Feeling a Bit Better…

That’s odd. Writing about the recent death of two friends somehow improved my mood. I have the mental energy now to get back to the gloomy subject of my last two blog posts.

Last week, I told you what I think about the state of the US economy. And I made some predictions, none of which were good. I predicted:

* Higher inflation

* A deeper recession

* Deflation of real estate

* The collapse of NFTs and most cryptocurrencies

* At least one more major stock market plunge – as much as an additional 30%

* And, possibly, the end of the dollar as the world’s reserve currency

The CPI index, which is now 8%, will move towards double digits next year. The negative GDP growth we’ve experienced over the last two quarters will continue. And those “robust” job reports that the Biden administration has been touting – they will soon be inverted into massive layoffs and record-breaking unemployment.

The stock market will drop at least another 30%, bringing investor assets down to half of what they were a year earlier. Government bonds and savings accounts will offer paltry returns of less than 5%, while inflation passes 10%. Gold might go up. Some commodities might go up. Energy stocks might do well. But none of that seems certain.

What does feel certain is that, because of the size of the problem this time, the US economy is not going to spring back to pre-2022 levels in a year or two, as it did in past corrections.

It’s foolish to try to predict both the level and the timing of a future economic event. But I’m going to go out on a limb and say that the stock market (and other financial markets) will not regain the losses they will be suffering in 2023 for at least five, and possibly as many as 10, years.

And that will all happen even if the dollar somehow manages to hold its place as the world’s reserve currency. But there are many reasons it may be toppled this time. And if that happens, things may get even worse than the grim picture I’ve just painted.

Why trust me? 

You shouldn’t take what I’m saying here as gospel. But you should take it seriously. Because if I’m right, it’s going to affect your life in a very substantial way. It’s not as though I’m an economic analyst who has won a Nobel Prize. (See last week’s bit on Bernanke.) I did predict the last big market crash prior to 2008. And I have been able to manage my investments in such a way that they have always gone up. But I could be wrong going forward. Keep that in mind as you read on.

As you probably know, I’ve been in the investment publishing business for 40 years. During those four decades, I’ve had a catbird’s seat to watch all the major corrections. I was watching and writing about the stock market on Black Monday in 1987. I was managing a crew of market analysts during the eight-month drop that took place three years later. I was supervising a larger group of analysts during the dot.com crash of 2000.

I was also there when the sub-prime bubble burst at the end of 2007 and ushered in the Great Recession. That led to the $10 trillion sell-off of 2015 and 2016, the cryptocurrency crash of 2018, and the 20+% correction (so far) this year.

If you were reading my thoughts about the economy and investing during that time, you know that my position has always been to leave the money I already had in stocks in stocks. There were some minor positions I had in speculative companies. But for 90+% of my stock portfolio, my position was to hold on and wait.

There is, by the way, a ton of research that supports that position. Investors that diversify their stocks and hold onto them through down periods have always done much better than investors that have tried to sell high and buy low.

And until now, I’ve felt the same way. For good reason…

Since the stock market was created in 1792, the US economy has been in a state of non-stop growth. We’ve had recessions, and even the Great Depression. But the economy has always bounced back from every downturn and then gone on to achieve new heights. The stock market has followed suit. Despite minor corrections every two years or so, and major corrections every eight to 10 years, the overall trend has been upwards for 230 years.

So, yes, the US stock market has always recovered from its dozens and dozens of crashes and corrections. And there are good reasons to believe that it will recover from the current correction. The question is: When? How long will it take?

This time, things just may be different. The big problems we are facing – in terms of federal debt, private debt, and corporate debt, combined with so many negative political issues, such as the war on fossil fuels, the cost of mass immigration, the likelihood that the US will get even more involved in Ukraine or Taiwan (or elsewhere) – loom large. And the very real possibility that the dollar will be abandoned in favor of national digital currencies could mean we won’t recover as before.

These challenges could be how things are for another five to 10 years. Maybe longer. So, here is how I’m changing the advice I’ve been giving for anyone that expects to tap into their stock account inside the next 10 years. If you are counting on the value of your stock portfolio to stay, more or less, at its current level into the 2030s, you should seriously consider converting some of your stock positions to financial assets that will not be diminished by falling stock prices.

Click here for an article by John Csiszar that identifies eight places you can put your money that will keep it safe from stock market dips and crashes: Treasury bills, CDs (Certificates of Deposit), high-yield savings accounts, TIPs (Treasury Inflation-Protected Securities), fixed annuities, money market accounts, high-dividend stocks, and preferred stocks.

