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The Market Is Finally Getting the Joke

My Comments: I struggle, day to day, just like you, to figure out what the markets are going to do because so many of my friends and clients are exposed to market risk. Are you exposed to market risk? Does it worry you at all?

If not, you don’t need to read this. But if it does worry you, then perhaps a few minutes reading these comments from Scott Minerd will be good for you. And oh yes, there are ways to shift the risk of a downward correction to an insurance company and by so doing, preserve your principal and market gains from a crash.

Scott Minerd, February 21, 2018

The last two weeks have been pretty exciting, certainly a lot more interesting than anything we’ve been through over the last year. Given the recent market dislocation, there is a basis to rebalance portfolios and do trades to take advantage of relative repricing. At a macro level, it should not surprise anyone that rates have begun to rise—we have been talking about the Federal Reserve (Fed) tightening, we have been talking about how the Fed is behind the curve, how the market has not believed the Fed, and that someday this was going to have to get resolved, probably by the market having to adjust to the Fed’s statements. The market has now gotten the joke. I still don’t think the yield curve is accurately priced, but it is a lot closer today than where it was at the beginning of the year.

The concern, as I explained in A Time for Courage, is that now the market is moving from complacency—where it really did not believe the Fed was going to do what it said it was going to do—to a time when it has begun to realize that the Fed may be behind the curve. The market is now coming to believe that the Fed is not going to make three rate increases this year, it is going to make four. And so, rates start to rise and the whole proposition that the valuation of risk assets is based upon, which is faith in ultra-low rates and continued central bank liquidity, comes into question. As markets lose confidence in that view, investors have started to rearrange the deck chairs by repositioning portfolios.

Anytime we see strength in economic data, we are going to see upward pressure on rates. Upward pressure on rates is going to result in concern over the value of risk assets, and we are going to have a selloff in equity markets, or the junk bond market, or both. Credit spreads will widen. The reality of the situation, however, is that the amount of fiscal stimulus in the pipeline, the U.S. economy fast approaching full employment, the economic bounceback in Europe, and the pickup in momentum in Japan and in China are all real. Against this backdrop, even a harsh selloff in risk assets is not going to derail the expansion.

The Fed knows this, and for that reason the Fed is shrugging its shoulders and saying, “Okay, we don’t have a mandate around risk assets, but we do have a mandate about price stability and full employment. And it looks like we’re at full employment or beyond full employment, and the thing that seems to be at risk now is price stability. We’ve got to raise rates.”

What does that mean for investors? Markets are engaged in a tug of war between higher bond yields and the stock market. In the near term, the two markets will act as governors on each other: Higher bond yields will drive down stock prices, and lower stock prices will cause bond yields to stop rising and to fall.

“The market is moving from complacency about the Fed to realizing that it may be behind the curve.”

Scott Minerd


An analogue to today may be 1987. That year began against the backdrop of 1985/1986, which had seen a collapse in energy prices. In 1986 oil prices were very low, and concerns around inflation had diminished. The Federal Reserve had dragged its feet on raising rates. As we entered 1987, in the first few months of the year the stock market took off. By the time we got to March, stocks were up 20 percent. In April there was a hard correction of approximately 10 percent. As fear overtook greed, market participants became cautious on stocks. Going into that summer the stock market rallied another 21 percent from the April lows. By August we were at record highs; interest rates started to move up; the Federal Reserve was raising rates; the dollar was under pressure; and there were increasing concerns over inflation. The concern was the Fed was behind the curve as it accelerated rate increases. By October things were becoming unhinged. Bond yields had risen in the face of an extended bull market in stocks. The market reached a tipping point and began its infamous slide. By the time we got to the end of the year, the stock market for the year was up just 2 percent. That was the stock market crash of 1987, which wiped out about a third of the value of equities in the course of a few weeks.

Today, investors have the same sorts of concerns they had in 1987. For now, the market has gotten a reprieve. Soon, investors will start to have confidence in risk assets again. Risk assets like stocks will start to take off. Eventually, the perception will be that the Fed is falling behind the curve because inflation and economic pressures will continue to mount. Eventually the Fed will acknowledge that three rate hikes will not be enough, but it is going to raise rates four times in 2018, and market speculation will increase that there may be a need for five or six rate hikes. That will be the straw that breaks the camel’s back.

