Tag Archives: financial advice

Turning 65 this year? Don’t overlook these 3 steps

retirement_roadMy Comments: The transition from working FOR money to having money FOR YOU is full of tension and hard to answer questions. If you’re beyond this stage, then don’t bother with this. On the other hand, if it’s today or in your future, then this is good stuff.

Gail MarksJarvis / The Chicago Tribune / January 6, 2017

If you will be turning 65 this year and plan to keep working, you have essential money decisions to make that can’t be ignored.

The arrival of your 65th birthday requires that you take specific steps so you don’t get in trouble with the government on Medicare rules and face fines later. And the years around your birthday command attention to money details that could make the difference between having plenty of money for retirement and running out of funds early. So don’t drift by this major time in your life without attention to the three issues people at age 65, or near retirement, must address.

Sign up for Medicare. When you are 65, you will be eligible to start taking Medicare to cover some of your doctor, hospital and other medical costs. Full Medicare coverage is not free so you typically don’t want to start taking it if you are still working full time, aren’t on Social Security and will have solid, affordable medical coverage at work until you decide to retire. But you can sign up for Medicare at 65 and get a small part of Medicare — the free benefits that cover some hospital care — even if you don’t need the full Medicare package while working. (See http://www.ssa.gov/pubs/EN-05-10530.pdf.) Signing up doesn’t have to mean you give up your health insurance at work. And the hospital coverage you get free through Medicare Part A can supplement the health insurance you have through your workplace insurance, said Philip Moeller, who walks people through the confusing Medicare requirements in his book, “Get What’s Yours for Medicare.”

If you are going to keep working after 65, you simply say on the Medicare form you fill out that you won’t be claiming the form of insurance yet that covers doctors because you have solid coverage through work. (See faq.ssa.gov/link/portal/34011/34019/Article/3773/How-do-I-sign-up-for-Medicare.) In other words, you aren’t taking Medicare Part B at that time. Part B is the Medicare insurance that you will use later in retirement to pay for doctors, outpatient treatment and supplies like knee braces or walkers.

After doing the basic sign-up at age 65, you will get a Medicare card in the mail and you will start being eligible for one of the three parts of Medicare: Part A. Later, when you actually retire, or when you don’t have solid medical insurance through work, you will need to sign up for full Medicare coverage. Then, you will be able to rely on all three parts of Medicare — Part A for hospitals, Part B for doctors, equipment like leg braces and walkers and outpatient medical services, and Part D for some prescriptions. For Part B, you will pay premiums each month — typically $104.90, although what you pay depends on your income. Your drug Part D cost depends on the plan you choose from numerous insurance companies, and you need to scrutinize them carefully to make sure they cover your particular prescriptions. Monthly premiums for popular drug plans range from about $18 to more than $66 and swing dramatically depending on where you live, Moeller said.

If you plan to rely on your employer insurance while working, beware: Employers can’t kick you out of their health insurance at 65 or as you age, but that rule applies only to businesses with 20 or more employees, Moeller notes. So if you work for a small company with only a few employees, at age 65 you could end up needing to sign up for Medicare and also start using — and paying for — all three types of Medicare: Parts A, B and D. Your employer is supposed to tell you if your insurance through work is considered to be sufficient enough that you don’t have to apply for full Medicare. If not, you will have to apply for full Medicare including Parts A and B.

If you don’t have acceptable coverage at work, and fail to sign up for Medicare when 65, the government can penalize you throughout your retirement. When you start using Medicare Part B for doctors, the penalties could boost your monthly payments by 10 percent for each full 12-month period. (See http://www.medicare.gov/your-medicare-costs/part-b-costs/penalty/part-b-late-enrollment-penalty.html.) If you miss the deadline for signing up for drug coverage through Part D, another penalty on drug coverage can last through retirement. (See http://www.medicare.gov/part-d/costs/penalty/part-d-late-enrollment-penalty.html.) There are specific times during the year when you must enroll. Make sure you pay attention to enrollment periods because there is no leeway.

If possible, wait on Social Security. Although you can start getting Medicare at age 65, and must pay attention to paperwork then, Social Security is different.

