Protect Your Retirement is back with another episode where we talk about the current financial markets and the European banks. Mike and Brian Decker of Decker Retirement Planning Inc. are here to tell you what it means for you. Tune in and check out all of our past episodes for more on how you can help protect your retirement!
MIKE: Good morning and thank you for listening to Decker Talk Radio’s Protect Your Retirement, a radio program brought to you by Decker Retirement Planning. This week Brian and I will be discussing current events in the financial markets as well as what’s going on overseas with the European banks. The comments on Decker Talk Radio are of the opinion of Brian Decker and Mike Decker.
MIKE: Good morning, everyone. This is Mike Decker.
BRIAN: And Brian Decker.
MIKE: And we’re here with Decker Talk Radio’s Protect Your Retirement. And to start our show, we are going to be going over the news that is absolutely important. What’s going on in the financial world today. So, Brian, will you take us off here and let’s dive right into what’s going on with the numerous amounts of things happening in our market today.
BRIAN: Sounds good, Mike. KVI listeners, we have our finger on the pulse and look for problems that may end up hurting portfolios for retired people.
BRIAN: So consider this retirement news and also information on how to protect your portfolio from Decker Talk Radio Decker Retirement Planning in Kirkland, Washington. First I wanna talk, KVI listeners, about cash levels. When cash levels are high that’s usually an indication of a market bottom, ’cause a lot of cash can be put to work. When cash levels are very low, that’s an indication and one of the many ways to find out if the market’s near a high. It’s just one of several things.
BRIAN: Fund managers have thumbed their nose at cash, lately. And according to the latest release from a leading industry association, mutual funds are holding only 3.2 percent of their assets in cash. Given the level of interest rates, they should be holding less cash than usual. We get that. But not this much less. According to some estimates, they should be holding around 1.5 percent more than what they’re holding in assets and cash. This is the largest difference since 2007.
BRIAN: KVI listeners, 2007 was a market top. Now I wanna go over and mention another thing that we’re watching and that is European banks. Specially Deutsche Bank. Deutsche Bank has roughly two trillion in assets. That’s almost 11 percent of the US GDP. By this metric that’s slightly larger than Wells Fargo that has 1.9 trillion in assets and Citigroup which has 1.8 trillion in assets.
BRIAN: But here’s the thing, which we’re watching, is Deutsche has tangible common equity ratio of just under three percent at 2.9 percent. That’s the bank’s tangible equity divided by its tangible assets. What this means is that the bank can sustain losses of only 2.9 percent before its equity capital is completely wiped out. By comparison Wells Fargo sits at 7.7 percent while Citigroup shows 10.3 percent.
BRIAN: According to the international monetary fund, Deutsche Bank now ranks as the riskiest financial institution in the world. The quote-unquote most important net contributor to global potential systemic risks. Unquote. But the problems don’t stop with Deutsche Bank. The likelihood of a Lehman moment in Europe gets closer when you include Italy’s banks. And KVI listeners, Greek’s banks and Spain’s banks and Portugal’s banks. Ireland’s banks. It is a major problem.
BRIAN: The banking potential crisis over there is something that we are watching very closely. And as retirees, please pay attention to the powder keg over there, the potential problems. Italy’s Banca Monte dei Paschi Di Siena, the world’s oldest… or the oldest bank of the world, they need to raise five billion Euros of equity on top of the eight billion that it’s raised in the past few years and dump 28 billion Euros of bad debt.
BRIAN: The bank is also considering encouraging its bond holders to swap debt for equity, essentially admitting that those are bad loans and are in default. The shares of the oldest bank in the world are down 85 percent so far this year. Italy’s UniCredit is also doomed as are banks like Banco Popular Espanol S.A. Now I wanna mention that the… oh gosh, I can’t remember his name.
BRIAN: The bank’s prime minister or president is running for major changes in the banking system and in the economy. And if they pass then there’s fantastic potential for fixing the problem in Italy. But if this person is not voted in, and we’ll see the vote count in the next couple weeks, if we don’t see his vote and his changes brought in, then that’s a major problem. We’re also watching that.
