Savers, investors and Newton's first law of motion
Newton’s first law of motion states that an object in motion tends to stay in motion unless something gets in its way. So it is with savers and investors as well.
This was very evident at the height of the equity culture when the cries of “It’s different this time” were echoed as 1,000 point Dow obstacles were beaten back like dust in the in wind. The idea that if the market is going up it will continue to go up or “projection bias” has cost investors and savers trillions of lost opportunities and dollars over the last 30 years.
In 1982, when analyst Henry Kauffman was saying that interest rates were headed to 30 percent and gold to 2,000, stocks and bonds were dirt cheap. Stocks were selling at a price earnings multiple of eight (a post-depression low) and tax-free municipal bonds could be bought with interest rates of 11 percent insured. Bonds went on in the next 30 years to post a total return of over 10 percent, with a few blips of higher rates in 1984, 1994 and 2004.
So, with rates stuck near 0 percent on an inflation adjusted basis and the S&P 500 near its all-time high, will savers and investors continue to look at extrapolating past results as gospel for the future?
Already, there are signs that investors and savers will not fall for the easy money theory that the Federal Reserve has enticed them with. For one thing, many investors have become savers and are looking at buying carousels of savings through FIAs and structured notes that allow them to pick the ponies with some upside risk and little downside. Secondly, they are watching the lessons of the parents and grandparents and choosing to be less risk tolerant. Last, this bear market trap where the market has doubled is getting some gray hair and thin skin as Q4 earnings results roll in and the election draws near.
Most bull markets last about four years. Investors realize that it’s not so much that the market has done better under Democrats than Republicans, but that whoever favors easy money drives markets higher in the short term, regardless of party, and promotes ultimate inflation and a debauching of a currency. We have seen this twice in our lifetime with Nixon-Carter easy money under Arthur Burns and the Fed's current policy of quantitative easing. As Reagan said, “Government programs, once launched, never disappear. Actually, a government bureau is the nearest thing to eternal life we will ever see on this earth." The Fed is playing the facilitator of monetary and fiscal policy alongside a Congress and president stuck in the mud on its role overseeing fiscal policy that will lead to more inflation in the years ahead. The Fed wants to hope and pray, as Greece and Spain did, that whenever we have good economic news, the bond market does not sell off as it did in the 2012 spring when we had good economic news, followed by falling bond prices. Sooner or later, as foreign creditors recognize our increasing plight and some good consistent economic news returns, we will see a slow ascent in rates that will cripple fixed income savers much the way that creeping inflation in the 1970s was devastating to SPIAs, fixed annuities and bonds. The market was susceptible to non-systemic risk like a war or spike in oil prices that solidified inflation’s nasty grip.
Fortunately, today there are many more savings and investment alternatives that provide a cushion against this potential scenario, such as lifetime retirement streams that provide increasing income or a CPI hedge, commodities linked indexed annuities that take advantage of plunging currencies or hard assets, equity-linked CDs, floating rate funds and put bonds.
Conversely, if we are in an environment like Japan that has government debt spiraling to 250 percent of GDP, staying put and sitting may be a prudent strategy that conserves principal and provides some upside. Either way, the dreams of 40-trillion-dollar wealth transfer forecasts for our industry from the early 2000s are going up in smoke and being paid out as new streams of safe income.
Wise advisors would be prudent to have a strategy in place for either scenario as they prepare their 2013 business plan. Changes in leadership can make huge differences in economic policy, as has been demonstrated so many times before. Sitting back on our thumbs and waiting for fiscal cliffs, tax Armageddon and election mandates promote the necessity of acting now.