More on the Long, Hard Road Ahead

We received a lot of responses to Tuesday’s essay about the seriously bad state of the US economy. Most were versions of “I think you’re right! What can I do about it?” But a few were along the lines of “What do you know?” and “Why should l listen to you?”

I will give you my thoughts on “What to do” next week. Today, I want to tell you what I know and why you should, or shouldn’t, listen to me.

First, I am not an economist or investment analyst. In fact, I have no academic interest in either discipline. But since I began making an above-average income, I’ve been very much interested in understanding enough about the economy and the financial markets to build my wealth.

It started in the early 1980s, when my partner (at the time) and I began to sell financial newsletters. We built a sizable business selling the advice of the analysts and economists that wrote for us. But I noticed that their success in making money year after year fluctuated for many reasons.

And then I read that, although the stock market has returned, on average, about 9% to 10% over 100 years, individual investors that tried to beat the market (by taking advice from experts like those that worked for us) fared much worse than that. Trying to outsmart the market, it turned out, was a risky game.

Eventually, I developed my own investment philosophy. Rather than hoping to outsmart the market, I would find the safest way possible to get each submarket’s average historical rate of return. And by weighting the assets I invested in according to their historical volatility patterns, I was able to increase my family’s wealth, without a single down year, for more than 40 years.

It wasn’t rocket science. It was quite the opposite. I stuck to a few simple rules that the world’s most successful investors had recommended. And I did not deviate from them when I got scared or greedy.

That’s how I’ve always explained it. And that’s what I always believed. But a friend of mine, an autodidact economist, said something to me recently that challenged my confidence. He pointed out that my track record, however impressive, was only 40 years long. I began investing in earnest in 1982, when I started making an above-average income. It was the year that Paul Volcker broke the back of the stagflation that the US had been suffering from during the prior decade, and the beginning of the biggest bull market in equities in history.

That was then. This is now. Will my investment strategy continue to work? Or could the economy have changed in some fundamental way?

Back then, the federal debt was one trillion dollars. We had Ronald Reagan in the White House and Paul Volcker as head of the Fed. Today, the federal debt is an unbelievable $31 trillion. Our president is Joe Biden and the head of the Fed in James Powell.

As I said Tuesday, I’m preparing for a long, tough road ahead – with double-digit inflation and low-to-negative economic growth. I’m expecting rising unemployment and a larger gap between personal income and inflation. I’m expecting the stock market to take another serious dive and stay down for many years. I’m expecting to see many areas of the real estate market decline. I’m expecting cryptocurrencies to be outlawed in favor of the digital dollar, which will guarantee the continuance of both higher income taxes and inflation.

I could go on. You get the picture.

And I think it’s all going to happen very soon. In fact, I think it’s already begun.

I had a conversation with one of my builders last week. This is a man I’ve worked with for 30 years. He’s been continually employed doing multimillion-dollar projects since the day I met him. He always had much more work than he could handle. It was always hard to persuade him to take on another one of my projects. Last week, he asked me if I had anything for him. I didn’t.

What am I going to do? I’m not 100% sure. But I’ll try to have a definite answer for you next week.

Buckle Up – It’s Going to Be a Long, Hard Ride 

The Republicans are grousing about inflation. It’s higher than it’s been in 40 years, they point out. It’s hurting working-class and even middle-class Americans. And it’s all Biden’s fault.

The Biden administration originally denied the complaints about the rising consumer price index (CPI). They said it was temporary. The result of the supply-chain problem, which was clearing up. Then, when the rise persisted, they said it was nothing to worry about. We have good employment numbers. Wages are going up. The economy is healthy. Even their top fiscal and monetary appointees, Treasury Secretary Janet Yellen and Fed Chairman Jerome Powell, discounted the early CPI data as a serious economic threat, just as they disputed the data that showed that the US had slid into a recession.

Republicans are implying that if they take control of the House and Senate in the mid-term elections, they will bring inflation down by reversing Democratic policies. That’s not true, Biden is saying. If the Republicans get control of Congress, inflation will go up!

If you’re younger than 50, you were just a kid the last time the US economy had multiple years of high inflation. It may be hard to imagine what a sustained period of double-digit CPI numbers, combined with a sluggish economy, feels like. But if you were working in the 1970s and early 80s, when US economy experienced an extended period of high (double-digit) inflation, you would be alarmed.