You don’t have to apply for Social Security at a certain age, and the longer you wait, the better. Most people who are around 65 now won’t be able to retire and get full Social Security retirement benefits until they are at least 66. If they are healthy and can work until 70, they will boost their Social Security benefits significantly. For each year a person waits to retire after 66, the person can increase his or her Social Security payments 8 percent a year. And there are also cost-of-living increases in Social Security benefits annually. Those payments are guaranteed. You aren’t going to find a guarantee like that in any investment. That makes waiting to retire a smart move if possible.

Budgeting and investing. When you start depending on Medicare, you will not be able to count on it for all your medical needs. Full Medicare covers only about half of your medical expenses. So as you plan for retirement, you will need to shop for supplemental insurance that picks up where Medicare leaves off. There are two types: Medigap insurance and Medicare Advantage plans. They differ in what they charge, what they cover, and whether they apply to your community, or cover your medicines, your doctors and the places where you might travel. Costs vary broadly with some of the expensive Medigap plans costing well over $600 a month per person. (See Medicare’s PlanFinder http://www.medicare.gov/find-a-plan/questions/home.aspx.)

Also, realize that your income impacts what you will be charged for Medicare and the taxes you pay on Social Security. So financial planners suggest that people examine their savings a few years before retiring to ensure that during retirement they have a blend of IRA and Roth IRA plans. Roth IRAs don’t get taxed in retirement and IRAs are taxed. So by plucking a little money from each of the two plans for expenses each year, retirees can keep their taxes down and hold on to more of their Social Security and Medicare benefits than they would if they didn’t consider tax implications.

Why the Stock Market Is Stacked Against Donald Trump

My Comments: I don’t think of myself as a woe and gloom person. I really want stocks and bonds to perform well and make money for my clients. That’s the ideal outcome for them and for me.

But as you’ve heard me say before, we do not live in a perfect world. And right now it’s far from perfect in terms of the markets and the opportunities for our investment portfolios to grow.

I wish I had a perfect answer, but I don’t.

by Shawn Tully | December 1, 2016

For a few golden weeks in November, U.S. stock markets loved Donald Trump. As this magazine went to press in late November, equities were in the middle of a record-setting rally that charged Wall Street pundits and strategists with a fresh sense of optimism. Market watchers at Goldman Sachs GS 2.54% , JPMorgan Chase JPM 1.98% , and Raymond James RJF 2.34% cited Trump’s pledge to roll back burdensome regulations and lower corporate tax rates as decidedly bullish for U.S. stocks.

But for investors who study the forces that govern stock prices long term, the outlook was no more upbeat after the election than it was before—and it was far from terrific. Put simply, equities are really, really expensive, and only became more so after Trump’s surprise victory. “The best predictor of future returns is whether you buy at low or high prices relative to earnings,” says Chris Brightman, chief investment officer of Research Affiliates, a firm that oversees strategies for $161 billion in mutual funds and ETFs. “Today individual investors and fund managers who expect the near-double-digit returns we’ve seen over history will be sorely disappointed.”

James Montier, a value investor at asset-management firm GMO, provided this dim appraisal of U.S. stocks: “This is a hideously expensive market, and I don’t need to own it.”

Take a deeper dive into the thinking of pessimists like these, and it’s hard not to reach similar conclusions. (More on that in a moment.) Fortunately, investors can garner much bigger rewards by looking beyond the super-rich American market and beyond stocks in general. This is the time to take a broad, venturesome view encompassing all the best—meaning mainly the cheapest—places to put your money.

As we’ll see, spreading your portfolio across a broad range of underpriced assets can add crucial percentage points to your returns. Best of all: If you do it thoughtfully, you can improve your odds while shouldering little or no extra risk.

Go Abroad

Chris Brightman, chief investment officer of Research Affiliates, thinks that a foreign-centric stock portfolio could outperform a U.S.-only portfolio by as much as three percentage points a year over the next decade.

Play Inflation
Rising inflation could be a mixed blessing for stocks. But it’s good for investors in floating-rate bank loans (whose interest payments rise with inflation) and TIPS, Treasury securities whose principal rises with consumer prices.

Collect a Check

When stock price growth is sluggish, dividends account for a much bigger share of investors’ gains. The problem: Dividend-paying stocks are historically expensive right now.

