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Broken Fences
I was down at the barn working on a busted mower when a neighbor jogs by wearing white Nikes and a maroon tracksuit. I wave, he stops, says hello and asks:
“So when are you going to get those fences fixed?”
The guy has a point. The fences are shot. But this is an old barn, and the horses are long gone, so I don’t really give a shit about the damn fences. I tried for a second or two to think of a nasty response; the best I could come up with was:
It’s on the to-do list. It will happen when the S&P hits 1,800!
I don’t think he liked that answer, so he jogged off.
Actually, there was a fair bit of truth to my answer. My spending patterns have changed the past four years. I’m sure that there are many like me. In the aggregate, it is a phenomenon that is extending the economic slowdown.
I believe that one should own equities in an investment portfolio. I think there should be some discipline as to how large a percentage equities should be as share of the total. A long establish rule on this question is that one takes their age, and subtracts it from 100. The result is the percentage that should be dedicated to stocks. For a person who is 20 years old, 80% in stocks was the recommendation. For a guy like me, at age 62, the number falls to only 38%.
After fours years of ZIRP and QE you can take that old formula and kiss it good by. It doesn’t work in June of 2012; it’s not going to work anytime over the next five years. With interest rates now at levels guaranteeing a negative real rate of return well past 10 years, the allocation to equities has to go way, way up in order to have a chance of matching the real rates of return achievable five years ago.
The dilemma that I face is exactly what Bernanke wants me to confront. He wants me to be 100% in equities. He is convinced that higher stock prices are the only way to get the economy moving. At this point in history, I think that his actions are now slowing the economy.
Equity returns are, to say the least, unpredictable. Given that I have now near zero investment income that is “certain” (high grade bonds) I have changed my planning/spending habits. I used to be able to look at a spreadsheet in January, and know that in June my NYS Dormitory bonds were going to pay me $X. So I would note in the calendar to call the contractor (for whatever needed mending) at the end of April. No longer. All those nice bonds have been called or matured. Now I say to myself:
“If XYZ stock gets to 60, I’ll sell half, pay the taxes and put up the damn new fences in the pony paddock”.
I’m not asking for one lick of sentiment. My point is to describe something that I believe is a big drag on the economy. When I (and others) book a job three months in advance, the contractor can hire more workers knowing when checks will be coming in. My visibility creates the contractors visibility. The predictability of revenue creates the opportunity for economic expansion and job creation.
The Federal Reserve is operating monetary policy using a simple formula:
Lower interest rates across all maturities ALWAYS increases economic growth.
My personal example proves this formula to be flawed. I think the formula is more complicated:
Lowering interest rates across all maturities has both positive and negative consequences. As interest rates approach zero, (with the prospect that they will remain so for years to come) the negative consequences outweigh any benefits.
The idea that lower interest rates are hurting savers is an old one. The question is, "How significant are the negative consequences of low interest rates?" The multi-decade efforts in Japan to reflate an economy with low interest rates is a shining example of policy that has not worked.
I’ve not seen any discussion that attempts to quantify how large a drag on economic activity low rates are. I know that some of the folks at the Fed will read this; my request/challenge to them is that they respond with an answer.
If the Fed did a fair job of looking at this, and took into consideration all of the consequences of the prolonged zero rate policy, it would be forced to conclude that it is now causing more harm then good. I doubt that we will see an analysis from Bernanke's Fed that answers my question. The Fed has no incentive to document the downside of their policies. So much for that “Open Communication Policy” Bernanke keeps selling.
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Notes: #1
I know that some will be itching to point at dividend stocks as the answer to the need for predictable revenue. Those that tout this approach (especially those on TV) often point to two stocks that are perfect for coupon clippers, AT&T and Verizon.
I think that T and VZ are trading fodder for computers. They are fine stocks to “rent” from time to time in an effort to make a buck. But those that buy this stuff, and then go to sleep thinking their money is safe, are either ill informed or crazy. At 45++ Xs earnings an investor could lose five years of income in any given month.
I can’t wait to hear the howls from retail investors when this lesson is learned (it will be learned). When it does happen, those investors will blame Bernanke for forcing them into inappropriate investments. As well they should.
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#2
Social Security is a good example of where low interest rates are causing severe pain. The SS Trust Fund is sitting on a wad of cash. The interest on the portfolio was projected to extend the life of the Trust Fund for decades to come. Bernanke's zero interest rate policy will accelerate the death of the Trust Fund by ten years. What's that going to cost us? Trillions is the answer.
H/T: PE from Seattle
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I have lived and worked in High Yield. I also have experience in a related security, Preferred Shares.
Trust me. The return results are very similar to equity returns. If you think that this is a predicable source of income, you are wrong.
The ONLY thing that matters is total return. What is the return on a 6% Pref stock that trades at 50% of issue price? If you bought it $25 and it is now $12 you may still get that 6% (maybe) but you sure won't be building any fences with that hole in your portfolio.
Much like stocks, HY has a place. I would put it in the same column as equities when looking at total risk.