This is a highly plausible scenario for this year, but who knows how these things play out in the end. The reality today is that the economy is strong, interest rates are rising, and equities look fairly cheap. The Fed model right now would tell you the market multiple should be 34 times earnings. That is just fair value, not overvalued. And based on current earnings estimates for the S&P this year, the market multiple is closer to 17 times earnings. If stocks go down by 10 percent, the market multiple would drop to 15 times earnings. This would be getting into the realm of where value stocks trade. If there were a 20 percent selloff, you’re at a 14 times multiple. These market multiples don’t make sense. Markets do not price at 14 times earnings in an accelerating economic expansion with low inflation.


A Time for Courage

My Comments: In past blog posts I’ve shared the words, and wisdom, of Scott Minerd. He’s one of the principal brains at Guggenheim Partners, a major player on the world stage when it comes to investing money. (BTW, this pic of Scott is from 12/21/2015)

Right now many of you are rightly worried by the fall in equity prices on Wall Street, if not across the planet. Don’t equate a crash on Wall Street with the American economy. What it means is there are strong feelings about the high valuations that we see in the DOW and the S&P500.

Is it time to bail out and wait for the bottom to appear? Probably not. But don’t take my word for it. Read below what Scott is saying and then sit back. From a strategic perspective, you need to decide how much of your overall portfolio is exposed to the markets and how much of it should be protected against severe downside movements. There are insurance policies available that make this possible and the price is reasonable.

By Scott Minerd, Chairman of Investments and Global CIO – 02/06/2018

In what otherwise might have been another quiet Monday with investors lulled to sleep by the low volatility world of the past year, I was surprised to be suddenly overwhelmed with a deluge of calls late in the day from clients and the media asking for an explanation of the collapse in equity prices. My answer in a word was simply “rates.”

The backup in bond yields has been significant, with the 10-year Treasury rising 23 basis points in the last month, and hitting a recent peak of 2.88 percent. The tax cut euphoria drove stocks up at an unsustainable pace, but concerns have been building about bond market supply congestion following the Treasury Department’s refunding announcement, and Friday’s employment report has increased speculation that the Fed may need to become more aggressive to head off potential inflationary concerns.

Contributing to inflation worries is impressive wage growth. Hourly earnings were up 0.3 percent in January and upwardly revised for December to 0.4 percent, supporting the concept of wage growth of 4 percent or more for 2018. These data are trending up even before we fully digest changes to the minimum wage and the effect of wage increases and bonuses related to the new tax plan. These are likely to give a lift to consumption, which will reinforce more labor demand, and thus drive unemployment lower.

Dare I say that some in the market are becoming concerned that the Federal Reserve may be falling behind the curve, especially as evidenced by the recent steepening in bond yields? This is also a possibility. The consensus for future rate hikes, was moving to four rate increases in 2018, and possibly more.

I think that the setback (the largest one-day point decline in history) is not over but we are approaching a bottom. This correction is a healthy development for the markets in the long run, and the equity bull market, while bloodied, is not broken. The lower bond yields will help but the curve steepening speaks more of flight to safety in times of market turmoil than concerns over the economy.

Ultimately, my previously held market views are intact. I still hold the opinion that the favorable economic fundamentals that are in place, where we are in the business cycle, the breadth of the market, and levels of current valuations are supportive of equities. Buying here will probably make investors happy campers later in the year, but the tug of war between stocks and bonds is just getting under way. This may be the big investment story for 2018.

Forecasting the Next Recession

My Comments: I may have retired from providing investment advice but I’ve not yet left the building. What happens in the world of money still interests me both professionally and personally.

Attached to this post, by way of a link to a 12 page, downloadable report, is a projection from Guggenheim that says we’ll experience a recession roughly 24 months from now.

Whether they are right or wrong, the next one is somewhere on the horizon. Knowing in advance when it might happen will help manage the financial resources you have that pay for your retirement.

Just don’t confuse the timing of a recession with the timing of market corrections of 10% or more. While there is some correlation, it is far from 100%. Also keep in mind the stock markets price things based on what people THINK will happen, not what actually does happen.

Here’s the link to download a copy of the report: Forecasting the Next Recession.