Let’s examine why the near future for U.S. stocks looks downbeat. Over the past 100 years, the S&P 500 has delivered average annual returns of 9.6%. Wall Street optimists and many pension fund managers believe that past is prologue and that equities will continue to deliver those historical returns. But it won’t happen for a while for one reason: On average the folks who pocketed those nearly double-digit gains in past decades were buying at far lower prices than the big valuations prevailing today.

Here’s why the market math is so daunting. When you purchase a broad swath of equities, say an S&P 500 index fund, the returns you can expect over the next decade or so comprise four building blocks: the starting dividend yield, projected growth in real earnings per share, expected inflation, and the expected change in “valuation”—that is, the expansion or contraction in the price/earnings (P/E) multiple.

Let’s start with the first building block: the dividend yield. The main reason high prices foretell paltry gains is that rich valuations make dividend yields smaller. It’s dividends that have provided the richest rewards to investors. Since 1871, the S&P dividend yield has averaged 4.9%, though it has been lower in recent decades.

The problem is today’s highly elevated P/E ratio. The P/E of the S&P 500 stands at 24; that’s well above the average of 16 over the past century, and 19 since around 1990. Big U.S. companies, on average, pay out half their earnings in dividends. But because the “P” is so towering, you get far fewer dollars in dividends for every dollar you pay for stocks. Today the S&P dividend yield stands at a slim 2%.

So how much will the second building block—real growth in earnings per share—add to that weak yield? In today’s bluebird forecasts for stocks, the biggest fallacy is highly inflated expectations for earnings. “Since the mid-1980s, profits have grown at unusually high rates, giving rise to the mistaken idea that we were in a ‘new normal,’ ” says Brightman. “Earnings rose to a historically high share of national income that they couldn’t possibly sustain.” In fact, the inevitable decline has already begun. S&P profits, based on trailing earnings per share over the past four quarters, peaked in September 2014 and have dropped by 15% over the past two years.

Although earnings careen in a zigzag pattern from year to year, their trend stretching over long periods is remarkably consistent. U.S. profits expand with the overall economy, growing at an annual clip that has exceeded 3% over the past century. But what matters to investors is earnings per share, what they’re effectively receiving in dividends, buybacks, and reinvested profits that drive capital gains. And it turns out EPS expands at just half that rate, or around 1.5%, adjusted for inflation.

The reason for the big lag is twofold. First, companies constantly issue new stock to reward executives and make acquisitions, and the new issues far exceed buybacks. Those extra shares dilute the portion of profits flowing to existing shareholders. Second, new enterprises, often funded by IPOs, invade their markets and reduce the incumbents’ share of the industry’s profit pie. “Profits can grow above trend for certain periods, but they’re still elevated,” says Brightman. “The best assumption is that they grow at the historical real rate of 1.5%.”

To sum up so far: A 2% dividend yield, plus the 1.5% projected EPS growth, should deliver a future real return of 3.5% a year for the next decade. Add the third building block, the approximately 2% inflation predicted by the Fed, and the total expected return on big-cap U.S. equities comes to just 5.5%.

Can Stocks, Bonds, Metals, Currencies All Be Wrong About Trump? Yes

bear-market-bearMy Comments: Perhaps it’s just time to go along for the ride and hope for the best. But I’ve never thought “hope” was an effective investment strategy. If the chance of a Lloyd’s of London type event was not so high, I’d be much happier.

By James Mackintosh | Nov. 28, 2016

Markets may not be the perfectly efficient trading venues of economic theory, but they do tend to be internally consistent. And so it is with Donald Trump. Three weeks after he won the U.S. election, pretty much every investment is telling the same story: renewed growth and inflation in the U.S., no retaliation by emerging markets for any tariffs he might impose and no foreign-policy mistakes.

As a result, there are multiple confirmations for the market’s interpretation of Mr. Trump, whether you look at the prices of shares, bonds, gold, metals or the dollar. How could so many asset classes be wrong?

Actually, quite easily. The danger is that investors are responding to their own prejudices, then receiving reinforcement from one another. While the market is internally consistent, that isn’t enough if it has misjudged the big picture—as it often does on the economy, and even more so on presidents.

The moves since Election Day are big, but in reality are just the acceleration of a trend that already was under way. The market noticed the scent of growth in the summer, and had been slowly switching away from bearish bets since the time Americans went to vote.

