Get your house in order…NOW — Part Three

Tuesday, 3 May 2022 — London, UK

[7 min read]

Dear Reader,

Market action on Wall Street is getting interesting.

More sellers than buyers…putting downward pressure on prices.

Is this a temporary lull in bull market proceedings OR the early stage of a very nasty bear market?

My money is on the latter.

Wall Street has been wildly overvalued for several years…it’s always been a matter of when, NOT if, this market gets hammered.

The fatiguing ‘Everything Bubble’ has the look and feel of past bubbles…it’s tired and it’s deflating.

There’s still time to get your house in order, however, my advice is don’t wait too long.

Today is the final in a three-part series on how to build a solid financial plan.

The advice offered is the product of what I’ve learned from almost four decades in the business.

I make no apologies for it being basic and boring.

Creating and retaining wealth is a lifelong exercise…you can never let your guard down or abandon the sound principles of financial management.

The current boom has done a great disservice to the investing public.

It’s lasted far too long.

Mistaken beliefs have been created.

Bad habits have taken hold.

Fundamentals have been abandoned.

A crash of some significance is coming.

Why?

Balance must be restored.

Thinking you can get rich AND stay rich from chasing meme stocks…that loss-making tech enterprises can perpetually burn cash…or negative rates can become a permanent fixture…these (and many other examples of excess and stupidity) are all in the realm of a fantasy world.

Society needs a massive wake-up call.

We need to get back to the basics of sustainable wealth creation.

Sadly, few are prepared for the brutal reality check that’s coming.

I hope in some small way this three-part series has been of value to you and how you think about your attitude and approach to managing your finances.

Don’t invest for tax reasons

No one likes to pay more tax than they have to, but never invest solely for tax reasons.

The taxman tells you upfront the percentage of your income and capital gain he intends to extract from you. The market gives you no indication of the percentages it can extract from you.

If you are a successful investor, you must pay tax. You can use certain structures to minimise tax, but ultimately, the investment must be sound.

Over the years, numerous agricultural, film, wine, cattle, and tree schemes have offered attractive upfront tax offsets. Very few schemes have been successful. The majority have failed and provided a great source of revenue for receivers.

Negative gearing and depreciation allowances are enticers used by the property industry to make an investment appear more affordable. What happens if the government of the day (in search of tax revenue) abolishes negative gearing and/or reduces the depreciation allowances?

Personally, I’d rather own a positively geared investment property (rental income exceeds interest and other holding costs) — and I’d be more than happy to pay tax on the additional income.

Being motivated to invest primarily for tax reasons is an error of sound investment judgement.

Think of it this way — a massive capital gains tax bill means you’ve been a successful investor. Much better to have that than a capital loss to carry forward.

If it sounds too good to be true...

Listen to your inner voice — if it’s saying ‘this is too good to be true’ — take the advice. You may genuinely miss out on a ‘once-in-a-lifetime opportunity’, but from my experience, you’re more likely to have dodged a bullet.

Guaranteed rental return is one ‘too good to be true’ that comes to mind.

In reality, the property developer (while they remain solvent) ‘guarantees’ to give you back your capital as taxable income.

Another favourite is ‘proven system for growth’.

The Chinese government is the only group I know of that has a proven formula for growth — they pump vast sums of money into infrastructure spending and then pluck a growth figure out of thin air. Presto! Guaranteed growth.

Unless the corporation offering you the ‘proven system’ is backed by the Chinese government…forget about it.

Many years ago, I read about a promotion for a share trading program. The big print boldly claimed a ‘proven track record of 800% per annum growth’ over X years. Sounds impressive until you do some quick maths. If your initial investment were a mere $1, within five years of 800% p.a. growth, your portfolio would be greater than US GDP.

Nigerian scams, lotto wins in foreign countries, etc., continue to thrive because of people’s gullibility.

The prospect of a quick road to riches or instant wealth is tempting. The harsh reality is the ‘too-good-to-be-true’ offering is actually a salivating wolf in sheep’s clothing.