MIKE: Now, Brian, can I ask you a quick question here and this might be [OVERLAP] later on but these are oversea banks, oversea situations. For the viewers that might not be able to connect it, how does this affect the American financial market and the American economy?
BRIAN: Good question. A lot of the world financial market is very connected these days. So a problem here with Lehman, a problem here with some other major banks have a ripple effect around the world. It’s called a contagion or a domino effect.
BRIAN: So this is something that we’re watching very closely even though it’s in Europe. It has the ability to affect many many people around the world. Many banks around the world. There’s a major investment, for example of Saudi Arabia, who has injected tremendous amount of capital into Deutsche Bank. All that evaporates if Deutsche Bank gets into trouble. So we’re very closely connected in the world markets on the financial side.
BRIAN: We could see the equivalent of a 2008 crisis in Europe. Rest assured the financial problems coming home to [roust?] abroad will spark a global sell off in equity so we wanna be very careful. By the way in our radio show, at Decker Retirement Planning Protect Your Retirement, we will talk about how to protect your retirement in just a couple minutes. I wanna get some more of the news out because there’s a growing body of evidence that the US economy is heading into recession soon.
BRIAN: We’ve talked about these signs repeatedly over the last several months. The longest running and most troubling sign is the ongoing declines in U.S. industrial production. Declines, Mike, in industrial production are among the most important and longest running leading indicators of a recession. In August the U.S. industrial production had officially fallen by 1.1 percent for the years. It was the 12th consecutive month of contraction. In the last 100 years we’ve never, never had a 12 month streak of continually declining industrial production that was not followed by a recession.
BRIAN: Here’s another one. The U.S. transportation sector has been in decline since 2014 based on the Dow Jones transportation average. The transportation stocks has been a leading economic indicator for than 100 years as transportation reflects the growth or decline in orders for consumer endurable goods and are trucked and moved around the country. Based on forecast earnings the S&P 500, here’s another indicator, will soon report its sixth consecutive quarterly decline in earnings.
BRIAN: In August the second quarter reporting was completed showing that the S&P 500 has longed now five consecutive earning declines for the first time since 2008 and 2009. Profit margins are declining and so for eight quarters in a row, beginning in the second quarter of 2014, the profit margins of the S&P 500 have been declining. With the index currently trading at 25 times last year’s earnings, a sustained declined in earnings will eventually trigger a drop in stock prices.
BRIAN: The thing… there’s two things that keep stock prices up. One is low interest rates. Where else are you gonna invest your money? And the second has to do with earnings growth. If you take away earnings growth and keep the low interest rates constant, there will be a downward adjustment in stock prices. KVI listeners, the greatest concern to me is the overall level of corporate debt. Here’s another indicator that we’re looking at. Corporate debt in the United States has consistently topped out at a little less than 45 percent of our GDP, gross domestic product.
BRIAN: Historically, the debt cycle has turned at that point. Defaults go up, issuance of new corporate debt go down and a bear market begins. Today that level sits at 45.4. This is the time when the default rates on U.S. junk bonds go up. And they have. The corporate… the default rate for U.S. junk bonds spiked up to 5.1 percent according to the credit agency rating company, Moody’s, and is expected to hit 6.4 percent before the end of the year.
BRIAN: Historically any default rate above five percent has signaled the beginning of a new credit default cycle and that’s especially true at this time given that the default rate hit record lows in 2014 and has been steadily rising since. Okay, finally, and this is… we don’t want to be the harbinger of bad news. We wanna be the watchmen on the tower to warn you to get things together. And, Mike, I wanna go in and talk about how we can protect our retirement after I cover this last little bit.
MIKE: Absolutely.
BRIAN: We’ve talked about the European banking crisis. I wanna go back to that. No one seems to be talking about that. Shares of Deutsche Bank are now down more than 66 percent. Two thirds over the last two years. Italy’s largest bank, UniCredit, is down the same. Same with Royal Bank of Scotland, the leading British bank. Globally it seems very unlikely that this credit cycle can continue to expand in the face of a serious banking crisis.