Bonds offer the most obvious example, with 10-year Treasury yields (which move inversely to prices) hitting a new low of 1.32% in early July, and rising ever since. By the election they were up to 1.86%, and have since leapt to 2.33%. Investors who held on have lost 7.4% in the 10-year since early July, the most over a similar period since the so-called taper tantrum of 2013.

The pattern in equities has been similar. As bond yields rose, growth-sensitive cyclical stocks beat safer defensive shares. By Election Day, cyclicals were well ahead, and have since gone stratospheric. Meanwhile, prices for industrial metals are surging. Gold has been left behind.

The market often misreads these big macro stories. Take the 2013 taper tantrum, or a period in 2010 when markets bet big on a rapid postrecession recovery—only for panic to set in when the economy proved weak.

One hopes Mr. Trump will inherit a recovering economy and boost growth further, and those who jumped onto market momentum will be right, if for the wrong reason.

But history suggests markets aren’t that good at judging presidents. And that presidents just aren’t that important to stock prices. The worst performance of U.S. stocks between Election Day and Inauguration Day came ahead of Franklin Roosevelt, Richard Nixon and Barack Obama’s first terms and Lyndon Johnson’s 1964 election, according to calculations by Birinyi Associates. Yet after FDR and Mr. Obama took office, the market boomed, while it did perfectly well under Nixon and LBJ.

The market wildly misjudged the potential of Herbert Hoover. His election-to-inauguration stock price jump hasn’t been bettered, but the 1929 crash was on his watch and no president since has overseen such poor returns. Dwight Eisenhower was rare, being welcomed with strongly rising stock prices which carried on up once he took office.

The 3.4% rise in the S&P 500 since the election is already more than Ronald Reagan received between the vote and inauguration in either of his terms. Maybe this time the market’s right, and a new boom beckons. Maybe.

Why Retirees Should Own Stocks

profit-loss-riskMy Comments: The basic premise here is accurate, but I have a problem with the author’s tactics. There is an inherent bias among those whose audience is mostly market traders. I understand this bias. I’d likely have it too if I practiced exclusively in that world.

But I don’t live or work in that world. My world is full of folks who consider anything other than a Certificate of Deposit as having too much risk. Not everyone, but enough that it becomes imperative to teach people that it’s not risk that’s bad, it’s the failure to manage the risk that’s bad.

There is a place for stocks and bonds in your retirement portfolio unless you plan to be dead soon. If so, you should try to buy more life insurance with your money. So, these words by Mr. Saletta are simplistic but the overall argument has merit.

By Chuck Saletta | November 06, 2016

As a retiree, you face conflicting priorities for your money. On one hand, you will likely need to take money out of your investments to cover your costs of living. Money you need for near-term expenses does not belong in stocks. On the other hand, the money to take care of your longer-term needs can remain invested in stocks.

After all, costs of living can rise for retirees faster than overall inflation. For instance, healthcare-related costs typically increase faster than overall inflation, and people frequently need more healthcare services as they age. Unless you already have enough saved up to directly cover your (inflation-adjusted) costs of living for the rest of your life, you’ll need money invested in assets like stocks that have the potential to grow.

Balancing stocks and bonds for retirees

Your retirement may very well last 30 years or more. That’s a long time for your investments to have to provide for you, and striking the right balance between stocks and bonds is a critical part of helping your money last as long as your retirement does.

If you put too much in bonds, particularly in today’s low interest rate environment, you risk not having enough long-term returns to cover your costs later in retirement. On the flip side, if you keep too much in stocks, then you risk having to liquidate shares to cover your costs of living when the market is moving against you. Enough of those forced liquidation events could also put you at risk of running out of money before the end of your retirement.

Somewhere in between is the sweet spot. Your goal is to have enough in higher-certainty investments like bonds to cover your near-term costs, and enough in higher growth potential investments like stocks to cover your longer-term needs. To achieve the right balance, you need two things: enough in bonds to cover a market swoon, and enough in stocks to let “normal” market returns replenish your bonds.

How much is enough?