The magic of maths

There’s an old saying, ‘Markets take the stairs up and the elevator down.’ If a market loses 50%, it needs to recover 100% for you to breakeven.

The 50% loss can happen in a blink of an eye.

Whereas the recovery process can take years.

Understanding your downside is far more critical than focusing on your potential gains.

The latest monthly issue of The Gowdie Letter included some calculations on the potential hit the US market is facing:

‘The Buffett Indicator is in a stratosphere all its own:

‘How far down [could this market go]?

‘The components of this equation are…

‘US GDP = US$24 trillion

‘Mean of Buffet Indicator = 78%

‘Based on simple mean reversion, here’s the dollar amount of the market air-pocket we are about to hit:

‘The amount of capital that’s likely to be destroyed is US$33.2 trillion…64% of the current market cap value.

‘The most recent “Durable Gains” update from John Hussman, validates the Buffett Indicator reversion to the mean maths.

‘The latest level of durable gain on the S&P 500 Index is around 1,500 points…that’s 65% below the current level of 4,100 points.

‘Understanding maths is one way of avoiding spatial disorientation in investment markets.’

Should the US market ‘mean revert’ to a 65% loss, the gain required to make an investor’s dollar whole again is 186%:

If, over the long term, market growth averages 6% per annum, it’s going to take more than two decades to get back to breakeven.

Understanding the maths is absolutely critical to your ability to take calculated risks.

Summary

In a boom, investors (inexperienced and experienced alike) ‘hang on tight and enjoy the ride’. Everyone is happy. Rarely is the sustainability of the boom questioned. Don’t jinx the market. Enjoy it.

However, we know from history, the party always ends.

In my experience, investors are not mentally prepared for the bust...especially one that wipes 65%-plus off market values.

There’s rarely a Plan B.

No one told you this could happen, which explains why the default position is panic followed by fear...and plenty of it.

My Plan A is also my Plan B.

My strategy is firmly focused on understanding the downside...what can go wrong, and if it does, what is the likely cost? Is this an acceptable or unacceptable cost? If these factors have been accurately assessed, you can make a reasoned decision on where to allocate your capital, and the upside can take care of itself.

Knowing your tolerance for loss is far more important than dreaming about the riches that await you.

Personally, my tolerance for loss is around 10–20% of our total portfolio, any more than that would make me uneasy.

The following chart of the S&P 500 Index clearly shows the prospect of a significant fall from current levels isn’t without precedent.

What’s your Plan B for a fall from this height? If you don’t have one, seriously consider reducing your market exposure to a level that can handle the next (and possibly most severe) downward leg in this secular bear market.

The rise and fall wave pattern in the S&P 500 are clearly evident in this next chart. The current wave appears to have crested…do you have the stomach for the potential plunge ahead?

If not, then you may want to consider hopping in a life raft before this happens.

My investment strategy these days is best summed as ‘Winning by not Losing’.

Regards,

Vern Gowdie,
Editor, The Daily Reckoning Australia

Dear Reader,

We are enjoying the elegant symmetry of real life.

‘Dollar Soars to 20-year High as Investors Bet on Fed Moves’, says the headline on page seven of Saturday’s Financial Times.

Meanwhile, on page 11 comes this news: ‘Yen Slides to 20-Year Low as BoJ Rejects Higher Rates’.

As ye sow, so do ye reap. What goes up must come down. For every action there is an equal and opposite reaction.

That kind of thing.

We are also basking in the rare glow of being proven right. Inflation has arrived. And the beginning of a recession. And as we saw earlier in the week, the techy high-flyers that did ride so high...doth dismount.

Yes, dear reader. It doesn’t happen very often. We warned for years that spending money you don’t have will bring inflation…and that inflation will bring recession. But it’s like being nice to your grandparents. It takes a lifetime — until you become a grandparent yourself — before you appreciate its importance.