One Of The Most Overbought Markets In History

My Comments: As someone with presumed knowledge about investing money, my record over these past 24 months has been pathetic. I’ve been defensive, expecting the markets to experience a significant correction “soon”…

I lived through the crash of 1987, the crash in 2000, and then the Great Recession crash in 2008-09. I saw first hand the pain and chaos from seeing one’s hard earned financial reserves decimated almost overnight.

Only the crash hasn’t happened. But every month there are new signals that one is imminent. And still it doesn’t happen.

I’ll leave it to you to decide if what Mr. Bilello says makes any sense. I’m not sure it does.

by Charlie Bilello, October 22, 2017

The Dow is trading at one of its most overbought levels in history. At 87.61, its 14-day RSI is higher than 99.999% of historical readings going back to 1900.

(Note: Developed by J. Welles Wilder, the Relative Strength Index (RSI) is a momentum oscillator that measures the speed and change of price movements. RSI oscillates between zero and 100. Traditionally, and according to Wilder, RSI is considered overbought when above 70 and oversold when below 30. Signals can also be generated by looking for divergences, failure swings, and centerline crossovers. RSI can also be used to identify the general trend. TK)

Sell everything?

If only it were that simple. Going back to 1900, the evidence suggests that such extreme overbought conditions (>99th percentile) are actually bullish in the near term, on average.

Come again? In the year following extreme overbought readings, the Dow has actually been higher roughly 70% of the time with an average price return of 14.2%. From 5 days forward through 1-year forward, the average returns and odds of positive returns are higher than any random day. While the 3-year and 5-year forward returns are below average, they are still positive.

Does that mean we’ll continue higher today? No, these are just probabilities, and 30% of the time the Dow is lower looking ahead one year.

What it does mean is that one cannot predict a market decline based solely on extreme overbought conditions. Declines can happen at any point in time and “overbought” is neither a predictor nor a precondition of a bear market to come.

If one is going to predict anything based on extreme overbought conditions (and I would advise against doing so), it would be further gains. I realize that doesn’t conform to the conventional narrative of “overbought = bearish,” but the truth in markets rarely does.

FIA: Dream Investment or Potential Nightmare?

My Comments: The article below by Jane Bryant Quinn in the AARP Bulletin are fine, as far as they go.

My initial reaction was to reject her comments out of hand as they reflect a bias that to my mind is not accurate. But then I decided to expand on her thoughts. I apologize if I made this too technical for some of you.

Most of the Fixed Index Annuities (FIA) sold are probably very close to having the features and limitations she describes. If there is indeed $60B flowing into FIAs each year, then they are being sold by every run of the mill agent across the planet. And most of those are probably selling whatever their company is telling them to sell. A strong reason for them to sell FIAs is that they make good money for the company. If the client benefits, it’s an incidental benefit for most of them.

I decided to add my two cents worth, below in red, based on what I know after 40 plus years as an entrepreneur in financial services, and the qualities and features of the FIAs I’ve chosen to present to potential clients. You should draw your own conclusions about the merits of FIAs, or the lack thereof.

by Jane Bryant Quinn, AARP Bulletin, October 2017

I’m getting mail about an apparent dream investment. It promises gains if stocks go up, zero loss if they fall and guaranteed lifetime income, too. What’s not to like? Plenty, as it turns out.

The investment is called a fixed-index annuity, or FIA, and it’s issued by an insurance company. Sales are booming — $60.9 billion in 2016. FIA contracts vary, but this is how they work. (Sales are booming, not so much because of the financial benefits, but because they offer emotional benefits as well. ie “I get to stay invested in the markets and I won’t lose any money…”)

You buy the annuity with a lump sum, which goes into the insurer’s general fund. You are credited with a tax-deferred return that’s linked to the market — for example, to Standard & Poor’s index of 500 stocks. If the S&P rises over 12 months, you receive some of the gain. For example, your credits might be capped at an increase of 5 percent, even if the market soars. If stocks go down, you take no loss — instead, your FIA receives zero credit for the year. ( Many FIAs do have caps limiting the upside potential. The one’s I offer clients have NO caps. If the index goes up 50%, you get 50%. If it goes down 50%, you get nothing credited. You have shifted the downside risk to an insurance company. It also means that when the market goes back up again, you are starting from zero and not from somewhere lower. That in turn means at the end of the next crediting period, you are higher than if you were starting in a hole somewhere.)