BRIAN: Likely it seems unlikely to me that U.S. banks with lots of global exposure won’t eventually face the same headwinds. Look at China’s debt expansion. Total private debt grew from 10 trillion to 30 trillion in just the last five years. Now I get it. Their economy has grown too but as a percent of their economy the debt is not going down. It’s not staying flat. It is going up. And to no surprise you’ll find tens of thousands of empty apartment buildings all over China and you’ll find huge stock piles of raw materials.
BRIAN: KVI listeners, if you want to see something just completely amazing go to YouTube and type in empty Chinese cities and you will see fully built Chinese cities that are completely uninhabited. Why do the Chinese do that? It’s better to keep their population busy than to risk social uprising by having unemployment. So even before people are ready to inhabit cities, they’ll keep their workers moving and keep them busy.
BRIAN: Back to the United States. Mike, I’m almost done. Look at the United States. What’s that, Mike?
MIKE: I said it’s a lot of information but this is so important to know. You have to know this information to protect your retirement. So let’s keep going.
BRIAN: Right.
MIKE: And then real quick after we get through this we’re gonna extend an offer to put people through the Decker approach, the analysis that will help you protect yourself from these situations. But let’s finish the thought first.
BRIAN: Okay. All right, I’m 30 seconds from finishing. Look at the United States 80 billion dollar automobile bail out. You’ll find record car sales but falling earnings from the major car makers. You’ll also find a startup Tesla that’s never made money and now has debts of almost seven billion dollars. An investor believes the company is worth 30 billion question mark. I don’t know how that math works. Finally Warren Buffett, the oracle of Omaha known for his investing acumen and foresight, he appears to be seeing the writing on the wall, having made billions in the fall out of 2008 crash by taking advantage of lucrative government machinations.
BRIAN: Buffett now looks to be positioning himself for a massive buying opportunity. According to analyst, Jeff Nielson, the head of one of the largest investment companies in the world, he is not invested as heavily into stock markets as you may think. In fact, Nielson says in the latest interview with the SGT, Sam George Tom, SGT report that Buffett has over 70 billion dollars sitting in cash on the sidelines. He’s an amazing guy. I really like watching Buffett and how he invests.
BRIAN: He has raised a lot of cash. Now, KVI listeners, we’re turning to you. We’ve talked about the news in the first quarter of the segment. We have an hour of commercial free information. Now let’s talk about how we can help you protect your retirement. Mike, I want to launch into what the banks do, what banks and brokers do and call safe money for people that are retired. By the way, there’s three… Now that we’re sadly the Mariners are not in the playoffs but we’re still in baseball season
BRIAN: There’s three strikes that we wanna tell you about. One has to do with the use of an asset allocation pie chart. KVI listeners, if you are using a pie chart in your asset allocation plan for diversification, you’re using something that is appropriate in your 20s, 30s, and 40s but it’s an accumulation plan that is totally fine if you’re getting a paycheck. When those paychecks have stopped and you’re retired and you’re still using an accumulation plan, that’s strike one.
BRIAN: That’s something that you need to get rid of and replace with a distribution plan. A distribution plan shows all your sources of income. It calculates mathematically how much money you can draw each year for the rest of your life, given your age, your assets, your social security, any penchant, rent or real estate income, and the income from your assets. It is mathematical. If you do not have a distribution plan, Mike, we should make an offer right here and offer for people to come in and see what we’re talking about and we can create one for them.
MIKE: Absolutely. And it’s really the difference between guessing how much you can take out and mathematically solving how much you can take out.
BRIAN: And about fiduciaries….
MIKE: Could we talk about that real quick? Because we’ve gotten some feedback from our KVI listeners of saying fiduciaries. People think that’s kind of jargon but this is a word that people need to understand. It’s a jargon, sure, but you need to know what this means. A fiduciary is a financial representative who is legally bound to do what’s in the best interest of the client. There’s a lot of people that claim to be good people out there that are claim to be on your side that are not fiduciaries. I just…
BRIAN: Well let’s give them the three point test so they can know if their banker, broker, financial advisor is a fiduciary or not. There’s a lot of people who claim that they’re a fiduciary. Let’s nail this one down.
