On this week’s episode of Protect Your Retirement, we will be going through each one of the four market bubbles that we think are going to burst sooner than many think. We will tell you what you can watch for in the market and how to help protect your retirement when any one of these bursts.
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 the four bubbles that could burst and other things to be watching for in today’s market. The comments on Decker Talk Radio are of the opinion of Brian Decker and Mike Decker
MIKE: Good morning KVI, this is Mike Decker.
BRIAN: And Brian Decker.
MIKE: And we’re here for another exciting show. Today we’re going to be talking about the four bubbles that could burst and other things to be watching for in the markets today. Now, Brian you just told me a recent statistic and I think we should kickoff the show here, that just seems unrealistic to be honest.
BRIAN: Right. I want to setup the show, what we’re going to cover, so that KVI listeners, you’re listening. What we’re going to cover today is a lot of data.
BRIAN: We’re going to talk about a political data point that just came out stating that the median household income for year over year 2014 to 2015 just increased by 5.2 percent. We’re going to call that into question by having that mesh up to a whole bunch of other economic data points, and we’re going to talk about the election. What stocks to own if Hillary gets in, what stocks to be careful of if Hillary gets in. What stocks to own if Donald Trump gets in, what stocks to be careful of if Trump gets in.
BRIAN: We’re going to talk about the four market bubbles, so your eyes are wide open and how you need to protect yourself, your portfolio, your real estate portfolio, your bond portfolio, we’re going to cover all of that. And then if we have time, we’re going to go into the Italian banks. We’re going to cover credit card debt. We’re going to try to squeeze that all into one show.
MIKE: So stay tuned.
BRIAN: All right. So…
MIKE: Yeah, buckle your seatbelts, as they say.
BRIAN: Yep. Let’s jump right in. So this is Brian Decker, Mike Decker with Decker Retirement Planning in Kirkland, and our website- we attach a lot of our shows to our website. This is going to be a good one.
BRIAN: www.deckerretirementplanning.com, a day after the show it’s on, the MP3s are linked. Okay here’s the data point that just came out. The headline yesterday was that there’s a 5.2 percent increase year over year in median household income for 2015 versus 2014, that would represent, by the way, KVI listeners, the largest jump in modern memory.
BRIAN: The official poverty rate went down, if the figures are to be believed. However, I’m going to match those up and show why they might not be believable. Now, I used to- in growing up I used to think, “Yeah, China, they would manufacture their data, but the United States? Oh dang,” this is provable that it’s probably happening. Both to GDP numbers when they come out on a quarterly basis, they come out high and they’re always revised down.
BRIAN: So it’s disappointing. But neither the poverty rate or the household income number square with actual economic performance based on tax collection, the labor participation rate, retail sales, average hourly earnings. Was the consensus bureau report influenced by political’s need as we enter the homestretch of the presidential election? You make the call.
BRIAN: But let’s call this into question, this 5.2 percent data point against so many other data points that say, in fact, KVI listeners, that we maybe already today in an economic recession. So number one, there’s- in fact, when I go through this information, these are economic data points. There’s 10 points that I’m going to talk about why we may already be in recession.
BRIAN: Number one, private sector GDP. The 12-month rate of change stands right now at 1.3 percent, year over year, that’s a level that since 1968 when the rate has slowed to that point, that’s coincided every time with a recession.
MIKE: Now, real quick, why is 1968 the important date there that you’re referring to?
BRIAN: Okay, good point. To clarify, that’s when the private sector GDP data point started.
MIKE: Okay.
BRIAN: Okay? The next point. Number two. Industrial production, the six month moving average of the rate of change, so rate of change means are we increasing and improving? Are we decreasing and weakening? The six month moving average of the 12-month rate of change has been negative for quite a while, which since the 1930s has never occurred outside of recession conditions.
BRIAN: So that’s industrial production, has continued to weaken five quarters in a row now. Number three, non-financial profits, these are national accounts. Since 1950s these have not been lower than three years ago without a recession with only one exception, that was 1986, ’87, but by the way that was a black Monday, October 19th, the market dropped 30 percent in one day on that date.
BRIAN: So non-financial profits are showing weakness. Number four, capital spending. The two-year rate of change is negative, and this situation has always coincided with a recession. Number five, new home building permits. The 12-month rate of change has swung negative which has often been a recession signal. Number six, exports. The six month moving average of the 12-month rate of change has gone negative now, which has almost always coincided with a recession
BRIAN: Number seven, industrial sales. The year over year change is negative, which has [CLEARS THROAT] usually been associated with a recession. Number eight, tax receipts. The six month moving average of a two-year variation is negative now, which has never happened outside of a recession. Number nine, we’re almost done.
