Long post and food for thought for those willing to read into the numbers instead of relying “experts” for counsel. , I will include some real investment tips for those who think long term and rightfully view the “consensus” mentality with scorn and contempt.
I take the pessimist’s view that, sometime in the near future (think 10 years, or even fewer), the 20 year annualized return of the US stock market will plunge from its current rate to 5% or less.
This abysmal outcome makes municipal bonds, which are tax free and generate around 5-8% a year, the more attractive option for most investors.
Now most of you are aware of the impending crash. As David Stockman (former Reagan OMB official and a current critic of neoliberalism) argues, stocks on average are trading at 25x GAAP earnings, when the historical average is 15x. This indicates an approximate 40%+ crash in the immediate horizon of 0-12 months. It is possible we will have another “melt-up” 1999-2000 style and a crash delayed, but don’t bet on it.
But what of the aftermath?
One statistic that many financial advisers do not tell you, and simple-mind(lessly) encourage you to “dollar cost average” a SP 500 ETF whenever possible, is the historical, declining rate of returns. This is either due to their sheer ignorance or the fact they need to lie to earn their living.
Let’s examine the facts to avert the web of chicanery and deceit:
I’d like to direct your utmost attention to the LOGARITHMIC line graph on the right hand margin. This renders the stock market climb less dramatic and allows you to view the ~20 year stagnation (~1996 to 2009) with greater clarity; incidentally, this period is where dividends were more likely to comprise a huge percentage of portfolio growth as opposed to stock appreciation (the expectation).
Astute readers will also note that the post-war growth years from 1950 to the early 1970’s were some of the best. This post-war boom translated into better corporate earnings and profits, which is what ultimately fuels stock market growth in the long run. It is not the Fed’s financial engineering nor binge spending by government, corporations, or households, but whether the capitalist system can continue to surge ahead in terms of productivity and demand for goods/services.
The second chart you should investigate is “Annual Returns.” Here, Wikipedia provides anywhere from 5 yr to 25 yr annualized return rates.
This is where I make my case – you will see a clear, definite, and secular (non-cyclical) decline in the 15, 20, or 25 annualized growth rates from the year 1998. My prediction is this trend will continue indefinitely, plunging below 5%.
Of course, I would be remiss to not stipulate some of my own assumptions. Here they are:
1) I excluded the 5 and 10 year annualized rates from this analysis because the unorthodox Fed policies of the last 9 years are unlikely to be replicated ever again with such “auspicious” results (“success”), and even if they were to be implemented, it will eventually lead to a Japanese-style recession or stagnation – therefore my point of a secular decline holds true regardless of which option the people in power take. 5 years and 10 years are subject to numerous fluctuations (“noise”) don’t capture the true dynamic of this process.
2) I will err on the side of caution and assume we will not see another “Internet revolution” of the 1990’s for decades, as that phenomenon was the culmination of decades of R&D beginning with ARPA-net in the 1960’s. The system today is more concerned with funneling money to the top, building weapons against imaginary enemies, and enriching the capitalist oligarchy at the expense of average Joe and Jane. There is no “magic bullet” this time that solves the problem of declining corporate profits, rising debt, and stagnant wages.
You had better prepare for the storm.
Aside: The Wikipedia figures do NOT account for inflation (correct me if I’m wrong about this), which means the annualized return rates should actually be even LOWER.
Lastly, I assume the US government will not go on a spending binge (“Keynesian economic policies”) nor will it attempt NIRP (Negative Interest Rate Policy) to prop up a sagging economy during the next major crisis. Keynesian ideas have been largely abandoned by the “ruling class,” because of the sheer debt-to-GDP ratio that already exists and the fear of inflation by creditors. As for NIRP, we already have real-world examples of their failure, and whether the Fed chooses to partake in such folly has no effect on my conclusion: the decline is real and irreversible, short of extraordinary circumstances (such as a non-nuclear World War or a mythical “deus ex machina” technology development out of nowhere).
This leaves the Fed and the US government powerless against the intrinsic forces of capitalism, and it is now we finally approach the million dollar question you’ve ALL been waiting for. (By “million dollar question,” I literally mean just that – making the wrong choice could indeed cost you millions down the road)
What SHOULD you invest in?