Each year’s gains or zeros yield your total investment return. . (Your money is NOT invested in an index, whether it’s an S&P500 index or any of dozens of other indices. The yield on bonds inside the insurer’s general fund is used to buy option contracts and the return given the client is a function of the performance resulting from those options.) But I see problems:

Low returns. Salespeople might claim that FIAs could earn 6 or 7 percent a year. But with fees, they’ll struggle to match the low returns from bonds, says Michael Kitces of the wealth management firm Pinnacle Advisory Group in Columbia, Md.(The product I prefer buys 2 year option contracts with the bond yield. Over a ten year period, any ten year period since 2000, a 2 year option result exceeds two consecutive one year options 87% of the time. Some of this is due to the fact that 2 year options are cheaper than 1 year options. In this scenario, a 6% geometric mean return is not unreasonable.)

High fees. You can’t find out what you’re paying for investment management. Costs are buried in the black-box system used to adjust the credits to your account. Sales commissions run 5 to 7 percent and may be hidden, too. Under the new fiduciary rule, which requires advisers to put your interests ahead of theirs, commissions have to be disclosed if you’re buying the annuity for a retirement account, but not for other accounts.

Salespeople sometimes claim, falsely, that their services are free. (Numbers shown in hypothetical illustrations provide by sales agents are always net of fees. At least the ones I show prospective clients. Yes there are obviously costs inside FIAs. I’m sorry but no one works for free. What is critical, however, is the net return to you the buyer.)

Profit limits. Every year, the insurer can raise or lower the amount of future gain credited to your account. You face high risk that returns will be adjusted down. (Yes, this happens. It’s a function of market cycles, of interest rates in general, and the performance of the index chosen. The FIAs I offer have NO CAPS and will credit whatever the option used calls for.)

Poor liquidity. You can usually withdraw 10 percent in cash, each year, without breaking your guarantee. But you’ll owe surrender charges if you need your money back before five or 10 years are up. You might also forfeit some gains. ( This lack of liquidity is the price you pay for shifting the risk of loss to an insurance company. It’s the same thing you do with your car, your house, your life when you buy life insurance, etc. The benefit to you from this ‘cost” is the avoidance of downside risk associated with market corrections. Without the ability to offset this risk to an insurance company, many people opt instead for ‘guaranteed’ returns which actually means you are guaranteed to go broke if you get less than the increase in the cost of living. The cost of a guaranteed returns might mean you run out of money sooner.)

Lifetime benefits. For about 1.5 percent a year, you can add a “guaranteed lifetime withdrawal benefit” to your FIA. Promised yearly payments run about 5 percent. But, Kitces asks, why do it? Your basic FIA already provides a lifetime income. What’s more, 5 percent is not a return on your investment. The insurer is merely paying you your own money back, in 5 percent increments — and charging you 1.5 percent for the “service.” If you live long enough, you’ll exhaust your money and the insurer will pay, but that doesn’t happen often. ( I choose not to offer these anciliary benefits to clients. They serve to make more money for the company by playing to your fears.)

For a guaranteed income, try a plain-vanilla immediate or deferred annuity. It’s cheaper, and you’re not apt to be led astray. (It’s possible you will be led astray. The rules today do not support a fiduciary standard. They should, but our current administration is working hard to avoid that outcome. It’s back to buyer beware despite the best efforts of some who think all financial advisors should be legally required to work in a clients best interest.)

On balance, Jane Bryant Quinn’s comments are essentially correct. But only if you are talking about the arguably poor contracts that so many companies and their agents are interested in selling. If you find someone who is happy and willing to act in your best interest, you are much more likely to find FIAs that resemble the contracts I prefer for my clients. They are a way for you to stay invested in the markets and at the same time, remove the risk of market losses within a crediting cycle.

Don’t Screw Up Index Investing By Making These 3 Mistakes

My Comments: First, my thanks to all of you who wished us well during IRMA’s visit to Florida. We came through unscathed. We were without power for a number of days and believe me when I tell you cold showers every day are not much fun. And we are now watching Maria carefully.

Second, there is increasing evidence that active asset management is starting to pull ahead of passive investing, which is the focus of this article, written a year ago by Walter Updegrave. Some of the references may be out of date but not the underlying message.