BRIAN: I know this is dry information.
MIKE: It’s a lot, it’s a bit of a firehose here that you’re sharing with us.
BRIAN: Yep.
MIKE: But it’s important, or it sounds… I mean, it’s fascinating.
BRIAN: Number nine, employment. Variations on a 12-month basis remains positive but are decelerating, and that deceleration tends to lag economic activity or growth by about a quarter, so that’s a leading indicator. Number 10, consumer spending. The real retail sales generating about one percent growth.
BRIAN: Yet the consumer spending was above two percent year over year, that’s the Obamacare impact. So what those 10 data points are telling us that we are in fact in a weakening recessionary economy, and it calls into question this 5.2 percent household income number that came out this week from the census bureau.
BRIAN: All right, I want to go now into what stocks to own if Trump wins. What stocks to own if Clinton wins. [LAUGH] There’s some people who believe that you should sell everything if Clinton gets in, there’s some people who believe that you should sell everything if Trump gets in. Not so. If Trump gets in there’s a huge gulf by the way, between the candidates checklist or bucket list of what they say they’re going to do.
BRIAN: Both of these candidates are so widely diverse that if one gets in, the markets will react quite differently from the other. So if Trump gets in, you should sell everything that is commodities related because it looks like obviously KVI listeners, we’re going to have a trade war with China. It’s coming.
MIKE: Well I don’t think he’s trying to hide that either, he’s openly talking about that.
BRIAN: Right.
MIKE: How he wants to challenge what’s going on here.
BRIAN: Right. So I’m going to go through the specifics in a second, but anything that is related to China probably is going to take a hit. China relies on our markets for their economic growth, and if we have some kind of a trade war, that’s going to hurt China. But if you think Clinton’s going to win, a simple victory means pain for the healthcare sector.
BRIAN: The EpiPen was just a precursor of things to come. The EpiPen had a big price increase, that made the news last week, and the company, Mylan labs caved in bringing the price way down. But the way Clinton talks about the cost of healthcare is, she is going to definitely jump in and where she can, apply cost ceilings or price controls.
BRIAN: So if Clinton gets in, and you own healthcare and biotech, the expectation there is that the lid will be on as far as growth on those.
MIKE: Didn’t biotech take a hit last year when Hillary had tweeted something?
BRIAN: Oh yeah.
MIKE: Do you remember that?
BRIAN: Yep. Yep. So price controls is anathema to growth in the pharmaceutical and biotech area. Mylan labs, Teva Pharmaceutical, and Valeant are the three that will definitely be in the crosshairs for a Hillary Clinton presidency.
BRIAN: Why these three? Because they’re widely conceded to do the most price increases and the least research and development, but the scrutiny would extend to the companies that do the research and development, and the least price increases. Pretty much everyone else in the industry. You’d expect that she would raise the capital gains rate too. Ouch. Let me say that again KVI listeners, with a Hillary Clinton presidency you should expect that the capital gains rate is going up. So think about what that means.
BRIAN: If you have or are thinking about selling low cost basis stocks or real estate, and you think, “Ah, I don’t want to pay the tax,” and you’re on the fence, you should definitely pay the taxes because if you think Hillary’s getting in the capital gains rate is expected to go higher. Worse on a landslide, if Hillary Clinton gets elected on a landslide, Elizabeth Warren is expected to come in as the most important finance person in the country.
BRIAN: Do you think she would run a bank oversight committee that would call for example, on a moratorium of bank cross-selling because of the wrongdoing that came out this week at Wells Fargo? Absolutely. Absolutely in a heartbeat. How about Trump? So this man wants a trade war with China, what would that affect? That would affect a ton of companies that make cell phones, so we’re talking Apple, and also the capital equipment company that builds roads and infrastructure.
BRIAN: So now you’re talking Cummins Engine, Caterpillar tractor. We sell a whole bunch of consumer goods to China, so now we’re talking Coke, Pepsi, Kimberly-Clark, Colgate, Procter & Gamble. Two huge restaurant chains, with KFC and Starbucks, say goodbye to that revenue. Those incremental revenues in a trade war with China will hurt us on our side in those areas.
BRIAN: The airlines that build aircraft, all of those contractors will be crushed so much, so Boeing, United Technologies, many of the industrials will be affected by a trade war. The nationwide minimum wage, by the way, will be going up if Hillary gets in. That will affect the bottom line for a lot of restaurant companies, we’re talking Arby’s, McDonalds, KFC.
BRIAN: And then there’s corporation subsidies for clean energy. This would be Tesla, without… if Hillary gets in, Tesla would continue to be okay, their funding and their subsidies would continue. If Trump gets in, I don’t think they get a dime of subsidy from the government. The only real common ground between Hillary Clinton and Donald Trump is defense gets more money.
