over the past seven plus years, Main Street is not likely to suffer nearly as much when stock prices come falling back to earth. In fact, many parts of Main Street might actually find themselves benefiting in many ways including even lower interest rates on loans, lower gasoline prices at the pump and the execution of more effective fiscal programs by policymakers that finally have had a long overdue fire lit under them.

Impossible, you might say. How can we have a major stock market decline with a relatively milder impact on the broader economy? One has to look no further than the bursting of the technology bubble from 2000 to 2002. During this time period, stocks declined by more than -50%, but the economy hardly even declined. Although we officially had a recession from March 2001 to November 2001 according to the National Bureau of Economic Research (NBER), the overall decline in U.S. real GDP was -0.3% and we didn’t even have two consecutive quarters of negative growth during this stretch. This recent example highlights the fact that it is certainly possible to have a stock market more than cut in half without any measurable contraction in economic activity. For if stock valuations get too far ahead of the economy, as they were then and are arguably today, they then have a huge air pocket through which to descend by simply falling back to the underlying economic reality.

What About Not Fighting The Fed? Lest We Forget – Lest We Forget!

What about fighting the Fed? Haven’t we learned by now during the post-crisis period that the U.S. Federal Reserve and their global central bank counterparts are going to do whatever it takes to protect stock prices at every turn? This has been definitely true in recent times as any attempts to try and short the market over the past seven years when it looked like stocks were going to break sharply to the downside have been absolutely steamrolled along the way. But in order to avoid falling victim to recency bias, just because this has been true in recent years does not mean that it is universally true.

In fact, the history of the Fed is filled with examples of them winning so many of the battles but ultimately losing the wars.

To set the stage for this point, let’s go back to the last great Fed victory, which was winning the war over inflation back in the early 1980s. How did the Fed win this war? Because it was willing to endure the hardship, lose the battles, and suffer the sacrifice to prevail with overall victory in the end. Then Fed Chair Paul Volcker did not coddle and cajole the economy and financial markets at the time in working to solve the problem. Instead, he dialed up interest rates to nearly 20% and ripped the heart out of the inflation problem. During this time, the economy endured two back-to-back recessions and a solid bear market, but it set the stage for the years of prosperity that followed in the 1980s and 1990s. In short, the Fed was willing to lose some battles to win the war. And until former Fed Board Governor Kevin Warsh is appointed to the position, Mr. Volcker will remain my favorite all-time Fed Chair.

So what have we seen since? Under Fed Chair Alan Greenspan, we saw the Fed win battle after battle. This included the stock market crash of 1987, the recession of 1990, the should-have-been recession of 1994, the Asian Flu in the late 1990s, and the collapse of Long-Term Capital Management in 1998. And the Fed did so by helping investors avoid any pain along the way. Yet, in the end, they lost the war, as the tech bubble finally burst with roughly four years of investor gains during the late 1990s evaporating in the process.

About that Fed put. While it is easy to forget, particularly when it has lifted markets for so many years, but the Fed does not always get what it wants from stocks with accommodative monetary policy. Lest we forget! During the bursting of the tech bubble, the Fed was aggressively lowering interest rates for three years starting in early 2000, yet stock prices lost more than half of their value before finally bottoming in late 2002 and early 2003.

But then came the post-tech bubble period. Under Fed Chairs Alan Greenspan and Ben Bernanke, the Fed once again was winning all of the wars thanks to low interest rates and a booming housing market. And once again, investors were able to bask in the warmth of an accommodating market filled with gains and free of pain. In the process, they managed to bring the stock market all the way back to its tech bubble highs. But in the end, the Fed once again lost the war, as the housing bubble burst with nearly catastrophic consequences. By the time the financial crisis was brought under control in March 2009 (not fixed, but brought under control), the market had exceeded the losses of the tech bubble to the downside and was back to the same level it had first reached more than a decade earlier.

Once again, the Fed put does not always work. Lest we forget! During the financial crisis, the Fed was once again aggressively lowering interest rates for nearly two years starting in mid-2007, eventually lowering interest rates to zero and launching into quantitative easing along the way, yet stock prices once again lost more than half of their value before finally bottoming in early 2009.

All of this leads us to today. Under Fed Chair Ben Bernanke, the Fed has won all of the battles by giving investors everything they could ever imagine and more. Stocks have skyrocketed virtually without interruption and investor pain has been virtually non-existent. In the process, the Fed managed to catapult the stock market more than one-third higher above its tech bubble and pre-financial crisis peaks. And they did so with a global economy that has been sluggish, uneven and lackluster at best.

Why The Next Recession Will Be Ruthless For Stocks

Maybe the outcome this time around will be different. But given the historical pattern over the past two decades, my bet remains that the Fed will end up losing this war once again.

Why? Let’s begin with the qualitative, which is that war is not won by bypassing the pain and sacrifice necessary to prevail. And until policymakers finally decide that they are ready to win the war and replace the monetary cotton candy with a steady diet of spinach, we are likely to continue in these monetary induced boom and bust cycles.

Now let’s get to the quantitative. What enabled the Fed to rescue the stock market after the last two lost wars? Because they entered financial markets firing all monetary guns for an extended period of time lasting two to three years in order to get the markets stabilized and moving higher again. But let’s assume whatever bubble of the many that exist today finally bursts and sends stocks sustainably lower despite all of the best efforts and jawboning by the U.S. Federal Reserve and their global cohorts. From exactly what arsenal are they going to fire from to turn the stock market around so quickly this next time around?

Will it be lowering interest rates by several percentage points? No, because interest rates are already effectively still at zero in the U.S. and negative in much of the developed world outside of the U.S. And the temptation to go further into negative interest rate territory is unlikely, for not only has it not lifted stock price in any measurable way, evidence is growing by the day that it simply does not work and is causing more harm than good.
Will it be launching into yet another round of aggressive quantitative easing? Perhaps, but what is the justification for putting our global fiat currency system that is still a baby at only less than half of a century old at even greater peril than it already is for returning to a program that simply has not worked in generating sustained economic growth over the past seven years? With that said, I still wouldn’t put it past the Fed to go back to this well, but it stands to question what the marginal benefit to stock prices would be at the end of the day. Lest we forget the experience that Japan (NYSEARCA:EWJ) had with quantitative easing from March 2001 to March 2006 when the Bank of Japan increased its balance sheet by more than seven-fold, with the lion share of the increases taking place during the first three years of the program.