MIKE: Let’s do it right now.
BRIAN: Number one they have to be independent. Someone working for a bank or an insurance company or a brokerage firm are being told from the top what they can and cannot sell. They are not independent. They’re a salesperson, a representative of a larger company.
BRIAN: So number one, they have to be independent. For example, we own our own firm. No one tells us what we can and can’t do. We are totally independent. That’s checkpoint number one. Point number two is we’ve chosen to be securities licensed by a Series 65 license. Series 65 license is different from the Series 7. Series 7 allows commission. Series 65 prohibits a person from commission sales. They have to be fee base. Everything has to be above board.
BRIAN: If your banker or broker or financial advisor tells you they’re a fiduciary, ask what securities license they hold. If they tell you Series 7, then there’s really no argument there. They cannot be a fiduciary if they’re a Series 7 commission receiving financial advisor. A fiduciary has a Series 65 license to be crystal clear. Number two. And number one is working for an independent company. Mike, you were gonna say?
MIKE: Well I was gonna say to put this in perspective, if you walk to a dealership. Let’s say Ford. You walk to a Ford dealership and you expect them to go through every auto manufacturing company, car, type, model that exists to find the right one, that would be insane. They’re gonna try and sell you a Ford. And they believe Ford is the best thing for you. To have someone in the financial world that can tell you about any investments and any opportunity that would be best for you is what you get with a fiduciary. Not a broker or someone that works for a bank or a brokerage firm or those other institutions.
BRIAN: Okay. All right. Number three. Number three, the third and final way that you can nail down for sure if your banker, broker, financial advisor is a fiduciary or not is if they have an RIA corporate structure. RIA is registered investment advisory corporate structure. That is specifically for a fiduciary. So your corporate structure is an RIA, you’re Series 65 licensed, and you’re independent. A lot of bankers and brokers are telling their customers they’re a fiduciary and it’s flat out not true.
BRIAN: Back to, Mike, I feel like we covered that. So let’s go back to, KVI listeners, the three strikes that we wanna warn you about once you’re retired and how you’re not protected. Number one, your banker and broker is using an asset allocation pie chart which keeps all your money at risk. Why do they want to keep all your money at risk? Because that’s how they get paid. They don’t get paid if you move money to the sidelines like in money market or cash or CDs. There’s no money management or commissions that come to them on those.
BRIAN: Okay, so now let’s talk about the second thing. The second thing is telling you that according to the rule of 100 that if you’re 65 years old, a banker or broker will put 65 percent of your money in bonds or bond funds. That doesn’t… That hurts you in a couple of ways. Number one, when interest rates on the 10 year treasury at all time record lows at one 1.5 percent, now your financial advisor has put 65 percent of your money earning nothing. But that’s not even the biggest problem. The biggest problem when it comes to this second point, the biggest problem has to do with interest rate risk.
BRIAN: They tell you that your safe money is in bond funds when interest rates eventually do go up, and they eventually will, when they do eventually go up you will lose a lot of money in your bond funds. In 1994 interest rates on the 10 year treasury went up in one year from six to eight percent. That represented a, according to Morningstar a 20 percent drop in principal. A loss. In 1999 the 10 year treasury went from four and a half to six and a half percent in one year.
BRIAN: That was a 17 percent loss. If we just go back to four percent on the 10 year treasury from where it is now at one a half, that’s over a 25 percent hit to principal on what your bankers and brokers are telling you is your safe money when it is mathematically provable that it’s not safe. When interest rates are at all time record lows, interest rate risk is at all time record highs. If your financial advisor is telling you that your safe money is in bond funds, that’s like a math teacher telling you that two plus two is 15.
BRIAN: The last one. Well, the last couple of things we wanna warn you about is that if your banker and broker is telling you to distribute your income based on the four percent rule, we wanna warn you that that is strike three. We hope you get up and walk out, because the four percent rule has destroyed more people’s retirement in this country, in our opinion, than any other piece of financial advice out there.
