Ray Dalio Is Kinda, Sorta, Really Wrong, Part 2
Last week, I basically agreed with Ray’s analysis of US income and wealth disparity. It obviously exists. The question is what, if anything, can we do about it? I think this is an important conversation, not just between two people but throughout the entire nation. The answers will make a huge difference to both our society and our children’s futures. Not to mention our own futures.
Why Debt Won’t Spark Inflation
Like Japan, the US will see yet more quantitative easing and extraordinarily low interest rates, along with annual federal deficits of $2 trillion and higher. Alternatives like restructuring the tax code and balancing the budget will be nowhere in sight.
Your Pension May Be Monetized
Defined benefit plans, usually those sponsored by state and local governments, labor unions, and a dwindling number of private businesses. Many sponsors haven’t set aside the assets needed to pay the benefits they’ve promised to current and future retirees. They can delay the inevitable for a long time but not forever. And “forever” is just around the corner.
Time to Change Strategy
Friends don’t let friends buy and hold. At a minimum, you need some type of hedging program on your equity portfolios. Using a simple 200-day moving average to signal the time for going to cash, while not the best, will help protect you from the worst of a massive bear market.
How I Learned to Love the Debt
The Treasury Department will sell bonds and run up the debt. That’s a given. Then there will be a recession, as there always is, and then the Federal Reserve will take interest rates down to the zero boundary (otherwise known as financial repression and the devastation of savers), followed by unprecedented amounts of quantitative easing… just like Japan has done.
Japanified World Ahead
I think the rest of the world will enter a period something like Japan endured following 1990, and is still grappling with today. It won’t be the end of the world; Japan is still there, but the little growth it’s had was due mainly to exports. That won’t work when every major economy is in the same position.
Capitalism Gone Wild
Recession is coming. We can debate the timing, but the economy will turn decisively downward at some point. My own analysis, looking at the data available on April 4, says recession isn’t likely this year but unfortunately looks very probable in 2020.
No Free Lunch, Part 2
Matching the stock market’s long-term average returns sounds like it should be easy, if you’re patient enough. But in fact it is remarkably difficult. In last week’s letter, Ed Easterling and I showed you why it is a longshot bet in almost every market environment. Returns over a decade or two are usually well above or well below average. Most of all, it’s fairly predictable which side of average will occur. Today Ed and I will expand on that discussion.
The Fed Is Playing a Dangerous Game
I would prefer that the market set rates at the lower end as opposed to the Federal Reserve, again, except in times of crisis. I don’t believe 12 people sitting around a desk, no matter how brilliant and educated they are, can arrive at a proper market-clearing rate better than the market itself. Seriously, LIBOR was set for decades without government intervention.
Capitalism Without Competition
Today’s capitalism has a contradiction that is increasingly hard to ignore: lack of competition in key markets. That’s a problem because competition incentivizes producers to get more efficient and reduce prices for consumers. Without competition, you end up with bloated monopolies that may be highly profitable for the owners, but don’t serve the greater cause of economic growth.
What Should We Then Expect (From Investing)?
Today we’ll look at what we should expect from our investing. In case you haven’t noticed, financial markets are really a giant expectations game. A company can report great quarterly results and still get crushed if earnings are less than analysts expected.
How Should We Then Invest?
It makes little difference to our portfolios whether recession strikes in 2019 or 2020. The benchmarks will drop between 40 and 50%—some more, some less. To the extent that you are exposed to stocks and other financial markets, your portfolio is going to take a hit.
Bull in the China Shop
This week’s letter focuses on China’s economy. We’ll look at some numbers showing the challenges China faces, but they don’t explain something important. The way China will meet those challenges is going to be substantially different than we would see in the West.
Something Wicked This Way Comes
Americans like to think we are insulated from the world. We have big oceans on either side of us. Geopolitically, they serve as buffers. But economically they connect us to other important markets that are critical to many US businesses. Problems in those markets are ultimately problems for the US, too.
The Year of Living Dangerously
I expect to spend this year Living Dangerously. Yes, I’m thinking of the 1982 film starring a very youthful Mel Gibson and Sigourney Weaver, based on an earlier Christopher Koch novel. It has an Asian setting and features corrupt politics, neophyte journalists, international intrigue plus a gender-bending Chinese dwarf. If you aren’t sure how all those fit together, then welcome to 2019. We are all stuck in this craziness and can only make the best of it.
Bear Markets, Fed Mistakes, and Quick Shots from John
Today, we’ll address several things, so think of this as my year-end “Quick Shots from the Frontline.” It will be more like a personal, from the heart, fireside chat. (Trigger warning: I will be taking off my politically correct gloves. Naming names and pointing fingers. Just Uncle John telling it like it is.)
The Misunderstood Flattening Yield Curve
Everybody is suddenly talking about the inverted yield curve. They’re right to do so, too, but alarm bells may be premature. Inversion is a historically reliable but early recession indicator. The yield curve isn’t saying recession is imminent, even if it were fully inverted, which it is not.
In my never-ending quest to keep you ahead of the curve, I’ll review what’s happening in Europe. This may be a turnabout for European readers who rely on me to describe what’s happening over here. But as you’ll see, we are far more connected than separated by distance.