BRIAN: So under the Obama administration, defense has been tanked. However, those defense stocks have been going up in the last few months in this rally since Brexit, so those are, I would say fully priced in, in my opinion. Unless you get a clear winner going into November, the uncertainty in the market between now and November is going to cause a lot of volatility because the two candidates are so diametrically opposed in their bucket list of what they’re going to do, day one.
MIKE: Right.
BRIAN: Okay, so we just covered a very important segment, talking about how your stock portfolio is affected if Clinton gets in or how your stock portfolio’s affected if Trump gets in.
BRIAN: We talked about the differences in their views and their focus. I want to go into, we mentioned last week that there’s four bubbles in the economy right now. There was one bubble in 2000, ’01, and ’02, that popped. It was the tech bubble. It took stocks down 50 percent, just one bubble.
BRIAN: There was another different bubble, although just one, that took stocks down more than 50 percent in 2008, and that was the mortgage disaster, the mortgage meltdown. There are currently right now four, one, two, three, four market bubbles right now. The Federal Reserve has taken interest rates down artificially to low levels. They’re not market forces, these are artificially low interest rates.
BRIAN: When you pull on one end of an economic event there are ramifications for that. So with artificially low interest rates, there is a major bubble right now in bonds, so the bond markets trading right now, the 10-year treasury is trading at 1.7 percent. That’s the lowest, that’s near the lowest it’s ever been in the history of our country.
BRIAN: So there’s a bubble in bonds, number one. Number two, there’s a bubble in debt. Debt. Our country’s debt, the G7 nation countries debt, because why not? It’s free. It’s almost free money. You take debt when the cost of that debt is low. So the countries around the world have loaded up with debt. And so have the consumers. We’ll talk about that.
BRIAN: So the second bubble is debt. The third bubble is the stock market. The stock market is currently trading at a price earnings ratio of 25, it’s only been higher twice before in the last 40 years, and that is November of ’99, and October of ’07. Those were at or near market highs, right before the markets dropped. And those are the four bubbles.
BRIAN: Oh, the fourth bubble, I’m sorry, those are three bubbles.
MIKE: Yeah, the fourth one is…
BRIAN: The fourth one is real estate. When interest rates are this low, investors want to stash their money anywhere except for in money markets, savings, checking accounts, where you’re not getting anything. So artificially held low interest rates have created four bubbles. We’ve never had this before.
BRIAN: So we’re in uncharted territory, want to make sure that you are protected. We worry about our clients and want to make sure KVI listeners, that you have downside protection in your stocks, bonds, your investments. By the way, I’m going to talk more about the four bubbles. Are you protected in your real estate, if real estate drops by 30 percent? Are you protected in your bonds, bond funds, if bonds drop 30 percent?
BRIAN: Are you protected in stocks if stocks drop 30 percent? And are you prudent enough to hold assets aside so that the debt levels that the typical consumer has, typical company has, typical country has, is there prudence to have assets that are liquid that can easily pay those off? All right. So here I’m going to dive right in. I mentioned that currently, the stock market is, the price earnings ratio is at 25, that’s the highest it’s ever been outside of 2000 and 2008.
BRIAN: The bubble in the stock market, there’s an even bigger bubble in bonds and commercial real estate, because of low interest rates. Our country now values its assets at more than 500 percent of the national income. In the past two recessions, they were ushered in by a collapse in asset prices. The risk of repeating is growing. US stocks have hit fresh highs, real estate is quietly doing the same. Home prices are just two percent below their peak that they hit in 2007, and commercial property values have hit all-time records.
BRIAN: The result is that the net worth in the United States now tops 500 percent of the national income. Ominously, net wealth has reached that level only twice before. First, 1999 which is a clear market top. And then ’99 to 2000 during the NASDAQ bubble and then again in 2008 during the housing boom. So here’s my concern. Excess valuations don’t necessarily trigger bear markets; you can’t time the markets using only valuation.
BRIAN: So what that means is, this over valuation KVI listeners, can last for years. It doesn’t mean that because we are overvalued, meaning that tomorrow, next day, next week, that all of the sudden we are going to have that bubble burst. There’s typically needs to be an event or a pin that bursts the bubble. But the more over valued a market becomes, the bigger the resulting damage when a recessionary or bear market finally arrives.
BRIAN: I see three triggers for a crash, all of which are already in motion. Number one, economic dislocations. So far, 25 percent of the companies in the S&P 500 Index have reported second quarter earnings on average year over year, the decline is 3.7 percent. This will be the first time the S&P 500 has reported five consecutive quarters of earnings declines since the recessions of 2002 and 2009.