Right now, the CPI is at 8%, while wages, on average, have gone up only 3%. That leaves a 5% gap. Five percent is not good, but the reality is even worse. There was a time when the CPI was a reliable indicator. Now, it’s skewed. The calculation no longer includes the cost of food and energy. And food and energy have gone up considerably more than 8%. For the average American, for whom food and energy represent a significant portion of the family income, the effective inflation rate is more like 12% to 15%, depending on how you do the math. That means the gap – the actual loss of buying power – is more like 9% to 12%. In other words, double-digit inflation.

Those of us that were supporting families in the 1970s and early 80s remember the effect of double-digit inflation over several years. It’s very, very significant. If your income isn’t increasing rapidly, you can feel yourself getting poorer, almost by the week.

Consider this: Four years of 12% inflation means your purchasing power drops by more than half.

The ABCs of Inflation 

Inflation is caused by deficit spending – i.e., governments spending money that they don’t have. They do this by some form of borrowing. The US does it by selling (and sometimes buying) Treasury bonds.

All responsible parents understand and teach their children that deficit spending is wrong. And children learn that they can’t have everything they want, just because they want it. Begging and pleading isn’t the right way to get it. They must earn it. Or, if they want to borrow it, they must be sure they can pay it back.

When it comes to government spending, many people seem to believe that this fundamental rule of economy (and ethics) does not apply. The politicians that vote for programs that require deficit spending, and the people that vote for those politicians, seem to believe that the same fundamental laws do not apply when it comes to the government. I’m sure some of them believe that what they are doing in ratcheting up US debt is for the greater good. If someone points out that they are spending money irresponsibly, they see such criticism as mean-spirited.

And that’s because most of them, along with most of the people that vote for them, haven’t the slightest understanding of what they are actually doing. Deficit spending and federal debt are abstractions to them. They tell themselves that what they are doing is good, that they are not interested in the theoretical warnings of the complainers. They are interested in the real world. And in helping real people by passing programs that will really help.

What they don’t know, because they don’t understand the ABCs of fiscal and monetary reality, is that the money they are spending is not real. It is IOU dollars, created out of thin air, that, one way or another, will one day be paid back.

In the meantime, they keep spending.

The programs that politicians spend money on depends on their political preferences. Historically, Democrats liked to spend money on social welfare programs. Republicans liked to spend it on warfare.

What’s happened in the last 20 years or so is that both parties have gradually widened their willingness to spend money. Democrats like war spending as much as or more than Republicans. And Republicans are happy to spend money on social programs so long as it gets them votes.

What We Should Expect 

There are many similarities to what is happening now and what was happening in the 1970s prior to the bouts of double-digit inflation we had then.

For one thing, each of those inflationary periods was triggered by Mideast energy crises (OPEC and Iran). We have an energy crisis today.

Those energy crises were triggers. But they were not causal. The cause was an accumulation of federal debt. In 1981, the debt was about $1 trillion. That was enough back then. And $1 trillion 40 years ago might be, say, $10 trillion today. But the federal debt is now $31 trillion. In absolute terms, that is 31 times more. Even in relative terms, it’s greater by 300%.

How can anyone possibly think that the US can pull itself out of this enormous level of debt without either a sustained period of double-digit inflation or a sustained recession, or both?

Inflation is here and it is likely to get worse. It was caused not just by the Biden administration, but by the Obama and Trump administrations, as well. Spending money you don’t have, pols believe, is how you get and stay elected. When the pandemic came along, the spending skyrocketed.

The only way to keep the US economy from moving into double-digit inflation is by raising the cost of money at the federal level. By making money more expensive, the supply of it and the velocity of it is reduced. Less money in circulation means lower inflation.

Jerome Powell has been pushing back against inflation by raising the federal lending rate. It was basically zero when he took office. He’s raised it four times. It’s currently 3% to 3.4%. That is a lot better than zero, but it’s not nearly enough. To defeat inflation, he’d have to do what Paul Volcker did during Ronald Reagan’s administration. Volcker realized that the only way to beat inflation was to raise the federal lending rate to 20% in June of 1981. That broke inflation’s back. By 1983, the inflation rate was down to 3%.

I don’t think Powell has the courage to do what Volcker did. Nor do I think that the Biden administration, even with a Republican majority in Congress, will have the courage to push him to do it.

I think what we will see is some tough talk on raising rates and then a capitulation. The Fed, the administration, and the Congress will continue to spend money they don’t have, while telling their constituents that it’s the other party’s fault… and hope that somehow the time bomb of federal debt will not explode while they are still in office.

Why We Need a Recession

Inflation is up. Not just a little. A lot. And according to the standard definition, the US is in a recession.

Working- and middle-class Americans have noticed. Everything from milk to toilet paper to automobiles and airline tickets are going up fast. And they are looking for someone or some thing to be angry with.