BRIAN: Here’s how the four percent rule works. It says that stocks have averaged around eight and a half percent for the last 100 years. Bonds have averaged around four and a half percent for the last 36 years. So let’s be really safe and just draw four percent from your assets for the rest of your life and that should be fine. That works beautifully if we have a forever bull market where stocks keep going up. But the market doesn’t trend. It cycles. For the last 100 years the markets move typically in 18 year market cycles.
BRIAN: So we are in a flat market cycle right now. Let’s say, KVI listeners, let’s say that you retire and you’re given four million dollars. You and your wife, you and your spouse, you individually, whatever. You retire January one of 2000 with four million dollars. That’s the good news. The bad news is in 2000, ’01 and ’02 the S&P lost 50 percent. But remember you lost more than that because you’re drawing four percent every year. So you’re down 62 percent going into 2003. The good news is the markets double between ’03 and ’07.
BRIAN: The bad news is you don’t get all that because you’re drawing four percent every year. And then you take a hit like 2008 where the S&P is down 37 percent plus four that you’ve drawn. Now you can no longer stay retired. And if you remember 2009, do you remember all the gray haired people that showed up in banks, fast foods, Wal-Mart, they had to sell their home, move in with the kids, they had to go to plan B because the four percent rule destroyed their retirement.
BRIAN: All of this goes away, KVI listeners if you come in and see a distribution plan. A distribution plan is what works for retirees. If you’re over 50 years old and you do not have a distribution plan then you are putting your retirement at unnecessary risk. A distribution plan shows all your sources of income. Your income from assets, your social security, your pension, your income from real estate. We total it all up minus taxes, gives you an annual and monthly income with a COLA increased to age 100.
BRIAN: We use math. We use mathematics to calculate how much money you can draw for the rest of your life. If you don’t have this you are… let me try to think of an analogy. You’re trying to go to a dentist to have your knee replaced. The training just isn’t there. These are good honest people. Nothing wrong with dentists. Nothing wrong with knee doctors. It’s just you’ve got to use the right training for what you need done.
BRIAN: At Decker Retirement Planning this is all we do. We are specialists in retirement planning. We know what we’re doing. We are not commission salesmens. We are fiduciaries. We don’t use the asset allocation pie chart. We don’t use the buy and hold strategy where with a straight face bankers and brokers are telling people… you, KVI listeners, that you should hold on. You can’t time the market. Just take that hit every seven or eight years of 30 or 40 percent. Take three or four years to get your money back after you lose it and you’ll be fine.
BRIAN: That is so ridiculous. Again, mathematically provable that that is harmful to your retirement health. We don’t do that. We have distribution plan. We can show people that the returns of these mangers made money in 2000, ’01 and ’02 when the S&P was down 50 percent. They doubled when the markets doubled from ’03 to ’07. And these managers collectively as a group made money in 2008. Now, KVI listeners, who else is talking to you like this? This is something you should come in and see for yourself who these managers are, how they work, and how they can be used in your retirement plan.
MIKE: Yeah.
BRIAN: Hey, Mike, I wanna take a different direction now and issue a little warning about a divided portfolio.
MIKE: Sounds good.
BRIAN: It’s very common for retirees to put together a dividend portfolio and sadly tragically they’re only getting half the information. So if you think that you’re getting great guidance by putting together a portfolio with dividends of four, five, six, seven percent, I wanna give you the other half of the equation to help you in this.
BRIAN: So many people will come in and proudly show that they’re getting seven, eight, nine percent dividend income in their portfolio. Right now the 10 year treasury is yielding 1.5 percent. We call that the riskless rate. The riskless rate means, and here’s the other part, that’s the standard where you have pretty close to a zero chance of default. Well isn’t, mathematically, isn’t a four percent rate better than a one and a half percent rate?
BRIAN: And let’s keep going. KVI listeners, isn’t a six percent rate, dividend rate, better than a four percent rate? And surely then an eight percent rate… why wouldn’t you get eight percent if you can. That’s better than six percent. And I keep going. We get to 10 percent, 12 percent, 15 percent. I have to keep going a long ways in some cases before some people will say, “Oh no, that’s too risky. At 15 percent or 20 percent my antenna goes up.” Well good, it should go up. Because at some point the risk of these dividend yields is tremendous.