I disagree with you on many things Bruce, but this is an excellent point you make (in the comment, not the post). I remember Jeffrey Gundlach on CNBC saying that people should NOT compare high div stocks to yields because there's no guarantee of getting the principal back on stocks, I was thinking "what the hell makes Gundlach think people will get the principal back on Bonds, even held to maturity??" I thought it was disingenuous statement by Gundlach as you know he knows better, and frankly a bold face lie. I still take the time to read and listen to Gundlach's thoughts, but I'll be damned if I don't weigh and measure 3 times everything that comes out of that bastard's mouth henceforth.
"The dilemma that I face is exactly what Bernanke wants me to confront. He wants me to be 100% in equities."
When you reach a point that a single unelected man can actually make you think that you should be in equities because he "wants" you to be in equities, it is time to get out.
Metals, mutuals, or money markets, whats a poor boy to do?
What the Fed fails to understand is the impact ZIRP has on the "animal spirits" of those with the wherewithal to spend, but who choose not to for psychological reasons. In my experience, this phenomenon is very real. Two examples: I go to a high-end dentist; I get lots of amenities plus his cell phone number which means if I have a problem on the weekend (inevitably) or in the middle of the night, I get what I need pronto. Unhappily, at age 64, I find myself facing some major dental expenses, so last month I went in explain that I was on going to have switch to another provider unless he agreed to big discount. Much to my surprise, he agreed immediately, and then explained that a number of his patients including some "with lots of money" were either putting off work they needed done or negotiating reduced fees. A few years ago, former associate of mine manuevered his way into a very lucrative business as a subcontractor to the U.S. military. In 2011, he personally pulled in a low seven-figure income after taxes. I had dinner with him last week in LA and he showed up in a pick-up truck. What happened to his top-of-the-line BMW? He told me sold it along with wife's Mercedes (now she drives a Prius). Why? There's so much uncertainty that he feels "the shit's gonna hit the fan," and he doesn't want to be driving around with "a target" on his back when it does. Now he spends his time splitting up his cash between ten different banks to make sure all of is covered by the FDIC. Next thing you know, he'll be burying coffee cans in the backyard -- are you listening, Benny?
"are you listening, Benny?"
NO
I'm glad I could clear that up for you,
At age 60 I have 100% equity in a cemetary plot. I have 0% in any other equities. All I will leave behind are various forms of metal.
I prefer buy and hold. I'm at 100% yield-on-cost on one stock, and I haven't paid a penny in capital gains.
No taste is most often associated with no tack.
No horsey, no tack.
tact.
Living in proximity with Bruce, he may otherwise actually have a riding horse.
Great post.
I don't think VZ or T are safe dividend plays, as they've got debt, pension, and dying business model concerns.
Check out the Silicon T-bill or the world's largest mass-market retailer for dividends instead.
Those stocks are the new bonds.
Last year Verizon's union guys that put in landlines went on strike. They didn't think Verizon had any right to change their contract even though nobody gets landlines any more. Yep. the telcos have massive problems and the unions are a big part of it. All of the union apologists can say what they want but unions have become a big part of the problem, not part of the solution.
Agreed. Them telco are all busted. Still hurting from sitting on the Lucent/Avaya fences ...memory is a bitch.
'Lower interest rates across all maturities ALWAYS increases economic growth.'
Or higher interest rates mean we go broke. Could go either way, I like mine better.
i'll mend the fences when SP hits 800. i'm afraid my fences will be mended before yours Bruce.
The way it would have gone down if it was Dr. Sandi instead of the more civilized Bruce Krasting:
I love it! In my neighborhood mister track suit would have a hammer and nails in his hand.
For the S&P prediction, 180 is more likely. At that point the fence will be extremely important - nothing else will be functional and the horse will need to be in the corrall.
Bruce, isn't it more like ZIRP and QE are fending off collapse temporarily, and the only choices are to do that or to go through the ringer now? I mean, what else could "work"? Aren't we in the late stages of a cycle that involves growth (of credit, at least), ripeness, rotting (now), and falling off the tree?
Antal Fekete teaches us that when interest rates are heading down that capital is destroyed! The new borrower gets a low rate, but it then becomes HARDER for all of the older borrowers to pay at their higher rates.
Three is NO easy way out, even for those who have saved a lot. Bruce points this out nicely. No income. And when rates go up, there will be lots of pain.
Bruce does point it out nicely. That is why I always make sure to read his stuff.
Bernanke can't understand that somebody that had $200,000 in a 5% CD 5 years ago was getting $10,000 per year. Today they are being herded into a .4% CD that will pay them $800 per year. And still the little jenius (sic) can't understand how that might negatively impact the economy.
I just wish that savers had some place they could safely store money that was not a bank. I mean physically store it. It would be great if they could just take their ball and go home to say a big "fuck you" to Bernanke and the rest of his clavern that believes in the same ridiculous voodoo.
You can store cash currencies in Switzerland outside the Swiss banking system. Google The Safewealth Group. Bob Prechter recommended them donkey's years ago. I use them and have been in their offices in Montreux.
WVI
"I just wish that savers had some place they could safely store money that was not a bank. I mean physically store it"
you are joking right? if not start with a shoe box and slowly fill it with gold....wait for the 'end' and then take out the shoe box and start helping with recapitalization.
SHORT THE PLANET (as matter of principle)!