We all like to see a good movie. A good movie for me is like reading a good book. I can identify with one of the characters and before you know it I’m either laughing like I am out of my mind or crying like a baby. Since 2000 investors have not just watched a couple of movies, we experienced them. Both were first hand experiences. Early in the last decade from 2000-02 we survived what I call Shock and Awe 1. This was after the last 5 years of the 90’s, where we saw investors’ stock market accounts double and in some cases quadruple in value. The first quarter of 2000 was awe inspiring as I recall some accounts in the tech sector were up significantly in January alone. Then on 3/24/00 reality kicked in with a vengeance and didn’t stop kicking assets until 10/9/02 when we woke up to an S&P 500 loss of -49%, according to Yahoo Finance. If you don’t feel like reading, you can watch this short video:
Shock & Awe 2 started appearing live and in color late 2007 and hit in full swing at the beginning of 2008, wiping away -37% to -60% of investors’ money in the S&P 500 and Nasdaq by year end, according to Yahoo Finance. That was painful. “We tend to think of 1999 as the off-the-charts nuttiness classic of all time, the ‘Caddyshack’ of stock-market wackiness.” In looking at the stock market today, MSN Money goes on to say, “By one way of looking at it, it isn’t the third biggest bubble at all. It may be the biggest.”
Don’t forget the past, learn from it
I agree with Edmund Burke when he says, “Those who don’t know history are doomed to repeat it.” As I look at markets today I see bubbles. In our studies of bubbles in various markets going back to tulips in the 1600s we have discovered that when bubbles burst they do two things:
- First, the prices from peak to trough go back to the prices at the beginning of the bubble.
- Second, when we look at the Tulip bubble in the 1600s, the Japanese stock and real estate markets in the 1990s, and the tech sector in 2000-02, we see that the average loss ranges from -70% to -90%, according to Dent Research.
We’ll take the middle ground of an average -80% loss. This means that sometime in the future, the next melodrama, Shock & Awe 3 may leave investors with 20 cents on the dollar. This might be bad timing when you planned to start taking income.
Let’s look at two situations starting in 2000. Suppose you were certain you could retire with your $1M invested in stocks as measured by the S&P 500 on 1/1/00 and you bought and held your positions with no further contributions and no withdrawals. As you can see, you woke up to about $666,000 on 1/1/03, enjoying a rebound that took your account to about $1.1M on 1/1/08, only to wake up and smell the coffee with $684,000 on 1/1/09. Wasn’t that fun! As a staunch buy and hold investor you finished 2013 with nearly $1.4M. That’s more like it, right?
Now let’s start with the same assumptions, except you begin taking income at 4% a year producing $40,000 to supplement your income. To keep it easy we will keep the $40,000 the same every year. As you can see, by 1/1/09 your balance is below $600,000. By 2010, your balance is well below $200,000 and by third quarter 2012, your nest egg is a goose egg. You got nothing. The game as you know it is over.
Be careful of that punchbowl
The New York Times wrote recently, “about how virtually all major asset classes on earth are relatively expensive compared with their historical values.” NYT called it “ the Everything Boom,” with a worrisome asterisk that “it could be, or become, the Everything Bubble.” Federal Reserve chairwoman, Janet Yellen addressed this possibility in her own way. Ms. Yellen said, “While prices of real estate, equities, and corporate bonds have risen appreciably and valuation metrics have increased, they remain generally in line with historical norms.” Now, don’t you feel better? Ms. Yellen doesn’t buy into the theory that bubbles are forming. Let us observe that most of us don’t recognize the bubble(s) until after the bubble(s) have burst. The central bankers are in complete agreement. It might be a first. But that doesn’t mean group thinking, even with the best of intentions, isn’t any more than flawed thinking. Humans can design ships, trains, cars, assembly lines, homes, and particle accelerators. Central bankers would have us believe there is a way to make the economy perform like a machine. In fact, with enough stimulus, every government can simply set the thermostat in the room of each country and let the machines do the work.
But life happens anyway and economies are based on human behavior, not machines. As we study demographics around the world it may be that between now and 2022, Germany, the primary engine of the EU, is going right over a demographic cliff that is even steeper than Japan cumbled over in the 1990’s. China has inflated a massive infrastructure bubble that is top down driven by centrally planned government that has provided unprecedented stimulus. If that bubble bursts there is little or nothing the People’s Bank of China, or any other central bank for that matter, can do to fight that hurricane.
It’s not the same, it’s different this time
As the Fed begins to taper toward zero this year it is also, as we have shown here, the year that peak spending in the US tops off. Our economy may not accelerate back into healthy growth, like the Fed wants you to desperately believe. It may be that thanks to our own demographic spending cliff, the US economy begins slowing in 2015. The Fed will likely figure this out after the dramatic leg down is in full swing. But you can’t say you didn’t see this one coming. So, here’s my prescription for you to prepare:
- By age 25 start saving 15% of your pre-tax income at the beginning of every month. You’re older than 25? Set aside no less than 20%.
- Learn from the past, look at 2000-02 and 2007-08 to see what can be learned? What held up better? How could losses have been minimized?
- Stress test your portfolio to stay in the game. Look at worst case scenarios so that you might minimize losses in the future.
My favorite American Proverb makes it very clear,
“Great success is always preceded by great preparation”.
I say, preparation is priceless.