Passive investing as a strategy is always ok for some of your money. Overlaying it with some tactical steps to add value is the next step, something that can be done effectively without going all in with skills you perhaps don’t have.

Walter Updegrave – August 10, 2016

For consistently competitive returns, index funds and their ETF counterparts are the way to go. If you doubt that, just take a look at this new Vanguard research paper that lays out the case for indexing and check out the latest S&P Dow Jones Indices index vs. active scorecard, which shows that fewer than 20% of large-company stock funds beat the Standard & Poor’s 500 index over the five- and 10-year periods ending Dec. 31. But just buying index funds and ETFs doesn’t guarantee investing success. To do that, you’ll also need to steer clear of these three all-too-common indexing mistakes.

Mistake #1: Assuming all index funds are cheap. Since index funds simply buy the stocks or bonds that make up indexes like the Standard & Poor’s 500 or Barclays U.S. Aggregate bond index rather than spend millions on costly research and manpower to identify which securities might perform best, they’re able to pass those savings along to shareholders in the form of lower annual fees. Lower fees translate to higher returns and more wealth over the long term. That advantage is especially valuable today given the forecasts for lower-than-usual investment returns in the years ahead.

But not all index funds and ETFs are bargains. While many are available at an annual cost of 0.10% or less, others sometimes charge 10 times or more than that amount, according to Morningstar data. For example, one fund, Rydex S&P 500 Class C, levies a whopping 2.31% in annual expenses, prompting this headline on a recent post about the fund on the American Institute For Economic Research’s Daily Economy blog: “Is This the Worst Mutual Fund in the World?”

Before you invest in an index fund or ETF, make it a point to know how much it charges in annual fees, especially if you’re investing through a broker or other financial adviser. Then don’t buy unless its expenses compare favorably to funds or ETFs that track the same benchmark. You can gauge whether you’re overpaying by seeing how the expenses of the fund you’re considering stack up versus the expenses of the index funds and ETFs that made the cut for the Money 50, Money Magazine’s list of the best mutual funds and ETFs.

Mistake #2: Playing the niche index game. The beauty of index investing is that it allows you to easily and inexpensively create a well-balanced portfolio for retirement savings or other money you’re looking to invest. For example, by combining just three funds—a total U.S. stock market index fund, a total international stock index fund and a total U.S. bond market index fund (or their ETF counterparts)—you have the foundation for a broadly diversified portfolio of stocks and bonds that can get you to and through retirement.

But many investors fall into the trap of believing that the more bases they cover, the more diversified and better off they’ll be. And investment firms are all too willing to oblige them by marketing ever more specialized index offerings, allowing investors to invest in indexes that track everything from wind power and cyber security to obesity and organic foods.

Diversity is a good thing, but you don’t want to overdo it. Once you have a diversified portfolio of stocks and bonds, the extra benefit you get from venturing into investments that focus on narrow slices of the market or obscure niches can be minuscule or even disappear, since more arcane investments often carry higher fees. You also run the risk of ending up with an unwieldy and overlapping jumble of holdings that’s difficult to manage. And, let’s face it, a lot of what’s done in the name of broader diversification is really more about riding the latest fad.

In short, the more you stick to tried-and-true index funds that track wide swaths of the market at a low cost and resist the temptation to invest in every new indexing variation some firm churns out, the less likely you’ll end up “di-worse-ifying” rather than diversifying your portfolio.

Mistake #3: Using index funds to gamble rather than invest. When the indexing revolution got underway back in the 1970s, the idea was for investors to track the performance of broad market benchmarks like the Standard & Poor’s 500 index. The rationale was that since it’s so difficult to outperform the market, investors are better off trying to match the market’s return as much as possible.

Today, however, many investors see index funds as vehicles that can help them juice performance by quickly darting in and out of the stock or bond market as a whole or making bets on a sector they believe is poised to soar, be it growth, value, small stocks, energy, technology, whatever. ETFs are especially popular with such investors since, unlike regular index funds, ETFs are priced constantly throughout the day and can be traded the same as stocks.