Painful contractions

On Wednesday, the US reported that the economy is now going backwards. Business Insider with details:

‘The US economy contracted for the first time since the early days of the pandemic as historic inflation crashed into the otherwise strong recovery.

‘The country’s gross domestic product shrank at an annualized rate of 1.4% through the first quarter of the year, the Commerce Department said Thursday morning. Economists surveyed by Bloomberg held a median estimate of 1.1% growth over the period. The print shows the recovery slowing massively from the 6.9% rate seen through the fourth quarter.’

Naturally, the Biden Team didn’t see the downturn coming. They hadn’t seen inflation coming either. It’s amazing that they can cross Pennsylvania Avenue without getting run over; they see nothing coming. But they keep a bag of fraudulent explanations at the ready, just in case. Bloomberg:

‘President Joe Biden blamed the first contraction of the U.S. economy since 2020 on “technical factors,” saying that employment, consumer spending and investment all remain strong.

‘“The American economy — powered by working families — continues to be resilient in the face of historic challenges,” Biden said in a statement. “While last quarter’s growth estimate was affected by technical factors, the United States confronts the challenges of COVID-19 around the world, Putin’s unprovoked invasion of Ukraine, and global inflation from a position of strength.”

‘The contraction came as a surprise, as economic forecasts projected growth of roughly 1%, presenting a fresh challenge for Biden and Democrats heading into the November midterm elections.’

There was nothing ‘technical’ about it. People have less money to spend (the gimmie/stimmies are running out). And wages are rising about three percentage points behind inflation — leaving people with less purchasing power. When people have less to spend, they spend less. And since spending is 70% of GDP, you should expect the economy to contract when spending goes down.

Nor was there anything surprising about it. Economists at several leading banks — along with former Treasury Secretary Larry Summers — have all said a recession is inevitable.

It’s not magic. It’s not luck. It’s just symmetry. The Fed jazzed up the economy. Now, it’s turning down the music.

On the obverse

Meanwhile, instead of dialling back inflation, the Japanese are turning up the knob — to 11.

CNBC elaborates:

‘The Bank of Japan said on Wednesday it has decided to offer to buy an unlimited amount of 10-year Japanese government bonds (JGB) at 0.25%, in its third move to defend its yield target since February.

‘The rise in yields comes as the yen weakens sharply to two-decade lows against the U.S. dollar, forcing markets to test the central bank’s commitment to its super easy yield-curve-control policy.’

What a marvellous experiment! What a learning opportunity! It’s ‘inflate or die’ for central banks all over the world. The Japanese, bless their hearts, are going with ‘inflate’. The yen rises as they signal that they’ll let the yen die rather than give up their goofy bond-buying program.

For now, at least, the Fed is taking the opposite side of the bet. It says it will take away the punchbowl; the party will die. Already, the Dow is off 8% for the year. The Nasdaq — where the high-flying techs are — is down 20%. These indices disguise the real damage. The average meat-and-potatoes stock is down some 40%. But the dollar —anticipating higher interest rates — is rising. Bloomberg:

‘The ascendant U.S. dollar headed for its best month in a decade, as renewed yen selling cemented the greenback’s strength against major peers. A Bloomberg gauge of the greenback climbed to its highest level in nearly two years and has risen 4.5% this month, set for its best performance since May 2012. The dollar extended gains versus the yen, hitting a two-decade high, after the Bank of Japan kept interest rates at rock-bottom levels and defended its easy monetary policy. That contrasts with a Federal Reserve that has signaled aggressive rate hikes to combat inflation.’

What will happen next? Who will be the winner? Who will flinch first? The Bank of Japan or the Fed? Will the Fed be able to stick to its ‘tightening’ program? Or will the Bank of Japan be forced to commit hari-kari, a kind of central bank ritual suicide, in which it atones for 30 years of jackass manipulation?

Tune in tomorrow...

Regards,

Bill Bonner,
For The Daily Reckoning Australia