BRIAN: The truth is, we’re in a recession right now. So we just talked about that, KVI listeners, how if you think that trees grow to the moon, they don’t. If you think that this stock market is going to continue to go up, I bet you my house it will not.
MIKE: I’ve just got to ask a very open question, and I apologize for it being such an open question because ambiguous questions do merit ambiguous answers.
MIKE: But don’t you think that we as a country would have learned our lesson after the tech bubble in 2000, and then 2008 with the market crash, that we’d figure out how to regulate and… or not regulate, but not drive up everything and overinflate everything. I mean, why do you think that’s happening? Is it human nature?
BRIAN: It’s human nature and investors have short term memories.
MIKE: [LAUGH]
BRIAN: It’s very typical of the, “What have you done for me lately,” attitude of investors.
BRIAN: It’s a very much a short term memory. That’s typical of human nature.
MIKE: So is that why you think the markets tank? Is it every seven years or so? That you’ve said?
BRIAN: Yeah, every seven years the markets get creamed. And this has been going on for decades. So 2008 was about… actually the markets bottomed in March of ’09, which was seven years ago. Here we are in 2016. Seven years before that, 2001, if we use 2008 as a market drop, seven years before 2008, 2001, that was the middle of a three year, 50 percent market drop. Twin Towers went down that year. Seven years before that was 1994. That was interest rates went up, the economy slowed down, stock market dropped. Seven years before that was 1987, Black Monday, October 19th. 550 points came out; 30 percent drop in a day. Seven years before that was 1980. From 1980 to 1982, that was a two year, 40 plus percent bear market. Seven years before that was ’73, ’74. That was also a 40 percent bear market.
BRIAN: And seven years before that was ’66, ’67, that was also a 40 plus percent bear market and it keeps going. Every seven years KVI listeners, the markets get creamed. I hope you’re ready.
MIKE: Just some, I mean frankly very important information on what you should expect that’s coming, and we’re just using historical data to make our, not predictions, but…
BRIAN: Make our points.
MIKE: Make our points, exactly.
BRIAN: Okay, there was an article that came out this week from UBS, that thinks the risk of a stock market crash is growing. According to the team on UBS analysts, led by Paul Winter, they note that 77 percent of stock market crashes are driven by earnings announcements. We just talked about how earnings announcements, the latest earnings are down 3.7 percent. Quote, this is Paul Winter, quote, of UBS. “We believe we are witnessing the end of the credit cycle.”
BRIAN: “Earnings growth rates are flattening and the stock market impact has been increasing. Importantly from a risk perspective, systemic risk is rising and economic policy uncertainty has hit all-time highs.” That’s an understatement of the year, KVI listeners, because we don’t know at this point with policy going forward, economic policy, geopolitical policy, etcetera, we don’t know if Trump or Clinton is going to get in.
BRIAN: UBS said that low bond yields and low interest rates have herded investors into the stock market to make some return, or try to make some return on their cash. In a world of heightened macro factors systemic in economic policy risk, we should expect higher levels of equity market volatility. By the way, we’re starting to see that. Last Friday, 400-point drop. Monday of this week, we saw a gain of 230 points, and then this week the next day [CLEARS THROAT] which was Tuesday, we saw a drop of over 200 points.
BRIAN: Economic policy uncertainty has soared this year with political crisis in the United Kingdom, with Brexit, Europe with the European banks, and a bumpy rebalancing of the Chinese economy away from manufacturing and towards consumer services. One of the most successful hedge fund managers of all time, Ray Dalio, who founded 82 billion dollar Bridgewater pure alpha fund, he said recently that 75-year debt boom was coming to an end, and it was going to get ugly. We’re going to go into detail on bonds in just a second.
BRIAN: He says that we’re seven years into the economic expansion phase of the business short term debt cycle which typically only lasts eight to 10 years. And near the end of the expansion phase of a long term debt cycle, which typically lasts 50 to 75 years. On bonds, when we talk about bonds, KVI listeners, you go into a bank or a broker and you’re asked how to diversify your portfolio, they’re going to use something called the rule of 100, which says that if you’re 65 years old you should have 65 percent of all your investments in bonds or bond funds.
MIKE: Now this is a really important point, KVI listeners, and we will be extending another call after this point for 10 people to come in, so listen up because this is a life changing, important point on how you plan your retirement and what not to do.
BRIAN: Okay. I bet you my house again that most every KVI listeners have been influenced by bankers and brokers on this point called the rule of 100. It’s pervasive. And it says that if you’re 65 years old, you should have 65 percent of your money, your investible funds in bonds or bond funds.