BRIAN: The way we check out… And by the way, KVI listeners, this is something you should pull over and jot a note down, if you’ve got a dividend portfolio and you know your dividend rate, you know half the equation. Let’s get the other half. Go to a free chart. It’s called bigcharts.com. Big charts. And you can use the financials of any company. Let’s say EOG. It’s a energy company. It pays a dividend. And you look at the cash flow on any of your dividend. Let’s say that it’s paying 25 cents a year in dividends.
BRIAN: And let’s say that it represents a fantastic six percent dividend yield. It all sounds good until you find out that cash flow per share is 20 cents. The cash flow per share doesn’t cover the dividend of 25 cents. So now your potential for default or a cutting of that dividend is very high. So I wanna make sure that you’re doing the other half. Definitely look at the dividend yield but do your homework on the other half and make sure that that dividend is covered by cash flow per share.
BRIAN: Net cash flow per share. Not gross cash flow per share but net cash flow per share. So after they paid taxes, which you have to pay, after you’ve paid overhead, what is the net cash flow per share? And make sure that it easily covers the dividend. So now let’s put default risk and assign that to your dividend rate of return. So KVI listeners, one and a half percent. That’s a really low dividend but it’s also a 100 percent… has zero percent default risk.
BRIAN: Four percent. That sounds better than one and a half but that has a 20 percent default risk. Now let’s talk about a six percent dividend yield but it also has a 40 percent default risk. Eight percent. Let’s go to eight percent. That has a 60 percent default risk. Let’s go to 10percent. Now you’ve got a 75 percent default risk. By the way, it’s not an accident that the higher the dividend yield, the higher the risk.
BRIAN: You were taught this as a child and growing up. The higher the yield, the higher the return, the higher the risk. When it comes to dividends and interest that’s true. By the way, you can get a 12 percent rate right now on a government bond. 10 year government bond out of Brazil. Out of Brazil. Not the best country to get a bond right now because they’re in financial trouble.
BRIAN: So that’s all I wanna say about dividends. We’re hopefully helping you here at Decker Retirement Planning in Kirkland we wanna look out for the retired investor. And by the way if all of your dividend portfolio is in the oil or energy sector, you’ve taken a beating in the last 18 months. You need to diversify this. Yes, the energy sector is offering the highest interest and dividends but you’ve got to diversify. Because it’s not very helpful to collect a six percent dividend when in the last 18 months you’ve lost 40 percent of your principal.
BRIAN: That’s a total return, let’s see, 40 minus six. You’ve lost 34 percent in total return in the last 18 months. So KVI listeners, we wanna make sure that we’re helping you in making sure that you know that a dividend portfolio is a risk portfolio. And we also wanna make sure that you know that when it comes to the planning we do for our clients, the most important thing we do for our clients has to do with making sure that the income, coming back to you from your portfolio, is coming from principal guaranteed sources.
BRIAN: So that means that if the interest rates go up or down, unlike bonds where you lose money, if the stock market goes up or down like the four percent rule that destroyed a lot of people’s… millions of people’s portfolios, and unlike the economic cycles as it goes up or down, our clients will have a steady stream of income from principal guaranteed laddered accounts where bucket one pays out for the first five years. Bucket two pays out for years six through 10, bucket three pays for years 11 through 20, etcetera.
BRIAN: When I show people this, and I circle buckets one, two, and three and tell them… or I ask them now do you see why our clients sailed through 2008 unaffected. Unaffected. It’s very important to accentuate this part of the planning where our clients, whether the markets go up or down, will have that priceless peace of mind that they will not have to sell their home, move in with the kids, go back to work. No plan B for our clients. Because it’s coming from principal guaranteed sources.
BRIAN: Mike, I’m full of hot air this morning.