Pyramids of Crisis
We are simply not prepared for a world in which old people outnumber the young. But it may be coming, thanks to life extension at the upper end and falling fertility rates below. National pension systems—what we call Social Security in the US but similar elsewhere—are not designed for that combination. They presume a high ratio of working young to retired old citizens. That is no longer happening and is increasingly hard to ignore.
Debt Alarm Ringing
Debt is future spending pulled forward in time. It lets you buy something now for which you otherwise don’t have cash available yet. Whether it’s wise or not depends on what you buy. Debt to educate yourself so you can get a better job may be a good idea. Borrowing money to finance your vacation? Probably not.
The Real Cost of Low-Fee Funds
Today, rather than tackle some big macroeconomic issue, we’ll go back to this letter’s roots and look at market timing and portfolio construction issues. I expect this will get both enthusiastic support and at the same time, make a number of readers uncomfortable—if not annoyed.
Red Hot China Mailbag
As I read the responses to last week's article, I realized that it didn’t have all the nuance I intended. Further, I needed to refine some of my own thinking. In the interest of brevity, I will ignore the positive comments and focus on a few (out of many) that pushed back. I picked a few examples because a proper tour of tariffs would take a complete book.
The Trade Deficit Isn’t the Boogeyman
Trade deficits or surpluses aren’t bad. Nor are they good. They are a natural characteristic of post-barter economies that have achieved division of labor… a sign of success, in other words. For certain countries, there are times when trade deficits simply don’t make a difference. And then there are times when they can be devastating. It all depends on the current account surplus, a concept we will deal with below, and/or whether the country’s currency has reserve status.
The Trump Trade War Recession?
I do not think the tariffs on China are going to cause a recession. But if we have a recession, that is precisely what the Democrats will say. Democrats will not run against the Fed, investor sentiment, markets, Italy, or anything else that actually causes the next recession. They will be running against Trump and everything will be his fault. It will be the Trump Trade War Recession. Whether or not it is true is immaterial.
China for the Trade Win?
The US will have the upper hand initially, and could hold it for a year or two. This is because, for now, our economy is relatively strong and we can better withstand any Chinese retaliation. Beyond that point I think our current policies will begin to backfire, maybe spectacularly.
China’s Command Innovation
Today and next week, we’ll look at the bright side: The good things happening in China, much of which will help the rest of the world, too. Just like the work going on in the US and Europe and other countries is helping the rest of the world. Entrepreneurs and scientists inventing new ways for us to better our lives is good for everyone everywhere. Then the third letter will consider some darker possibilities. It is not all sweetness and light in China, as long-time readers know.
The Growing Economic Sandpile
Change will be today’s topic. Below I’m reproducing part of a letter I originally wrote in December 2007 and have referred to several times. It is the single most-read letter I have written and the most commented-on, too. I consider it, in some ways, my most important letter. If you’ve read it before, you should read it again. I have updated it a little bit, but the principles are just as timeless as ever. And for the time conscious, we have shortened it a bit and at the end, I try to apply those principles to present economic times.
The Good News Economy
I see some major problems coming in the 2020s (and perhaps a bit sooner), but I also see a lot of good things happening right now. The economic recovery, while still weak by historic standards, is gaining some momentum that ought to carry it forward for another year or two, assuming (as I perhaps naïvely do) that we can put this trade war thing to rest. That’s good news because it buys us time to prepare for worse times, but it’s also just plain good news.
The Maine Surprise Was Time
This year at "Camp Kotok," I quickly sensed a more upbeat mood. Not that many that were wildly bullish, but most were positive or at least neutral. There weren’t nearly as many bears as I expected. “Cautious optimism” seemed to be the theme. That led me to refine my own views with a wide variety of participants. Today, I’ll do the same for you.
The Distribution of Pain, Redux
This week I have something special for you: an update of “The Distribution of Pain,” one of 2017’s most popular letters. I say “popular” just in terms of feedback and reprint requests. It was thought-provoking but also sobering. I started with the original version, re-edited to clarify a few points, and added some new comments. It is still a timely, important topic.
Last week I gave you some rules to follow with your investments. They were necessarily general because I’m writing to a broad audience. Today, I will get more specific by discussing some possible strategies for high-net-worth “accredited investors.”
How to Dodge the Debt Train
An active manager worth his or her salt will manage risk as part of the deal, and risk management is exactly what you need when you live on a railroad track. It doesn’t have to be perfect, just good enough to mitigate the major drawdowns. If everybody else loses 40% and you only lose 25%, you’ll be way ahead of the crowd. And the right manager should avoid even that scenario and keep you near break-even.
An American Story
This week, in the spirit of July 4 and Independence Day, I’m going to share the inspirational story of a friend who “Came to America.” But it’s also a teaching moment. I think the story is timely as we reflect on what this country means, to both its residents and the broader world. I hope you enjoy it.
Uncle Sam has made too many promises to too many people, with little regard for its future ability to fulfill them. These are debt. Worse, some of them are additional debt on top of the obligations we already see on the national balance sheet. Even worse, entire generations have planned their retirement lives around the government fulfilling those promises. If those promises aren’t met, their lifestyles will indeed become a potential train wreck.