The conservative media are blaming the Biden administration and the Green New Deal for the state of the economy. And it’s going to worse, they say, because of the insane levels of unfunded spending by the Democrats to shore up their chances of doing well in the mid-terms. They cite the trillions spent during the first year of Biden’s presidency. And they are lambasting the Orwellian-named Inflation Reduction Act, pointing out that it will add at least another $600 billion of fuel to the inflation fire.

The Biden administration and the mainstream media are disputing both points. As to inflation, they point out that July’s numbers were down slightly from June’s. (About one-half of one percent.) And they are denying we are actually in a recession.

The standard definition of a recession is two consecutive quarters of lower GDP. This, in fact, did happen from January to June this year. But the Biden administration and the mainstream media and their pundits are noting that official unemployment rates are very low. How can we be in a recession when there are two jobs waiting for everyone that wants one?

It’s confusing. Doubly so because it is so political.

My take: Inflation is here to stay. But it’s not the fault of the Biden administration or the Democrats. Or rather, it’s not solely their doing. Inflation is the natural and inevitable response to what our government has been doing since Nixon unhooked the value of the dollar to the price of gold bullion in 1971. Since then, every administration, Democrat or Republican, has continued to print heaps of fake dollars. The only thing one can fairly and accurately state about this is that the overspending has accelerated drastically since 2008. Today, federal debt exceeds $30 trillion.

What most people don’t realize is that the government can’t magically make that debt disappear. It has to “balance” its books by finding money to pay off the interest on it. It does so by selling Treasury bills. To attract buyers for those bills, it has to offer an attractive interest rate by raising the federal lending rate. Which the Fed is currently doing.

The problem is that when you raise the federal interest rate, you make it more expensive for everyone – banks, businesses, and even the government – to do their business. That means charging more for loans, products, and services, which has to be paid for by taxpayers. Both commercial taxpayers and working people. Those rising costs result in less business growth and less consumer spending. And that, my friends, leads to continuing higher prices, lower economic growth, and higher unemployment.

That’s the bind the US finds itself in now. There is no magic cure. The fiddler must be paid. And it’s done in two ways: inflation and/or recession.

That’s how I see it. In a future issue, I’ll tell you what I’ve done (and am still doing) to protect myself and my family from what seems inevitable.

Meanwhile, I found what I thought was a very clear and simple explanation of all this by Ramin Nakisa from PensionCraft. He believes that the Fed will continue to battle inflation by raising interest rates. That will prolong and possibly deepen the current recession. But he also believes that a moderate amount of inflation is not such a bad thing.

You can hear his argument here.

Tipping Is Going Up: What Gives?

This chart was derived from a study by Toast, a point-of-sale (POS) platform that restaurants and other retail food services use to cash out customers.

The study found that…

* The average tip in full-service restaurants was 19.6%, compared to 16.9% for fast-food places.

* Tips rose 10% year-over-year, compared to 7.6% for food costs.

Well, that’s encouraging. Tips are at least meeting the cost of inflation. Is that because customers are feeling compassionate? Not according to the digital news site Hustle. They note, “POS platforms like Toast have ushered in the rise of ‘iPad tipping,’ leading many to tip when they normally wouldn’t to avoid looking stingy in front of the cashier.”

I’m sure you’ve had a lot of these “complete your transaction” experiences lately. I have. And they nudge me to tip higher than I usually would.

Here’s a funny video clip that explains what may be going on.

ABBOTT: Good subject. It’s 3.6%.

COSTELLO: That many people are out of work?

ABBOTT: No, that’s 23%.

COSTELLO: You just said 3.6%.

ABBOTT: 3.6% unemployed.

COSTELLO: Right. 3.6% out of work.

ABBOTT: No, that’s 23%.

COSTELLO: Okay, so it’s 23% unemployed.

ABBOTT: No, that’s 3.6%.

COSTELLO: WAIT A MINUTE. Is it 3.6% or 23%?

ABBOTT: 3.6% are unemployed. 23% are out of work.

COSTELLO: If you are out of work, you are unemployed.

ABBOTT: You can’t count the “out of work” as unemployed. You have to look for work to be unemployed.

COSTELLO: BUT THEY ARE OUT OF WORK!!!

ABBOTT: No, you miss the point.

COSTELLO: What point?

ABBOTT: Someone who doesn’t look for work can’t be counted with those who look for work. It wouldn’t be fair.

COSTELLO: To whom?

ABBOTT: The unemployed.

COSTELLO: But ALL of them are out of work.