BRIAN: If you are 70 years old, you should have 70 percent of your money in bonds or bond funds. Let me restate that differently. If you’re 65 years old, you have 65 percent of your money earning almost nothing. When interest rates are this low, almost nothing. Same thing for a 70 year old, 70 percent of your money is earning nothing. You can’t afford to do that, number one. But the bigger problem, the much bigger problem has to do with banks and brokers telling you that that’s your safe money and telling you that according to the rule of 100, that you should have your safe money in bonds or bond funds.
BRIAN: That is like a math teacher telling class, that two plus two is 20. It is demonstrably false, and we want to warn you that when it comes to bonds, and the bubbles that we’re talking about here, that when your bond funds are investing your safe money, what happens when interest rates eventually go up? And they will. When interest rates eventually go up, you can lose a huge, huge amount of money.
BRIAN: That money is not safe. Bond funds, when interest rates are at 100 year lows, you have what’s called interest rate risk. And interest rate risk right now is at or near 100 year highs. So when interest rates do go back up, you can easily lose 15, 20, 25 percent in a year on just a typical move in interest rates, and that will decimate, that will hurt a lot of people that counted on good advice coming from their bankers and brokers.
BRIAN: We’re going to continue to talk about bonds.
MIKE: Oh. More on bonds.
BRIAN: [CLEARS THROAT] Okay. So we’re approaching a severe credit default cycle. More than a trillion dollars’ worth of corporate bonds will default in the next three or four years.
BRIAN: Let me say that again. We’re approaching a severe credit default cycle. When interest rates are this low, and the spread, the difference between a triple-A corporate bond, and a junk bond is tiny small, you have a credit default cycle that when interest rates go up and the economy slows down, you have a lot of money that is going to default in the corporate bonds in the next three or four years.
BRIAN: So the default rates have doubled in the last year already, the cost of credit in the corporate bond market has begun to significantly increase for the first time since 2008. This is a canary in the coal mine. Historically every six to eight years one of these credit default cycles begin. By the way, they coincide with the economy and the stock market every seven to eight years. Typically between 20 and 30 percent of all non-investment grade bonds that are outstanding will default.
BRIAN: Usually about five percent of investment grades default too. Let me say this differently, KVI listeners. If you are in what’s called a junk bond fund, another name for it is a high yield bond fund, I hope you just get out. Let me say that again. If you own high yield bonds, you should sell them. You should move into corporate bonds, investment grade corporate bonds, short term duration corporate bonds, but when you come in, the people who come in and talk with me, I will tell you, I’ll look you in the eyes and tell you, “Do you want to take a 20 or 30 percent hit? Because that’s what you’re looking at with your quote unquote ‘safe money’ because you were reaching for a yield.”
BRIAN: “And you saw that the safe stuff was only yielding one or two percent. Why not try this one? These are corporate bonds. Well guess what? This one is a junk bond fund.” I want to make sure that you know that your bond funds are not safe.
MIKE: [COUGHS]
BRIAN: And any money that you have in high yield bond funds is not safe, and any money that you have in emerging market bond funds is the highest extreme of the risk cycle in bonds. When, not if, when emerging markets go down, those bonds are the first to tank.
BRIAN: So default rates have doubled in the last year, the cost of credit and the corporate bonds have significantly increased for the first time since 2008. Before 2009, the US junk bond market never issued more than 150 billion dollars’ worth of credit in a year. Issuance was more than double that amount in 2012, ’13, and ’14. Everyone wants yield. And while the bond market was issuing twice as much debt as normal, it was doing so with the lowest interest rates and the easiest terms the market had ever seen.
BRIAN: We’re in uncharted territory. In short, the Federal Reserve’s action to send short term interest rates to zero had the unexpected effect of forcing investors to buy far riskier forms of debt, like junk bonds to earn any yield at all. So we get this. This is Brian Decker and Mike Decker with Decker Retirement Planning, warning you that one of the four bond… one of the four bubbles in with interest rates that are unsustainably low, we want to warn you. At Decker Retirement Planning we want to warn you that your bond funds are not safe.
BRIAN: And your high yield bond funds are not safe. And your emerging market debt is not safe.
MIKE: Now, Brian real quick when you take someone through the planning process, you know, through the Decker approach, is this… where do you talk about this? I mean, as far as the importance level, is this one of the first things you talk about and address?
BRIAN: We go through all of their portfolio and we will show them what is safe and what isn’t safe. What is at risk and what isn’t at risk. What is going to produce income and what isn’t, and we rearrange the chess board of your portfolio to make sure it all makes sense.
