Volker, Greenspan and Donner, Too

[laurence]

Just curious, but how long would it have to tank before you started to question this wisdom? I only ask because 5 years clearly wasn't long enough for Japan's recovery, and we consume a lot more oil than they do. So, if you believe the "peak oil" theory, believe that retiring boomers will be an economic anchor, and believe that our wacky fiscal policies will bite us in the ass, there's a chance you might also believe in a long-term secular bear market.

Well, I definitely believe our wacky fiscal policies are endanger our posterior, I'm not so sure about the effects of the former (I believe they will affect, I can't say the magnitude), but my portfolio is heavy in value and dividend bearing stocks, definitely learned from my "buy anything that ends it .com!" phase. But let's say the market goes through gyrations and I'm flat on returns come a decade from now once adjusted for inflation. How much better would I have been holding a portfolio of 50% gold 50% cd ladder? Now the stock market may go the way of the great depression, but at that point I'll have bigger worries, like finding a job. I think inflation is the most likely bad case scenario for the next decade. So I guess maybe I should dabble in commodities and/or gold as a hedge? I just figured those plays are over my head as a relative neophyte to investing.

So what would you do, Wab? Here is where I am now:

20% Wellington
10% Vanguard Value Viper
30% S&P 500 index
20% small cap value
20% global

I figure if I go more conservative, I push off retirement by up to a decade, so 25 years should be enough to balance out a wacky stock market anyway. I'm always open to input/insight, it's why I hang around.

 

[wildcat]

Not much I can do really. Continue to DCA into index funds. Maybe I should look more into some short-term bond exposure. My riskier plays are very small bets. Only hold one individual stock at this time and it is a small bet. Only hold one real risky non-diversified MF and it is a small bet. Everything else is in index funds and I try to maintain a small cash position.

My time horizon is even longer than L's.

One comment on the boomer drag. Many of you fail to account for the huge gen after Xers. Good times = large gen. Regardless I don't buy the generation/bad demographics argument.

 

[wabmester]

OK, let's first try to enumerate some of the factors that could weigh on the economy (ignoring the "unknown unknowns," which are often the biggest risk).

I) Fiscal policy

1) Easy money from the fed = asset bubble, inflation
2) Trade deficit = net outflow of capital, less to invest domestically and less domestic production
3) Enormous treasury debt = increasing tax burden, higher interest rates

II) Demographics

1) Fewer workers = smaller tax base, lower economic output, higher wages, inflation
2) More Retirees = increased SS/pension burden, less consumer activity, asset liquidation (or at least, less investment inflow)

III) Peak Oil

1) less cheap energy = lower economic output, inflation, reallocation of real estate (suburban ghost towns, higher density cities)

Of these three categories (and I'm sure there are more), the one that everybody seems to worry about is fiscal policy, and that seems to me the easiest to fix.   The dollar has already weakened, inflation has already increased, and these are the trends needed to address our trade deficit.    The fed has already tightened the money supply considerably.   So, all that's left is deflation of the asset bubble (mostly real estate) and an increase in taxes.    I would expect both to happen in the mid-term (fewer than 5 years), but in the short-term (and who knows how long that will last), these things are bullish.

The demographic trend is harder to correct.   If we have more babies now (we're not) and increase immigration (we're decreasing it), then in 20 years, we might be OK.   There will be a hit on the ecomony, but it's probably not going to be as big as the hit Japan and Germany are taking, for example.    And we're already seeing how Japan is dealing with their demographics: people are simply working longer.

If we really hit peak oil, that means we'll have to lower consumption and find alternative energy.   Neither is easy to do in the short term, so this is probably the biggest risk, but nobody really knows if we've hit peak oil yet.

All of these risks lead to inflation.   All of them lead to asset revaluation.   And these are just the known issues.   Maybe China decides to start empire building again.   Maybe the terrorists get bolder.   Maybe global warming causes H2O to become our most expensive commodity.   Who knows.

What can you do to hedge?   Keep working!   Your own skills are your most valuable commodity.   Buy oil futures if you think we've hit peak oil.   Buy TIPS and other inflation hedges.   Buy real estate in mixed-use urban areas (if you think we're headed towards European-style living conditions).    Buy short-term bonds.   And figure that somehow we'll make it through all of this, and buy some stock too.     You have to decide for yourself what the likelihood of the various outcomes are and invest accordingly.

Obviously, some people think there's close to 100% chance that we'll make it over these bumps unscathed over the long-term, and for them a large stock exposure makes sense.   Personally, I'm 30% stocks because that represents both my (lack of) confidence in knowing the future and my tolerance for equity risk.