MIKE: So, Brian, let’s keep going. I know we’ve talked a lot about the Decker approach and about the distribution plan, the four percent rule, and bonds as well. There’s a lot to talk about as well but is there one that’s just you’re itching to cover here for the [remainder?] of the show?
BRIAN: Yeah. Yeah. I wanna go into how people in their stock picking have it completely backwards. So KVI listeners, I’m gonna give you another nugget here.
BRIAN: How many of you will spend hours and hours of research on stocks and why you like stocks and it’s cash flow and it’s debt level and it’s cash on hand per share and you do all the critical analysis of the stock and you leave the most important things behind. Let me suggest that the analysis should be number one. The stock market is the market in one of three directions. Up, down, or flat. Is the trend in the market up, down, or flat? ‘Cause this is gonna determine how you pick your portfolio.
BRIAN: By the way, every person that picks his own stocks needs to know that the markets cycle. And they get hammered every seven or eight years. Let me rattle off the dates. Last time we got hammered was 2008. From October of ’07 to March of ’09 that was a more than 50 percent hit. And that was called the… there was one bubble that was the mortgage disaster.
BRIAN: The previous bubble was the tech bubble. From January one of 2000 to March of ’03 that was more than a 50 percent drop in those three years. But seven years before 2008 is 2001. That’s the middle of the… that’s when the Twin Towers went down. Middle of a 50 percent drop. Seven years before that was 1994. Iraq had invaded Kuwait. The interest rates had gone up. The recession had started. Markets were hit.
BRIAN: Seven years before that was 1987. Black Monday, October 19th, 550 points come out of the Dow Jones. 30 percent loss in one day. Seven years before that was 1980. Huge inflation. Two year recession. 40 percent drop in the market. Seven years before that was 1973, ’74, 44 percent drop in the stock market. Seven years before that was ’66, ’67. That was a 42 percent drop in the stock market and it keeps going.
BRIAN: Every one of those drops had one bubble that had burst. Today we have four. Because the federal reserve bank and the central banks around the world have artificially kept interest rates low. Why would they do that? Because the massive debts that they’ve taken on and they know that if interest rates go back up that would be the pin that burst those bubbles. Because of the artificially low interest rates there are now four bubbles that are ready to burst.
BRIAN: One is the debt bubble with the countries that once a country takes on more than 100 percent of their GDP, their gross domestic product, that’s typically the marginal line, the point of no return where it’s very difficult for a country to rebound from having over 100 percent debt to their GDP. But now all G7 nations, all the major countries around the world have that situation. Never before have we been in these straits.
BRIAN: This is uncharted territory. That’s debt bubble number one. Number two has to do with the bond market. The bond market is a bubble right now. It’s also contingent to the debt bubble but there’s more bonds out there than we’ve ever had before in corporate stock market history. When interest rates go up the default cycle that I talked about in the beginning of the hour kicks in and the dominoes start.
BRIAN: And we’ve talked about the default cycle. Once you get a high yield bond fund where interest rates go up and losses are happening and people are trying to get out of a bond fund. It’s Katy bar the door. You will have more bond funds shutting their doors. We had three of them in January of this year that just went illiquid because they couldn’t meet redemptions. That will happen more and more but that’s the second bubble. It’s the debt bubble.
BRIAN: The third bubble has to do with real estate. That is a bubble right now because the affordability index. In each major metropolitan area in the country there is an average wage number in that area. Well, we take the average wage number and see what home in today’s interest rates that average wage would qualify for. And we call that X. And then we look at what the average home is in the area and that’s Y and Y is higher than X by a larger spread called the affordability index.
BRIAN: It’s the biggest spread that we’ve ever had. It’s a record. So we have a real estate bubble. A residential real estate bubble. And the last one is the S&P with negative earnings for the last five years and a price earnings ratio of 25. IT’s only been higher twice before. That’s in 1999, which was a market top. And this also in October of ’07 when it was a little bit higher than where we are now.
BRIAN: So we have four bubbles right now so please when you do your stock portfolio picking, KVI listeners, I implore you to look at the stock market first. Seven years plus March of ’09 which is the bottom of the market is right now. In the next 18 months we fully expect that it’s going to be very difficult for stock investors. So number one, check your history. See where you rein the stock market.