BRIAN: And we’re totally transparent asking you, “Why do you own this?” Or, “What’s the purpose of that?” So when we finish, it’s a purpose based plan, so that risk assets are clearly identified and have a function to grow and we separate those out. Intermediate term assets are principle guaranteed because we need those assets to produce income in the next five to seven years, and short term investments are needed for their income in the next five years.
MIKE: That’s how it should be though. Transparency, we’re fiduciaries, we’re on your side, we do what’s in the best interest for you. And that’s a really important point that we really want to drive home, is we’re here to protect your retirement, that’s what the show is called, that’s what we want to do, that’s why this radio show is kind of a community service to warn people to make sure that you… or to help you do the right things going forward.
BRIAN: So I’m spending a lot of time on bonds, Mike.
MIKE: But it’s because of the rule of 100, this is probably one of the most… people are at more risk with bonds probably than with the other bubbles right now.
BRIAN: Absolutely.
MIKE: For retirement at least.
BRIAN: Right. So absolutely, people think that they believe their banker or broker that told them that they should have 60 or 70 percent of their portfolio in bonds. So we’re spending a lot of time on this. So anyhow, to continue by the mid-2013 bonds that normally paid double digit interest rates to compensate for the risk of default in high yield bonds, now they’re paying less than five percent on average.
BRIAN: [CLEARS THROAT] Since then the entire market has been like a ticking time bomb, as many of these bonds are designed, are destined to blow up as soon as credit tightens. Credit tightening is code for interest rates going back up. And that by the way, is starting to happen right now. For most investors, this’ll be the greatest financial tragedy of their lives, even worse than the losses they suffered in 2008 and 2009. As junk bonds blow up, they will become nearly impossible to sell. Bond funds, now this is a very important point.
BRIAN: Bond funds now own billions and billions of dollars’ worth of these bonds, so track with me on this KVI listeners, we’re going to go through trying to sell a junk bond in a junk bond fund when the prices or the bids are non-existent. Mutual funds own almost about, almost 20 percent of all corporate bonds by the end of 2014. It won’t just be one or two big mutual funds that blow up. There are now 10 bond mutual funds that manage more than 40 billion.
BRIAN: That’s up from only two that managed more than 40 billion in 2010. As credit tightens, which again is code for higher interest rates, and riskier bonds begin to fall substantially in price, investors will panic, try to redeem their investments in these mutual funds but guess what happens? The funds are required to provide seven-day liquidity. They’ll be forced to sell something to generate cash to meet the demands for distribution.
BRIAN: Are they going to sell a junk bond trading at 60 cents on the dollar? And eat a 40 percent loss? Or will they sell an investment grade bond that’s still trading around par? The truth is they won’t have a choice. They’ll have to sell the higher quality bonds at the front end of this debacle. These mutual funds will have to supply daily price quotes to their investors, and they’ll have to provide weekly liquidity. Trust me, when retired investors see they’re safe, said that they’re safe by, I just say this in absolute disdain, Mike and KVI listeners.
BRIAN: Bankers and brokers are committing financial malpractice telling you that your safe money is in bonds and bond funds.
MIKE: Well, I don’t think a doctor enjoys telling their patients that they’re sick, we don’t enjoy telling people that their portfolio is this high of risk.
BRIAN: But this kind of malpractice is like a doctor telling a cancer patient that they’re fine and don’t need any treatment. It is just horrible. So when investors, retired investors see their quote unquote “safe bond funds” virtually down 20 percent, they’re going to panic, and then they will want to sell and the cycle continues.
BRIAN: The cycle generates a distribution rushed to the exit, at which point many of these bond funds will have to do what? They’re going to have to close. This is already happened a few times this year already. The value of the funds continue to fall even faster, spiraling additional redemption demands until eventually there aren’t any more liquid bonds to sell. At that point the mutual funds will have to halt all redemptions. I hate to be such a downer, I’m an optimistic guy, but I am not showing responsibility.
BRIAN: And not continuing my fiduciary liability if I don’t point out that these market cycles coincide to a pretty predictable calendar. Every seven or eight years, the markets get creamed. Stock markets do, we talked about the stock market bubble, how right now it’s trading at 25 times earnings, it’s only been higher twice in 2000 and in 2007. Which were both in the last 16 in a half years, the peak of the markets.
BRIAN: We aren’t necessarily saying that markets because they are overvalued are going to tank, but with incredibly artificially low interest rates, we have four bubbles. Just to catch up, KVI listeners, this is Brian Decker and Mike Decker with Decker Retirement Planning talking about the four bubbles that have been created by the feds NIRP, negative interest rate policy in most countries, but ZIRP, zero interest rate policy in our country.