A general guideline among retirement planners is something known as the 4% rule. Under that guideline, if you do all of the following,you have a very strong chance of seeing your money last at least as long as your retirement will:
• Start with a diversified portfolio of stocks and bonds.
• Withdraw 4% of the value of your portfolio in the first year of your retirement.
• Adjust your withdrawals for inflation every year.
• Maintain portfolio diversification throughout your retirement.

The 4% rule means your overall portfolio should have about 25 times the annual living expenses you need it to cover by the time you call it quits. Of that total portfolio, you need at least five years’ worth of expenses in investment-quality bonds, with those bonds selected to mature and convert to cash around the time you need to spend the money. You’ll also want enough cash to cover your immediate expenses, as even short-term bonds can move based on interest rate changes.

For instance, assume you expect to need $50,000 per year to cover your retirement expenses, and you’re anticipating $15,000 per year from Social Security. Since Social Security’s benefits are indexed for inflation, you’ll need your portfolio to cover $35,000 per year of income. By the 4% rule, that would require a portfolio of $875,000. If you assume 3% inflation, your starting portfolio might look something like this:

How to use your stocks in retirement

With a portfolio set up like that, your immediate expected living expense are covered by your cash, and your bonds will become cash at maturity to allow you to cover your future anticipated costs. That covers your near-term needs, but as your bonds mature, they’ll need to be replaced to supply your longer-term future spending needs. That’s a great role for stocks to play in your retirement.

As you own your investments, you should receive interest from your bonds and, potentially, dividends from your stocks. That cash can go toward replenishing the long-dated portion of your bonds as they march toward maturity. In addition, if the stock market cooperates, you can sell a portion of your stocks as they rise in price to also help replenish your bonds.

If the stock market performs incredibly well, you can use the excess gains to extend your bond holdings — instead of five years, perhaps you can extend it up to six, seven, or more. If the stock market suffers a downturn, you don’t need to sell right away to cover your costs thanks to your bonds and cash. Just be sure you do convert enough stocks to bonds as the market recovers over time so that you can keep that combination of flexibility and higher certainty of cash flows throughout your retirement.

Help your money last throughout your retirement

With cash for your immediate needs, bonds for your short- to mid-term future, and stocks for your longer-term future, you set yourself up with a plan that matches your assets to what they do best. That gives you a great leg up on the top financial priority most retirees have: the quest to make your money last as long as your retirement does.

Chuck Saletta has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned.

We See the Glass as Half Empty, Yet Our Cup Is Overflowing

bruegel-wedding-dance-ouMy Comments: The Prophet of Doom is not yet vanquished but… hopefully soon.

Marian L. Tupy | Wednesday, October 26, 2016

It is perhaps an understatement to say that we live in an era of great pessimism. This pessimism, while not distributed evenly across the world, appears to be felt most acutely in many Western countries, including the United States. Some two-thirds of Americans, for example, feel that the United States is heading in the wrong direction and the two main candidates for the presidency exacerbate, rather than soothe, the feeling of national gloom.

Americans feel poorer, even though their GDP per capita has never been higher. We feel less safe, even though international conflicts have almost disappeared and deaths from terrorism are extremely rare. Overall life expectancy is at an all-time high and progress is being made in curing cancer, Alzheimer’s disease, and HIV/AIDS.

It’s Not Just America That’s Doing Better

Globally, the speed of improvements in human well-being is staggering. Fueled by its embrace of capitalism and globalization, Chinese per capita income has grown by an incredible 900 percent in my lifetime. During that time, Indian life expectancy rose by a third – from 52 years to 68 years. These two countries contain close to 3 billion people and their improving living standards ought to be cause for celebration, not resentment. Intellectual Enlightenment is on the rise, replacing traditions and superstitions with reason and empiricism.

Luckily, a small, but influential, group of optimists has been trying to cheer us up. The late Julian Simon got the ball rolling with the publication of The Ultimate Resource in 1981 and The Ultimate Resource II in 1996. Indur Goklany’s The Improving State of the World: Why We’re Living Longer, Healthier, More Comfortable Lives on a Cleaner Planet came out ten years later, Matt Ridley’s The Rational Optimist followed in 2010 and Ronald Bailey’s The End of Doom: Environmental Renewal in the Twenty-first Century came out last year.