BRIAN: Some potentially good investments right now are… gosh, this is hard. Biotechnology, maybe not.
MIKE: Wouldn’t that depend on the election? With biotech?
BRIAN: Yes. Yes.
MIKE: ‘Cause Hillary doesn’t like biotech.
BRIAN: Yes, ’cause Hillary… Hillary could shut the door on biotech and healthcare if… And what we… By the way, what we mean by that is typically… I’m not saying one’s right and one’s wrong but typically liberals will go after price controls and will insist that the pricing for drugs needs to come down.
BRIAN: And so liberals on the one hand are promoting an incredibly expensive approval process for drugs that costs many hundreds of millions of dollars. And then at the other end when they try to recover that with higher prices the liberals will claim unfair price gouging and that, if they do that then that will put out the fire of creativity and invention in the biotech arena.
BRIAN: So you’re right, Mike. The election will determine what happens there. I’m trying to think what goes up in a down market. In 2008 it was gold, treasury bonds, the U.S. dollar, and the VIX, the volatility index. Those are the four things that went up in 2008. Slim pickings I guess. Once we get past the next 18 months and the markets get creamed I just I envision how… do you remember in the 90s how the monkeys were throwing darts at… the CNBC chimpanzees were throwing monkeys. And they were outperforming many major money managers.
BRIAN: That’s how it is in the next seven years after the markets get creamed. Warren Buffet has many great sayings. One is it’s when the tide goes out that you can see who’s swimming naked. And if you don’t have a downside protection program in place the next 18 months your financial advisor is gonna be exposed for the frauds that they are in trying to be retirement experts. You will take a massive hit and jeopardize your retirement because you listened to buy and hold strategy which is absolutely ridiculous and it’s financial malpractice for bankers and brokers to tell you to buy and hold when you’re over 50 years old and take these massive hits that come around every seven or eight years.
BRIAN: Okay, when you’re picking stocks look at where the stock market is first. Look at the cycle, where it is, the trend, etcetera. Because that will determine everything else. Next you look at the market sector. You look at the leading sectors and then third and very last you look at the leading stocks in the leading sectors.
BRIAN: That’s how it should be working. If you consider yourself a stock expert most people I’ve talked to they have it absolutely backwards in looking at stocks first. Markets first, where you are in the market cycle. Next, sector, what the leading sectors are. And the third and at the very end what the leading stocks are in the leading sectors. And then how do you protect your capital.
BRIAN: Well you’re gonna tell me that you’re gonna protect your capital with stop losses. So let’s talk about stop losses. Mike, are we good with time?
MIKE: We’ve got about six more minutes left.
BRIAN: Okay. KVI listeners, we’re talking about stock portfolio management and the traditional ways that you think that you’re gonna protect yourself and the problems… And right now we’re gonna talk about stop losses.
BRIAN: So let’s say that you buy Microsoft at 40. It goes to 50 and you move your stop loss up to where you’re gonna say if it moves by 10 percent you’re gonna lock in your gain. So at 45, you’re going to take yourself out. But then we have a move like August of last year in 2015 where the markets dropped 1200 points, boom, just like that in one month. And then turn on a dime and go back to new highs.
BRIAN: Well guess what, you got stopped out and now Microsoft is trading 10 points higher than where you got stopped out. 25 percent higher than where you got stopped out. It’s very frustrating. So in a seven-year cycle typical market volatility take you out. And you’re frustrated because you’re always re-buying your stopped out positions at a higher price. And you think that you need a discipline. You try to disciplined but it’s just not working because the stocks that you have stops on get stopped out and they just turn on dime and rocket higher.
BRIAN: So this time you’re gonna do something smarter. You’re gonna have mental stops. Mental stops is where mentally you’re gonna take yourself out if it gets to that point but you leave yourself room to assess. Here’s the problem with that. The problem with that is every seven or eight years and because you’re human you have fear and greed. Here’s what happens. Every seven years markets get creamed.