 

[laurence]

Thanks for the well thought out response, Wab. So we agree that inflation keeps coming up on the magic 8 ball. As far as higher oil prices affecting the economy, I read somewhere that the cost of energy as a percentage of per unit production is still much lower than it was circa 1980, due to increased efficiency. I understand peak oil theory would view this as a minor influence, but how soon will the peak arrive? TIPS-ack, I get them, but again, the return is so low, I miss all my goals anyway. You have your nest egg, so asset protection should be top priority. I have barely begun to build a nest (barely nosed over 100k) so I feel compelled to roll the dice. In the interest of full disclosure, I have about 20k on top of that sitting in a MM, trying to find something to buy, because nothing seems of value. The growth of the 100k in investments is driven by 401k contributions, due to the company match.

 

[haha]

Thanks for the well thought out response, Wab.  So we agree that inflation keeps coming up on the magic 8 ball.  As far as higher oil prices affecting the economy, I read somewhere that the cost of energy as a percentage of per unit production is still much lower than it was circa 1980, due to increased efficiency.  I understand peak oil theory would view this as a minor influence, but how soon will the peak arrive?  TIPS-ack, I get them, but again, the return is so low, I miss all my goals anyway.  You have your nest egg, so asset protection should be top priority.  I have barely begun to build a nest (barely nosed over 100k) so I feel compelled to roll the dice.  In the interest of full disclosure, I have about 20k on top of that sitting in a MM, trying to find something to buy, because nothing seems of value.  The growth of the 100k in investments is driven by 401k contributions, due to the company match.

I know this is not really a popular viewpoint, but I would say that generally if one feels "compelled to roll the dice", he shouldn't.

Their are of course crises where you must do just that , because you may not survive to play another day. But investment choices roll around often. Lately we have had unusually low volatility, which gives the impression that choices must be made from the currently available menu. History says his is very likely to prove untrue. There will be new menu before long; so what is the rush?

Haha

 

[Marshac]

There will be new menu before long; so what is the rush?

I'm hungry now. When is lunch?

 

[haha]

I'm hungry now. When is lunch?

Oh man, I don't know. I'm only now getting around to breakfast-pork cube steak seasoned with Italian herbs, eggs over easy, cantaloupe and coffee.

Ha

 

[brewer12345]

Thanks for the well thought out response, Wab.  So we agree that inflation keeps coming up on the magic 8 ball.  As far as higher oil prices affecting the economy, I read somewhere that the cost of energy as a percentage of per unit production is still much lower than it was circa 1980, due to increased efficiency.  I understand peak oil theory would view this as a minor influence, but how soon will the peak arrive?  TIPS-ack, I get them, but again, the return is so low, I miss all my goals anyway.  You have your nest egg, so asset protection should be top priority.  I have barely begun to build a nest (barely nosed over 100k) so I feel compelled to roll the dice.  In the interest of full disclosure, I have about 20k on top of that sitting in a MM, trying to find something to buy, because nothing seems of value.  The growth of the 100k in investments is driven by 401k contributions, due to the company match.

The only thing I keep coming back to as an inflaion hedge is commodity exposure.  If you are working, you are already largely protected from inflation in unit-labor costs (not that it has been an issue in recent years).  So what is exposed is commodity price inflation.  So go get you some natural resources funds or something like PCRIX/PCRDX.  Just don't overdo it.

 

[laurence]

The only thing I keep coming back to as an inflaion hedge is commodity exposure. If you are working, you are already largely protected from inflation in unit-labor costs (not that it has been an issue in recent years). So what is exposed is commodity price inflation. So go get you some natural resources funds or something like PCRIX/PCRDX. Just don't overdo it.

Sounds fair enough, I'll do some DD.

Ugh, lunch was a frozen salsbury steak...no time to make a real one, another benefit of ER.

 

[Danny]

Sounds fair enough, I'll do some DD.

Ugh, lunch was a frozen salsbury steak...no time to make a real one, another benefit of ER.

Ah, steak(even if it is only ala Salsbury) for lunch....I'm on the Boca burger diet...

 

[wildcat]

Question -

I only have bond exposure via GIM. Intl' exposure at that. I think it is a better place to be in terms of risk/reward. I have PCRIX which has done nicely as a hedge. However, no US short bond exposure at all. Mostly diversified equities, both US and Intl'. Some cash. Anyone think I should have exposure to US short bonds given a looooooooooong investment horizon? To me it is just not a great place to be even though it is the best way to play domestic bonds.

 

[Marshac]

The only thing I keep coming back to as an inflaion hedge is commodity exposure.  If you are working, you are already largely protected from inflation in unit-labor costs (not that it has been an issue in recent years).  So what is exposed is commodity price inflation.  So go get you some natural resources funds or something like PCRIX/PCRDX.  Just don't overdo it.

