(A message I sent to my family last night...)
Three generations rich, fourth generation poor.
- Ancient Chinese Proverb
Heard spoken this past weekend:
"I was on vacation last week and when I got back I saw the S&P 500 gained 4 points. Did I miss anything?" (sailrmac)
Most of you know that I've been a pessimist about our national economy for a number of years now. What you may not know is how deep that pessimism truly runs. You can't say the things I believe, after all, without folks quickly shaking their heads and immediately dismissing one to the tin-hat-wearing, lunatic fringe. So I don't say a whole lot, to many people.
But things are bad. Truly. And so it makes me think that a gentle caution might be in order.
What we saw late last winter when Bear Sterns imploded, picking up steam through the spring and summer with the credit crisis, and wending through to the extraordinary events of last week, were predictable. They are the continuing unfolding of a foreseeable phenomenon. The only mystery is why it remained so obtuse, for so long, to so many.
I find economics to be a fascinating field. It exposes the entire gamut of human emotion. Fear, greed, envy, determination - it's all there. And so it's no surprise that I approach it not just from a numbers perspective - profit and loss and balance sheets and income statements and discount rates and price-to-earnings multiples and GDP and tax rates and all the other arcana of modern finance - but also through the prism of history.
It seems very distant to most of us today but, really, the 1930's were just a hop, skip, and jump back.
I often see that time in my mind's eye. Wondering what it was like. The everyday things. The mundane. How people lived and managed during such a difficult period. How the government and the politicians responded. Or didn't. How it might have been different.
Of course it's been common knowledge all my life, a canard pulled out whenever things might look a little rocky, that it could never happen again. We're so much smarter than they were back then, after all. "It's different this time".
Famous words, those.
Nine or ten years ago I was studying how much one needed to save in order to comfortably retire. How big did your nest egg really have to be? This was back when most financial experts were suggesting 6, 7, or even 8% could be withdrawn every year.
I came across a couple of studies which had back-tested every year-combination going back eighty or a hundred years. The results of those studies were rather more sobering: 4% was pretty much the upper end of what one could safely withdraw. These, like all studies, had some basic starting assumptions. The most paramount being that the Great Depression of the 30's was the worst economic calamity that could ever be imagined. Or, said differently, you could withdraw up to 4% out of your savings and be perfectly good to go - as long as things never got any worse than they did back then.
If you were invested in the stock market in October of 1929, it took 27 years - until 1956 - before your stock values came back to par. That's a long time to sit on a zero percent return. Surely, then, the pundits must be right - it couldn't get any worse than that. Right?
My mind keyed on that assumption. And it led me to wonder what was so uniquely special about the 20's and 30's. What were the mistakes made by people back then and why were they so consequential that we can now blithely view it as the permanent nadir of the American economy? Is it truly beyond the ken to imagine that something even worse could ever happen?
There were, and remain, many parallels between today and the late 20's. The charts and the numbers will be our history, even as they were theirs. But actually, having said that, I'll put the tin hat on for just a moment and offer a single observation: It's worse than that. The macro economic fundamentals today are worse - in some cases far worse - than they were in the summer of 1929.
A couple years ago I had a debate with a fellow who is a perma-bull optimist. He suggested that because none of the dire things I had spoken of for some time had come to pass - we were talking about housing, which had yet to make its turn - I was crazy. I replied that I didn't need to know, having discovered that the bridge I cross every day has cracks in it, the exact day and time of its failure in order to know I should find another way to work.
I don't know when the bad stuff will happen. All I know is that it will.
There are a litany of reasons why. The primary thing we are seeing now - the locking up of credit markets because counterparty risk via hundreds of trillions of dollars of derivatives contracts is so obtuse as to be unknowable - is not even the worst. There is a larger shoe which will eventually drop.
But that's probably a ways away. The range of scenarios I see coming out of the recent events ranges from simply very difficult - a run of the mill recessionary environment with a concomitant decline in market values for a few years - to utterly catastrophic. We are all enjoying the pleasure - wry smile - of witnessing history.
I will give the government credit. They've been far more energetic and aggressive in attempting to respond to events than I ever would have imagined - noting at the same time that their being asleep at the switch for so long was what led to much of this in the first place. But whether they can be successful in stemming the tide is another matter. Of that I'm doubtful. If they're lucky they might defer the day of reckoning for awhile. Eventually, though, that first domino will fall.
So what do you do?
Notwithstanding the 20 - 25% hit most have already taken, I remain convinced that equity markets around the globe are in danger of a continued, sustained decline. Even the best scenarios have them returning very modest, single-digit real returns over the next decade. They're not a good place to be.
Normally in a situation like that you'd look to hard assets, like real estate. But, as we all know, real estate has had its own unique bubble in recent years. Some markets have already declined by 15-20% and many prognosticators are calling a bottom. Don't believe them. Real estate in the larger markets will be 40% or more off its peak before this is done.
Cash. But realize that all cash is not created equal. Currency - the stuff-it-in-the-mattress kind - is ok. CD's and FDIC-insured bank accounts are fine. Money market funds may or may not be. Banks and investment houses invest money market funds in short-term paper and many of them, attempting to goose returns, have turned to commercial paper of dubious nature. Best bet is a money market fund which invests primarily or wholly in Treasuries. But sometimes you don't have a choice - most 401K's, for example, don't provide multiple money market fund options. In those cases you just take what you're given.
And then there's gold. The oldest form of money there is. The last refuge. And the only one that will outlive all of us. The goldbugs around the world, those people who earnestly believe that gold is the one true answer to all our monetary questions, have much of it right. But not everything. I'm convinced that gold will experience its own bubble at some point down the road as panicked investors across the globe scramble for something, anything, to preserve what they've earned. So you need to understand that gold's price will probably escalate quite a bit from where it is today, perhaps to stratospheric levels, only to collapse when the financial storm abates. For this storm, too, shall pass.
But in the meantime you should have some gold. You can buy it in an IRA. And you can buy it via an ETF, like shares of a stock. So it's not that hard.
The most important thing to realize is that now is not the time to look for returns. Now is the time to simply keep what you've got. To be ready for a better day.
And, finally, I'll give a nodding acquiescence to what got us all here - greed. As a nation, as communities, and all too frequently as individuals, we've become acculturated to the notion that we can have it all. Today, no waiting necessary. We don't save. We live in houses we can hardly afford to heat, much less pay the mortgage on. We drive nice, big cars that are always new. And we hardly give a thought to what the next new bauble costs - we just pull out the plastic. After all, we work hard and deserve it, right? Our kids deserve it, right?
Alas, the worm always turns. There will be a rude awakening for many. A day of reckoning they can hardly imagine.
Which leads to my last little bit of advice... live below your means. Avoid debt. Save like crazy. You may feel a bit like a rube next to all your friends and neighbors who have all that nice stuff. But know, in doing so, that you are doing the one thing - the only thing - that has always worked, at all times and in all places.
Because you know what? We're not really smarter than those people of 1929.
(A message I sent to my family last night...)