ABBOTT: No, the unemployed are actively looking for work. Those who are out of work gave up looking. And if you give up, you are no longer in the ranks of the unemployed.

COSTELLO: So if you’re off the unemployment rolls, that would count as less unemployment?

ABBOTT: Unemployment would go down. Absolutely!

COSTELLO: The unemployment just goes down because you don’t look for work?

ABBOTT: Absolutely it goes down. That’s how it gets to 3.6%. Otherwise it would be 23%.

COSTELLO: Wait, I got a question for you. That means there are two ways to bring down the unemployment number?

ABBOTT: Two ways is correct.

COSTELLO: Unemployment can go down if someone gets a job?

ABBOTT: Correct.

COSTELLO: And unemployment can also go down if you stop looking for a job?

ABBOTT: Bingo.

COSTELLO: So there are two ways to bring unemployment down, and the easier of the two is to have people stop looking for work.

Real Estate: A Time to Buy. A Time to Sell.

In April and May, housing prices in the US were at all-time highs. In some areas, they are higher than they were at the early 2007 peak, right before the real estate industry began melting down before collapsing in 2008.

Could we be in for a repeat of that?

As I’m sure you remember, when the real estate bubble burst, it sent the US economy (and the rest of the world) into what became known as The Great Recession. In less than three years, it wiped out trillions of dollars’ worth of wealth – mostly from working- and middle -class homebuyers. Thanks to the government bailout, a good deal of that money was transferred to the financial upper classes, through the conduit of Wall Street, bankers, brokers, and insurance companies.

Media pundits and Wall Street CEOs called the crash “unprecedented” and “unpredictable.” That was balderdash, Americans learned later, when books and movies about the collapse started hitting the bestseller and top-rated film lists.

I was heavily invested in real estate prior to 2006. I started pulling back in 2007, and was out entirely before the crash. My investments had been in rental houses and apartments, not in REITs or other real-estate dependent stocks. So, I wasn’t listening to CNN or reading the NYT to find out what was going on with real estate. I was looking at the local markets, and making my buy/sell decisions accordingly.

My goal back then was to make an 8% return on my investment, cash on cash, and at least 12% with leverage (a mortgage). When prices got so high that I couldn’t make those numbers, I stopped buying. It was as simple as that.

When my friends, colleagues, and Jiu Jitsu buddies that were gobbling up properties like syrup-slathered pancakes asked me why I had stopped buying, I explained it another way. I told them that I was bothered by the discrepancy between the average income of first-time homebuyers and the average cost of a starter home.

I had always heard that a healthy ratio of household income-to-house price was about 1:5 (20%). In other words, a family with an income of $50,000 should be able to buy a house priced at up to $250,000. But in 2007, the average startup houses where I was looking in South Florida were selling for $400,000 to $500,000. And the average income for first-time homebuyers was just $60,000 to $70,000.

The numbers didn’t work. Still, banks were giving mortgages to anyone and everyone that had a pulse. And then packaging that “sub-prime” paper in bundles and selling them to huge financial institutions. You know, the ones that the government later bailed out, leaving millions of middle- and working-class Americans with debt they could not possibly repay.

Today, housing prices in South Florida – and up and down the coasts – are as high (or higher) as they were back then. Household income has risen, but not as much. In terms of household income and starter-home prices, the ratio is just as bad as it was in 2007. There is a difference, however, that is important. Banks are not handing out mortgages as freely as they did back then.

What this means to me: I am not expecting another real estate collapse like the one we had 14 years ago. I’m expecting to see prices come down to a sustainable level, and, in fact, it’s already started to happen. With interest rates going up, I’m expecting them to come down a good deal more in the coming six to 18 months.

As a direct investor in real estate, that doesn’t worry me terribly. That’s because I haven’t been buying property for several years. (And won’t again till prices move into buying territory.) However, I am keeping my eye on rental rates in the areas where I own property. If those rates go down significantly, so will my future ROIs.

I’m also wondering what to do with the cash I’ve been collecting from selling off some of my properties – particularly office buildings in cities (like Baltimore) that are seeing corporate flight due to high taxes and rising crime.

I’ve been looking around in states like Texas and Nevada that are benefitting from the emigration out of California. There are some pockets of hope there. I’ve toyed with the idea of investing in REITs, but given the way the economy looks generally, and rising interest rates, I’m not sanguine about any real estate-related stocks.

More on this in an upcoming issue.

Meanwhile, here’s an interesting chart that shows the average home prices in various cities around the US and the average yearly income it would take to buy one at the 1:5 ratio. Click here.