The list of optimists, which also includes a list of such luminaries as the economic historian Deidre McCloskey, Nobel Prize-winning economist Angus Deaton, environmentalist Bjorn Lomborg, psychologist Steven Pinker, economist Max Roser and statistician Hans Rosling, has just grown longer with the publication of Johan Norberg’s Progress: Ten Reasons to Look Forward to the Future. It is a must-read for anyone interested in the realistic picture of the state of humanity.

Norberg, a Swedish writer and Cato Institute Senior Fellow, has looked at the state of the world from global food supply to child labor. He found that:
“Despite what we hear on the news and from many authorities, the great story of our era is that we are witnessing the greatest improvement in global living standards ever to take place. Poverty, malnutrition, illiteracy, child labor and infant mortality are falling faster than at any other time in human history.

Life expectancy at birth has increased more than twice as much in the last century as it did in the previous 200,000 years. The risk that any individual will be exposed to war, die in a natural disaster, or be subject to dictatorship has become smaller than in any other epoch. A child born today is more likely to reach retirement age than his forbearers were to live to their fifth birthday.”

And what were the reasons for the massive improvements in global standards of living? First, Norberg credits intellectual Enlightenment, which replaced traditions and superstitions with reason and empiricism. Second, he points to the ideas of classical liberalism, which replaced serfdom and authoritarianism with individual liberty and liberal democracy. Last, but not least, Norberg notes the role played by the Industrial Revolution in replacing hunger and poverty with prosperity and abundance.

The improvements that Norberg writes about started in the West – the home of Enlightenment, classical liberalism and Industrial Revolution. As such, the West got a head start and powered ahead of the rest of the world. Inequality, as Angus Deaton wrote in his book The Great Escape: Health, Wealth, and Origins of Inequality, was the “price” that humanity had to pay for progress. Without the Western “escape” from poverty, the rest would have none to emulate.

Western Civilization Is Contagious. And So Is Its Success.

Over time, the gap between the West and the rest grew larger, reaching its apex at the start of the 20th century. But then, as Western ideas and inventions spread across the world, the gap started to narrow. The global economy is not a fixed pie. China’s economic successes do not translate to American losses.Academic researchers—from Xavier Sala-i-Martin of Columbia University to Surjit Bhalla, formerly of the Brookings Institution and Rand Corporation, to Paolo Liberati of the University of Rome—all agree that global inequality is declining.

Maybe it is too much to ask of people living in the West to feel gratified by the improvements experienced by people across the globe. Quite understandably, our point of reference is not a global, but national, standard of living.

And clearly, the speed of improvements has been uneven. Just consider the tremendous progress that China has made – at least in terms of its economy rather than its openness to democracy – since it embraced free markets in 1978, versus improvements experienced by Americans over the same time period:
But the global economy is not a fixed pie. China’s economic successes do not translate to American losses. In spite of what Donald Trump says, for example, the output of the American manufacturing sector is at an all-time high. The same cannot be said about employment in that sector, which has declined. But many of those manufacturing jobs were difficult and dangerous. There is no point romanticizing them in the same way that people in the midst of the Industrial Revolution romanticized the agricultural past. Moreover, many of the jobs lost in the US manufacturing sector have not “gone” to China. They were lost to robots, computers, and other efficiencies.

As it comes to election time, the American electorate should insist not that the United States punish China for its success by erecting barriers, but that our decision makers create an economic environment – low and simple taxation and unobtrusive regulatory regime – that will make rapid growth in the United States possible again.

Why A Market Crash Could Be Just Around The Corner

bear-market-bearMy Comments: The prophet of doom strikes again!

No, seriously, the evidence is mounting and the financial pundits are all talking about this. Some of it is the threat of a Trump presidency, which I believe is a real threat. The rest of it is mostly mathematics and economics and history.

If you have money in places where you can control how it’s invested, I encourage you to call someone and have them move it to cash or something similar. While accurately timing the market is a myth, a defensive move on your part for the next six to twelve months could eliminate a lot of chaos in your life.

Oct. 28, 2016 by INVESTIV

Summary

  • We’ll discuss some risks first and then discuss potential rewards.
  • Valuations are the tipping point toward a riskier perspective.
  • After reading this article you’ll be able to decide for yourself what the best strategy is for you to follow.