Here, I will outline general ideas instead of specific cases. This is because I am not a “professional” financial adviser (though I certainly consider myself more intelligent than 95% of them, and I am probably understating that figure), and I am a strong proponent of doing your own research. Learning is a fun and exciting process, and letting someone tell you what to think/do isn’t.
My first and foremost rule of investing is to minimize possibility of loss. These choices outlined below will indicate level of risk.
The first alternative to mindlessly buying a SP 500 ETF after it crashes is to look abroad. China is steeped in debt currently, but still has room to restructure due to its growing economy (though it WILL be painful in the short term), and will likely not turn into Japan (or the USA) for at least another 20-30 years. Additionally, the yuan will, at some point, replace the dollar, which places a premium on their asset values. Chinese stocks are a good bet for the future.
That being said, make sure you read their balance sheets and remain skeptical of any figures they put out, as Chinese companies have a reputation for being dishonest. (Anyone who has tried using Alibaba knows this already)
Some developing countries that still have room to expand – India, Chile, Mexico, Malaysia, Vietnam, Indonesia, and South Africa. Make sure you do the research on currency issues, corruption, etc. and you will minimize risk. (I didn’t include Brazil because their government is well known for being highly corrupt, and Russia routinely deals with international sanctions that harm their economy)
The second alternative, if the first is too cumbersome, is to look into USA municipal bonds. Here, I will suggest Investopedia and talking to whichever brokerage you use. Tax-free returns are certainly nothing to scoff at and most cities will not default on their debt.
Don’t panic sell municipal bonds just because their prices goes down, hold them until the price goes back up or it matures. You will get your full principal back + 5-8% interest.
Edit: I apologize for assuming muni yields was 5-8%, my knowledge on muni’s came from something I read almost 10 years ago. As of now, the yield on A-rated 30 year bonds is only 3%. This is the result of the Fed’s financial engineering, as historically muni’s pay upwards of 5%. When the dust settles, they will be attractive options once again!
The third option is to buy a mix of domestic stocks (but not ETFs) and US long-term treasury bonds. I know, your financial advisory tells you not to buy bonds until you’re nearing retirement. I know, your financial advisory tells you to buy ETFs because “diversification.”
That’s a load of horse-dung (not the “diversification” part, which you should do, I mean everything else).
On long-term bonds: the US is nowhere near to defaulting on its debt and investors worldwide flee to US bonds (a safe haven) when economic crisis is in full force, which pushes price up and yields down. When growth – or what little growth there will be -picks up again, you can sell the bonds for a good price. A bond fund is an acceptable substitute.
On ETFs: I’ve stated earlier using well-reasoned arguments and deduction that the picture for the entire stock market looks bleak, but there is still room for a minority of corporations to shine. Some blue-chips like Visa and Home Depot will continue to grow. (Don’t buy them now!) This is where, once again, you must do your own research, and remember to DIVERSIFY across individual stocks and sectors – just don’t trust the ETF nonsense.
The 15 year ETF hype will go away at some point and the SP 500 will not be a good investment when you can earn 1.5x or 2x more in SAFER alternatives.
I recommend a minor portion (25% maximum, 5% minimum) be allocated to cash. Cash is the most liquid form of wealth, but it slowly loses value even under low inflation (1-2%). Grade A muni bonds yield 3%, but you might have to wait 3-12 months for the bond to regain the price you paid for if you need the money that badly (which you shouldn’t).
Alternatively, I know there are some people obsessed with the idea of systemic collapse (not just the economy, as in EVERYTHING goes to shit). Stockpiling food, water, medical supplies, ammo, etc. and “living off the grid.” I don’t recommend this since I don’t think such a scenario is likely in the next 10-20 years. The decline of capitalism in the West introduces new parameters of uncertainty, but it would take the likes of nuclear war or depletion of fossil fuels to destabilize the entire construct (at which point your investments will be the last thing to worry about).
It is certainly important to pay down debt as quickly as possible, or join the growing # of student loan defaulters…just keep in mind the risks involved. I have no say on this matter.
Good luck to all of you.