BRIAN: When you have rates this low, we have a real estate bubble, we have a bond market bubble, we have a stock market bubble, and we have a debt, a country, the G7 nations have taken on free money with debt levels that have never been seen before.
MIKE: And if you’re just tuning in, you can catch the entire show at deckerretirementplanning.com, we repost every radio show the next day. So that’s deckerretirementplanning.com. All right, we got to keep cruising here, there’s still a lot to cover.
BRIAN: Okay, I’m going to switch.
BRIAN: We talked about the bubbles, I’m going to switch, we’ve got time, we may…
MIKE: You talked about bonds. Yeah, you…
BRIAN: Okay, we talked about bonds.
MIKE: And you touched on stocks, a little bit on debt, but you didn’t touch about real estate.
BRIAN: Okay. Real estate, there’s an important number called the affordability index. Let me describe what that is. And this is the mathematical calculation of valuation that we use to value whether or not the real estate market is over or undervalued.
BRIAN: Here’s how we get the affordability index. In any metropolitan area, Boston, Seattle, Dallas, New York, Los Angeles, wherever, you go into a metropolitan area and you have as the bureau of labor statistics provides, you have the median household income in that area. Let’s say that it’s 85,000 dollars, I’m just throwing a number out. Now with today interest rates and current lending environment, how much in Seattle will 85,000 buy for a house?
BRIAN: And let’s say that that number is, and I’m just making that up, is 400,000. 450,000. Now the next number that we take from the bureau of labor’s statistics in the Seattle metropolitan King County area, is we take the number of the median home price in that area. Which right now, and again I’m making it up, is 550,000. There’s a 100,000-dollar gap now called a negative affordability, or an affordability index. When the affordability index is negative, and it’s this negative.
BRIAN: And by the way, we are in uncharted territory, as far as the negative affordability index goes, in most all metropolitan areas around our country, it’s just a slam dunk for residential real estate that we are in a bubble. We’re beyond where we were with the affordability index because unlike 2007 when real estate went back to these levels, we haven’t had much income or wage growth in the last seven or eight years. So real estate has gone up, but wages have not kept track.
BRIAN: So that’s all I want to say about real estate, we covered bonds in depth. Stocks, it’s just a matter of price earnings ratios and market cycles, and it may go higher, but when you come into see me, those callers, when you called and you want a second opinion? I’m going to look at your bond funds, and I’m going to look at your stock portfolio, and I’m just going to ask the question, “What’s the plan?” “What’s the plan to protect what you’ve taken a lifetime to accumulate?” And when you tell me your plan, I’ll tell you our plan, and you can see what works best.
BRIAN: In our plan, the clients that we manage money for and did the planning for, went through 2008 and the money that they had set aside for income for five years, 10 years, 15 years, 20 years, they didn’t lose a dime. Not a dime. And on the risk portfolio, we use what are called two-sided models. Because the market’s a two-sided market. It goes up and it goes down. For reasons that make no sense, KVI listeners, for reasons that make no sense banks and brokers will tell you to buy and hold.
BRIAN: It’s a one-sided strategy in a two-sided market, it works great if the stock market continues to go up year after year. But sadly it doesn’t. The stock market has a cycle attached to it. So every seven or eight years you guys in retirement take a 30 percent hit, and then you take four years to get your money back, and your drawing from that portfolio while the market is fluctuating your portfolio up and down. And when you do that, if that is your plan, you are committing financial suicide by drawing income out of a fluctuating account.
BRIAN: And again, it’s just math. You are compromising the gains when your portfolio’s going up and you are accentuating the losses when the markets are going down. That’s something we want to warn you against doing. Never, never, never draw income from a fluctuating account. If your banker or broker is having you do that, gosh, I hope you go to our website. We have written many, many articles about how bankers and brokers can hurt you, and this is one of them. Go to our website, www.deckerretirementplanning.com and go to our tabs that one of ‘em, Mike, says, “How can bankers and brokers hurt you?”
MIKE: That’s right. It’s on the front page, right below the main picture on the bottom left. And on the right side is, “Why work with a fiduciary?” Which is who we are.
BRIAN: Right. Okay, I’m going to dive into something that sounds totally bizarre, but it can be the pin that can cause a contagion and start the unraveling. I’m just going to throw it out there. Italian banks. I’m going to talk to you about Italian banks. Prime ministers come and go in Italy for… since the financial crisis, but the latest incumbent’s name is Matteo Renzi.
BRIAN: He’s pursued structural reform more energetically than his predecessors. He’s now in a bid to secure a popular mandate for his restructuring program. Renzi has bet his premiership on a referendum over badly needed constitutional reforms. If Renzi wins the vote, which is due in late October, beginning of November, the proposed measures will streamline Italy’s legislative process, breaking the parliamentary gridlock which has crippled successive governments, and opened the way for far reaching economic reforms.