Introduction
In order to see where the market is going, let us first take a look at what the market has been doing in the last two years. The market has had a 7% yearly return if we look at it from October 15, 2014, however, if we wait a month, the yearly return for the last two years will fall to 1.8% per year. 1.8% a year plus a dividend yield of 2% isn’t bad in the current low yield environment, but it is bad when compared to the risks stock investors are running.

Risks: Where The Market Could Go

As the market is severely influenced by the actions or inactions of the Fed, the first risk comes from an interest rate increase likely to come in December. The market is already preparing for it as 10-year yields are slowly increasing and the dollar is strengthening.

This is a risk for stocks as a stronger dollar lowers international revenues in dollar terms and consequently lowers earnings. Also, higher interest rates and treasury yields will lower the demand for dividend yielders. Since this bull market started back in 2009, the yield spread between the S&P 500 dividend yield and bonds has consistently been around 300 basis points. If yields increase, the S&P 500 is bound to decline in order to continue having a yield advantage which is inherent for the risk premium for stocks.

If the FED increases rates, the risks are high. Unfortunately, if the FED doesn’t increase rates the risks are also high. The FED might not increase rates or may quickly lower them after an increase if the economic and employment situation starts to deteriorate. As we’ll show you in a moment, the economic situation isn’t that great.

The FED looks primarily at three factors: economic growth, employment, and inflation.

Economic growth has been slowing down in the last two years, alongside declining corporate earnings. The estimates foresee improving economic growth of around 2.5% for the next few quarters, but you know how estimates are, made to be missed.

Bad economic news would be detrimental for stocks as it would mean slower growth and lowered earnings, while good economic news would also put pressure on stocks with increased interest rates and a stronger dollar.

On the employment side, things have improved substantially in the last 7 years but similarly to GDP growth, labor market conditions haven’t seemed to improve in the last two years. The Labor Market Condition Index derived from 19 labor indicators has been trending down for two years now and even entered negative territory in 2016.

Inflation has been increasing in the last 12 months which isn’t a good sign if economic activity and labor conditions continue to deteriorate because it will force the Fed to increase rates even though the economics aren’t that good.

All of the above mentioned risks are a normal consequence of economic cycles as there are always things that improve and others that slow down. We can also see this in the current downturn in the oil market. But when these risks are related to current valuations, we can see the real risks low interest rates, a recession, a weaker labor market, and higher inflation create.

As the S&P 500 has a dividend yield of 2.08% and an earnings yield of 4.04%, any significant increase in interest rates would result in a bear market. Similarly, a recession, declining employment or higher wages would push down earnings as well as asset prices.

On top of internal risks, external risks could also have an impact, like fears over China had back in August 2015 and on Thursday when the index was down 1.2% at one point as a result of a decline in Chinese exports.

The main question is, when might the above mentioned risks materialize? Well, forecasting is an ungrateful profession, but I can take an approximate shot at it.

I wouldn’t be surprised if we see a bear market in the next 12 to 24 months as we are currently in an environment without clear indications, the economic growth period already exceeds the average growth period between recessions, and the current economic recovery has been the weakest since the second world war despite the incredibly low rates and quantitative easing.

Let’s attach a 50% probability for a bear market in the next two years, which is a bit higher than J.P.Morgan’s 38% probability, but in line with predictions from Deutsche Bank.

Now that we’ve shown the risks, let’s analyze the potential upside.

Rewards: Where The Market Could Go

A person yelling that the market was overvalued in January 1998 was completely right, but the market went up a whopping 36% in the next two years only to fall by 46% after 2000. Similarly, we can now yell that the market is overvalued, which it is, and then watch it climb to new highs in the next couple of years. Let’s see what the probability and reasons for such a bullish perspective are.

• The Cavalry: The FED will step in at any sign of trouble.

The current bull market is clearly fueled by the FED’s stimulus. If the market shows indications that it will drop or that there is a probable recession, the FED will probably do the only thing it can do, print more money.

• Corporate profit growth.

Unlikely in the case of a recession and with the high competition in business created by the low interest rates, but a recovery in oil prices could push earnings up and consequently the market.

• Tax Holiday: Increased buybacks and dividends due to profit repatriation.

If the government would allow corporations to repatriate the $2.1 trillion in cash stashed overseas at no cost, it would certainly give a boost to buybacks and push stocks higher as managers never think they are overpaying for their own stock. You can read more about this topic in our article here.