What about deflation?

 

[wabmester]

What about deflation?

Could somebody explain the argument for deflation to me? I thought the main causes of deflation were over-production and tight money supply. We have corps hording cash (so over-production isn't likely), and we have a fiat currency. Where's the deflation risk?

Obviously, we can have deflation in some limited sectors (like SUVs), but I just can't see anything that points to overall deflation.

 

[haha]

Could somebody explain the argument for deflation to me? 

Sure Wab, here it is: "                                       ."

Ha

 

[laurence]

The last period of true deflation was the great depression, no? And at the point it kicked in, things already really stunk...

 

[wabmester]

The last period of true deflation was the great depression, no?  And at the point it kicked in, things already really stunk...

Well, that was the last period in the US, and it was one of the main reasons we got off the gold standard. Having a gold-backed currency meant that we had no flexibility in monetary policy, and money got too tight.

 

[brewer12345]

I am generally not a doom and gloom type WRT investing. However, I will note that galloping commodities prices, steadily rising short term interest rates, foreign wars, and a tapped out gummint look an awful lot like a possible case of stagflation or recession. If we have a short term blip in energy and other prices, it won't manke much of a difference. A prolonged commodity shortage coupled with Fed rate raising to try to keep a lid on inflation could be pretty painful.

Based on what I have heard from a long time observer of the oil and gas industry, this winter is unlikely to show no let up in energy prices. This and the nearly inverted yield curve have me a bit worried. I sold off my most premium priicced equity position, and I am strongly considering either further trimming my exposure or putting a hedge in place.

 

[Marshac]

Could somebody explain the argument for deflation to me?

http://globaleconomicanalysis.blogspot.com/2005/06/deflation-debate-heats-up.html

 

[SteveL]

I'm digging through my closet to find my old WIN Button from the days of Jimmy Carter (WHIP INFLATION NOW). I remember mile long lines at gas stations, hostages in IRAN, mortgage rates of 15%, and a prime of 21%. Anybody remember who was chair of the FED then?

 

[HFWR]

WIN was from the Ford admin, an idea attributed to non other than Alan Greenspan, chairman of the Council of Economic Advisors. Also, I believe Arthur Burns was Fed chairman (70-78), followed by Paul Volcker (79-87), then Alan Greenspan.

 

[moghopper]

WIN was from the Ford admin, an idea attributed to non other than Alan Greenspan, chairman of the Council of Economic Advisors. Also, I believe Arthur Burns was Fed chairman (70-78), followed by Paul Volcker (79-87), then Alan Greenspan.

Arthur F. Burns (February 1, 1970 – January 31, 1978)
G. William Miller (March 8, 1978 – August 6, 1979)
Paul A. Volcker (August 6, 1979 – August 11, 1987)

(I looked it up, yea)

 

[Jarhead*]

I'm digging through my closet to find my old WIN Button from the days of Jimmy Carter (WHIP INFLATION NOW).  I remember mile long lines at gas stations, hostages in IRAN, mortgage rates of 15%, and a prime of 21%.  Anybody remember who was chair of the FED then?

SteveL:  Those are times I'd like to forget.

I believe Burns was Fed Chairmen early on in those days, but "Big Paul Volker", in 1979 took over the reins, and allowed the interest rates to
rise to the above heights in an effort to kill inflation.  He was successful, after a helluva lot of pain.

The rest is history.  We started the amazing bull run in both stocks and bonds, (1982) until present.

To go through that once in a lifetime is more than enough, but I am personally a little concerned that I may get "seconds on the chow line".

 

[REWahoo]

To go through that once in a lifetime is more than enough, but I am personally a little concerned that I may get "seconds on the chow line".

And the only thing on the menu is SOS...

REW

 

[SteveL]

My Econ 1A text, many years ago, was by P. Samuelson, and what I remember was the part about Guns and Butter that we had such a hard lesson on during the Vietnam War. I no longer hear the daily reports on the money supply that used to be a part of the news. I used to think that the Commerce Dept overstated inflation, but now, I think it is understated. These problems seem to keep coming around but the lessons of the past are not remembered.

 

[OldAgePensioner]

Today, I went shopping for winter gear.  The shops along Michigan Ave were deserted at 2 PM.  

Bloomingdales is 5-6 floors and each floor could not have had more than 4-5 shoppers.

Marshall Fields 8 floors of no shoppers.

Wow, this looks bad to me.  Maybe I don't shop enough to know but how does a multi-million dollar store survive with that level of traffic?  Bad economy ahead.