Problem is, succeeding at this approach requires investors to have the foresight to know where the market or specific sectors are headed. That’s a dubious assumption at best. Consider how investors swarmed into tech and growth stocks at the end of the ’90s dot.com bubble, confident that double- or even triple-digit returns would continue, only to see shares crash and burn. Or, more recently, how pundits were predicting Armageddon for stocks in the wake of the Brexit vote, only to see the market climb to new highs.

Bottom line: Indexing works best when you use low-cost index funds that cover broad segments of the stock and bond markets as building blocks to create a diversified portfolio that matches your tolerance for risk—and that, aside from periodic rebalancing, you’ll stick with through good markets and bad. Remember that, and you’ll be more likely to benefit from all that indexing has to offer.

Why Sign Up for Medicare If I Have Insurance Already?

My Comments: I’m increasingly asked about signing up for Medicare at 65 or not. This happens as more and more of us are still working at age 65 and expect to keep working for several years to come. This article by Matthew Frankel will give you the background necessary to help your decision.

by Matthew Frankel \ Jul 16, 2017

The standard eligibility age for Medicare in the United States is 65. However, many people don’t know if they need to sign up for Medicare if they already have other health insurance coverage, such as through a job, a spouse’s employer, from their former employer, or through COBRA. Here’s a quick guide that can help you determine if you need to sign up for Medicare when you turn 65 or if you can wait longer without paying a penalty.

How Medicare works with your other insurance

When you have more than one insurance provider, there are certain rules that determine who pays what it owes first and who pays based on the remaining balance. For seniors who don’t have other insurance, Medicare is obviously the primary payer. However, when you have other insurance, it’s a little more complicated.

Depending on the type of insurance you have (group coverage, retiree coverage, COBRA, marketplace coverage, etc.), Medicare can either be the primary or the secondary payer. If Medicare would be a secondary payer to your current insurance, you can delay signing up for Medicare Part B. If your current insurance would become a secondary payer to Medicare, you should sign up during your initial enrollment period, which is the seven-month period that begins three months prior to the month you’ll turn 65.

It’s also worth noting that although I’m specifically mentioning Medicare Part B, which is medical insurance, this applies to Part A (hospital insurance) as well. However, Medicare Part A is free to the vast majority of Americans, so it’s probably worth signing up for Part A whether you’re required to or not. On the other hand, Medicare Part B has a monthly premium you’ll have to pay, which is why it can make sense to delay signing up if it’s not going to be your primary insurance.

Who can delay signing up for Medicare?

So, whose insurance remains the primary payer? In a nutshell, if you have coverage through your or your spouse’s current employment, and the employer has 20 or more employees, your insurance plan remains the primary payer.

If you aren’t sure if your employer meets the “group health coverage” criteria, ask your employer’s benefits manager.

If you do qualify, you can delay signing up for Medicare for as long as you (or your spouse) are still working. Once the employment or your employer-based health coverage ends, you’ll have eight months to sign up for Medicare Part B without paying a penalty, which is a permanently higher premium.

It’s also important to note that regardless of whether you’re still working or not, if you’ve already signed up for Social Security benefits, you’ll be automatically enrolled in Medicare Parts A and B when you turn 65. If you don’t want to keep Part B, you’ll need to cancel it (instructions are on the Medicare card you’ll receive).

Who should sign up at 65, even if they have other insurance?

This leaves a fairly long list of other types of insurance that become secondary payers to Medicare. Therefore, if you’re turning 65 and any of these situations apply to you, you should sign up for Medicare during your initial enrollment period.

• You have group coverage through your or your spouse’s employer, but the employer has fewer than 20 workers.

• You have retiree coverage, either through your former employer or your spouse’s former employer.

• You have group coverage through COBRA.

• You have TRICARE, the healthcare program for military service members, retirees, and their families. Retired service members must get Medicare Part B when eligible in order to keep their TRICARE coverage. (Note: If you’re still on active duty, you don’t have to enroll in Medicare until after you retire.)

• You have veterans’ benefits.

• You have coverage through the healthcare marketplace or have other private insurance. Once your Medicare coverage begins, you’ll no longer get any reduced premium or tax credit for marketplace coverage, and you should drop this coverage as you’ll no longer need it (unless you’re not eligible for premium-free Part A, which is not common).

If one of these situations applies to you and you don’t sign up for Medicare Part B during your initial enrollment period, you could face permanently higher premiums when you do.