• Global economic growth.

As emerging markets are bound to reach the level developed countries have due to improvements in technology, trade, and capital flows, the global economy could push ahead with big strides, especially if commodities rise. This will happen for certain as commodities are a pure cyclical play.

What is the probability of the above happening? Well, faster global economic growth, corporate profit growth, and a tax holiday will all happen eventually, while we don’t know if the FED is going to increase its stimulus to prevent a market decline.

Conclusion

With market risks and potential catalysts being almost equal weight, the tipping point is valuations. Ask yourself if you are happy owning assets that can easily drop by more than 25% for a meager 2% dividend yield, a 4% earnings yield and no earnings growth.

If you are convinced that the stock market is risky, what you can do is invest in uncorrelated assets, lower your exposure to the general market, and have a larger cash position. More cash will provide you with the necessary firepower to buy if there is an eventual market downturn and stocks become much cheaper.

It’s hard to believe but Nike (NYSE:NKE) was trading below $10 a share back in 2009. A bear market will produce plenty of such opportunities so have some cash ready.

The Stage Is Set For The Next 10% Plunge In Stocks

bear-market-bearMy Comments: Some of you are starting to call me tiresome. And you are right; I keep saying the sky is about to fall and it never happens. But ignore me at your peril.

Actually, if it only falls 10%, we can all recover quickly and go about our lives once again. But my guess is it’s going to be 25%. The longer it takes to happen, the deeper it’s likely to be.

These words were written last August and still no correction. Any bets on when it will happen?

Sam Ro  |  August 22, 2016

The stock market (^GSPC) continues to trend higher as earnings growth remains lackluster. This has caused valuations to get very expensive, signaling a stock market that’s becoming increasingly due for a sharp sell-off.

Everyone is flagging this anxiety-inducing pattern, and yet the market continues to rally arguably nonsensically.

“The S&P 500 has advanced 6.8% YTD (8.4% including dividends) despite a more modest improvement in the earnings outlook (+1.4%),” RBC’s Jonathan Golub observed in a note to clients on Monday. “Put differently, the market’s move higher has been fueled almost exclusively by multiples.”

Most analysts argue that these record-high stock prices are unsustainable without a significant pickup in earnings growth. Unfortunately, there isn’t much hope for that.

“Since EPS trends have typically been associated with S&P 500 index patterns, a sharper-than-expected uptick in profits would be a necessary prerequisite for additional upside,” Citi’s Tobias Levkovich said on Friday. “[A Citi survey suggests] new positive developments would need to emerge to justify more in terms of net income generation. With outstanding issues such as the impact of Brexit and/or fiscal policy post the US elections, it seems challenging to come to any powerful conclusions at this juncture.”

The Fed wants to hike, and the S&P fell 10% after the last hike.

Economic data in the US has been positive, highlighted by notably strong labor market and housing market data. This has put pressure on the Federal Reserve to tighten monetary policy with an interest rate hike sooner than later.

In fact, three members of the Fed have signaled that a hike will come sooner in just the past week. Last Tuesday, NY Fed President William Dudley said “we’re edging closer towards the point in time where it will be appropriate to raise rates further.” On Thursday, San Francisco Fed President John Williams said every meeting, including the one coming in September, should “be in play” for a rate hike. On Sunday, Fed Vice Chair Stanley Fischer said “we are close to our targets.”

“A more hawkish Fed could trigger a return of volatility if financial conditions (USD, credit spreads) start to deteriorate again,” Societe Generale’s Patrick Legland said on Monday. “The S&P 500 fell c.10% following the first rate hike last December.”

In that same breath, Legland warned of the importance of earnings to the stock market.

“US company earnings were better than expected in Q2,” he acknowledged. “But the sharp increase in valuation ratios (S&P 500 forward P/E 17x, P/B 2.9x) puts the onus on EPS growth at a time when global GDP growth remains uninspiring.”
16-09-forward-12-month

Could fund flows save the day?

The sad thing about the current stock market rally is that it comes at a time when retail investors are spilling out of the stock market. “US equity funds saw outflows deepen to a new 6 year low in July,” Credit Suisse’s Lori Calvasina observed on Thursday.