How to Fight the Investment Enemies Now Mobilizing

Default averted!

That was the dispatch made by the popular press on Thursday following word there would be a short-term debt limit extension.  But was a default really averted?

Was a default averted when Nixon closed the gold window and put the world on an irredeemable paper standard?

Naturally, Wall Street didn’t bother considering the long-term effects of Washington’s policies of infinite debt – or the soft inflationary default Congress is engineering.  Instead, Wall Street did what it loves to do most; it bid up the major stock market indexes.

What a difference a week makes.  September may have been painful for stocks.  But the first week of October has been all pleasure.

Once again, Washington has a plan to keep the money spigots flowing.  It’s roughly the same plan that’s been in operation for the last 50 years.  The playbook is real simple: kick the can down the road.

Wall Street generally favors this plan.  More debt, both public and private, has loosely translated to higher stock market indexes.  And higher stock prices make everyone believe they’re getting rich.

There have been several notable episodic exceptions.  But, by and large, the rampant influx of debt based money has brought forth higher stock market indexes.

Still, this relationship is not set in stone.  What if things don’t go according to plan?  What if the recent past turns out to be much different than the near future?

What would then happen to investors?

We’ll have more on this in just a moment.  But first, some perspective is needed…

A Work of Genius

“The best laid schemes of mice and men / Go often askew, And leave us nothing but grief and pain, For promised joy!” wrote Robert Burns in 1785, though in a light Scots dialect.

What Burns may have meant is that things don’t always work out according to plan.  What’s more, even the best of plans can cause grief and pain.  Sometimes they can be a liability.

André Maginot, for example, had a plan.  The World War I veteran and French Minister of War, convinced the French government, in 1930, to invest in and build a line of concrete fortifications, tank obstacles, artillery casemates, and machine gun posts, along its border with Germany.  Maginot’s plan looked back at the recent past.  Not forward to the near future.

World War I had offered a destructive insight.  Mass cavalry and bayonet charges were no longer an effective military tactic in the machine gun era.  Advanced firearms could mow down attacking forces with machine-like precision long before they reached the defensive line.  The successful military tactic in World War I was static, defensive combat.

French leaders took the lesson to heart.  They focused their energy and resources on constructing the most advanced defensive line the world had ever seen.  Military experts called it a work of genius.  France believed there’d never be another invasion from the east.

But this belief was quickly erased.  On May 10, 1940, the same year construction was finalized, Germany attacked.  But it wasn’t a direct attack.  Germany flanked the Maginot Line through Belgium’s Ardennes forest.  France was conquered in about six weeks and the Maginot Line, a work of military genius, was exposed as strategically ineffective.

“Generals always fight the last war,” goes the adage.  For interwar French Military leaders, the insights from World War I were not an asset; they were a liability.  They diverted France’s attention and resources and distorted its thinking so that it couldn’t effectively defend itself.

When it comes to money and investing, are you applying lessons of the last financial crisis to the future?

How to Fight the Investment Enemies Now Mobilizing

The lessons of 2008-09 leave many smart and intelligent people’s finances as unsuspectingly vulnerable as Paris in the spring of 1940.  Treasury bills provided cover and safety when the stock market was falling in late 2008 and early 2009.  This strategy may not work so well during the next crisis.

The lesson of the Great Depression in the United States was that cash is king.  The instruction from the mass bank failures and bank runs of the 1930s was that cash should be hoarded, even stuffed in the mattress, where it’s safe.  Yet this lesson cost the depression era generation dearly in the inflationary 1970s.  In just a 10-year period, the purchasing power of their savings was inflated away by half.

Similarly, today’s retirement investors may be focused on another stock market crash.  No doubt, they should be.  Another stock market crash appears to be highly likely.

Moreover, the lesson from 2008-09, the COVID panic of 2020, and every financial panic going back to 1987, is that the Federal Reserve has investor’s backs.  And that a 60/40 stock to bond portfolio allocation provides the ultimate strategy for both capital appreciation and capital preservation.

But what if the Federal Reserve is no longer in the position to have investor’s backs?

When Alan Greenspan first executed the “Greenspan put” following the 1987 Black Monday crash, financial markets were well positioned for this centrally coordinated intervention.  Interest rates, after peaking out in 1981, were still high.  The yield on the 10-Year Treasury note was about 9 percent.  There was plenty of room for borrowing costs to fall.

The mechanics of the Greenspan put are extraordinarily simple.  When the stock market drops by about 20 percent, like in March of 2020 year, the Fed intervenes by lowering the federal funds rate.  This typically results in a negative real yield, and an abundance of cheap credit.

This tactic has a twofold effect of observable market distortions.  First, the burst of liquidity puts an elevated floor under how far the stock market falls – the put option effect.  Second, the interest rate cuts inflate bond prices, as bond prices move inversely to interest rates.  A 60/40 portfolio under this condition is a work of genius.

Thanks to the Greenspan put, the Fed has been running an implicit program of counter-cyclical stock market monetary stimulus since the late 1980s.  Greenspan’s successors – Ben Bernanke, Janet Yellen, and Jay Powell – have all ratcheted up the Fed’s extreme intervention in financial markets via countless programs of outright money printing.

The purpose of these money printing programs is to bail out big banks and big businesses, and to keep financial markets inflated and Washington supplied with cheap credit.  By all honest accounts, U.S. financial markets have been rigged for at least three decades.  And there’s no turning back.

At the same time, the conditions that made the Greenspan put possible are largely gone.  The federal funds rate is near zero.  The yield on the 10-Year Treasury note is about 1.59 percent.  And consumer price inflation is now reducing the purchasing power in earnest.

The Fed has painted itself into a corner.  What’s more, a 60/40 stock to bond portfolio allocation is targeted to fighting the last war.  For investors, it’s a liability.  Those that employ it will be mowed down with machine-like precision.

Something more thoughtful is needed to successfully fight the investment enemies now mobilizing.  Only full spectrum analysis will deliver the means needed to come out on top.

Consider the impossible; allocate your investments accordingly.

Sincerely,

MN Gordon
for Economic Prism

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