BRIAN: If he loses, let me say that again. If Renzi loses, he has promised to step down. A no vote in October/November will not just precipitate the fall of Renzi’s government, it could throw Italy into a long-term membership of the Eurozone into doubt, plunging the single currency once again into crisis. There is liquidity ratios that need to be maintained for banks in Europe. The PIIGS, Portugal, Italian, Italy, Ireland, Spain and Greece have banks right now that are technically insolvent.
BRIAN: And are only kept afloat… by the way Mike, what’s the name of that show where they drag around that dead guy?
MIKE: Oh, Weekend at Bernie’s.
BRIAN: Weekend at Bernie’s.
MIKE: [LAUGH]
BRIAN: It sounds kind of horrible, but [LAUGH] what they’re doing with these banks that are technically insolvent is kind of like the Weekend at Bernie’s movie, where if everyone just doesn’t look at the bottom line, we can just pretend that this bank is solvent. Once the banks start to be called what they are, insolvent.
BRIAN: That may start, or has potential to start a contagion that goes through [here up?] and will affect the United States and the world banking markets.
MIKE: Sounds like dominoes are set up.
BRIAN: Right.
MIKE: And it just takes one push.
BRIAN: Right. So I want to talk to you more about Renzi. The currency devaluation together with fiscal spending to support the poorer regions of the company’s health is part of his plan. Signing up the euro put an end to all of that preventing devaluations and prohibiting budget deficits at 10 percent GDP.
BRIAN: The result has not just been depressed growth in Italy’s economy and relative impoverishment, Italy’s real GDP per capita has slumped to a 20 year low. That’s where they are right now. Such a below par economic performance has led to a buildup of bad assets on the balance sheet of Italy’s banks where 18 percent of all loans today, right now, are classed as non-performing. The result is stagnation. Italy needs to enact wholesale structure reforms to enhance its competitiveness, relative to the Eurozone neighbors.
BRIAN: It needs to make labor markets more flexible to encourage job creation, it needs to lower the barriers to entry to protect much of the country’s service sectors, it needs to overhaul a judicial system so that bankruptcy proceedings can last, I’m sorry, to avoid bankruptcy proceedings that can last 10 years or more, and finally it needs to restructure its fragmented and dysfunctional banking system. There’s a lot on the line for this Renzi vote in October/November. Renzi’s attempt ran into bruising opposition from Italy’s powerful and well subscribed trade unions.
BRIAN: Trade unions, by the way, offer a near lifetime guaranteed employment. There’s entrenched interest with the unions. They protect their professions, and so the consequence is political and economic stagnation if the reforms don’t go through. Renzi’s referendum aims to change all of that. The promise to cut the size of the upper house, this is kind of interesting, KVI listeners, Renzi is going in and trying to change their version of Congress.
BRIAN: Cutting the size of the upper house from 315 senators to just 100 senators. Under his proposal, senators will no longer be directly elected but will instead be chosen by regional councils, nominated by the mayors of big cities. And in the case of five of them, be appointed by the Italian president. The reforms will not only cut the cost of notoriously bloated and wasteful upper house where senators have traditionally enjoyed lavish expenses and generous pensions, most importantly will downgrade the political power of the senate so it will no longer be able to obstruct government legislation entirely.
BRIAN: But only to propose amendments that will be adopted at the discretion of the lower house. The objective is to increase the executive power of the government and to tackle entrenched interests with additional measures that allow for new laws to facilitate popular referendums and to promote citizen participation in the political process. So I don’t want to go into any more detail on this, but if Renzi loses the referendum, not only will Italy remain in policy limbo, but it’s highly likely that his subsequent resignation will trigger a parliamentary election.
BRIAN: And create a vacuum in the Euro, for banking confidence. So Italy is the third largest economy in the monetary union in the European union of its core members. Its departure, if it were to depart, would surely hasten the breakup of the whole Euro project. So if Renzi wins in October, the Eurozone has fresh hope. But if he fails, Italy fails, and very likely the Eurozone fails.
BRIAN: And I want you KVI listeners to know about this and keep an eye on this. Because if that vote fails, it has ramifications for Europe and through banking contagion to the United States and our markets and your pocketbook and your portfolio.
MIKE: Now, tune in next week for Sunday, 9:00 AM for Decker Talk Radio, but in signing off this is Mike Decker.
BRIAN: And Brian Decker.
MIKE: Out of Kirkland, Washington with Decker Retirement Planning. Take care, have a great week.
