Stay True to the Path or Take the Fork in the Road

The years rolled slowly past
And I found myself alone
Surrounded by strangers I thought were my friends
I found myself further and further from my home
And I guess I lost my way
There were oh so many roads
I was living to run and running to live
Never worried about paying or even how much I owed

Against the Wind - Bob Seger

So here I am 3 blog's into this endeavor, and I'm already contemplating how my messages are coming across to you.  Are they striking the right cord or am I missing your pain?  Am I coming across as a long term investor or someone who trades daily? Are you learning anything?  Is what I'm covering fresh or was it talked about on the 6 o'clock news?

Then I remember an email I got a few days ago:

... I wouldn't worry about writing to the masses. Write stuff that is most important to you and make that your target audience. Your personal quips and passion will draw interest. Build it for you and others will come.

With that in mind, I turn away from the news and share an article from Minyanville that struck a cord with me: Pre-Eating Some Crow in the Analytical Trap

There's a trap that's easy for analysts to fall into. Let's imagine you've been bearish for a while and anticipating a top. Let's also imagine that the market has continued going up anyway, and yet continues to give signs of a top... but it hasn't actually topped (read: a bit of self-flagellation). The longer this goes on, the more you are becoming increasingly trapped by your own prior analysis. The signs are all there for a top, and are actually increasing, but the market's kept rallying anyway. What do you do?

Do you shift your stance to bullish? Well, you can't really just jump in and randomly start buying, because the rally is long in the tooth, the indicators are overbought, and every objective piece of evidence says the rally is due for a pause at the minimum. Do you continue looking for a top? That's challenging, because the market is blowing up the bear view and busting through resistance levels like they weren't there -- plus you're starting to feel like the boy who cried wolf.

And then the real psychological trap comes: What if you shift to a bullish stance right before the market tops? Oh, the humiliation! If only you'd held onto your views for a couple more days. I think this is a trap that a number of analysts have fallen into, which locks them into being on the perpetual lookout for a top.

While this article refers to short term trading and not long term investing, it broadly applies to me. The article also saved me writing a bit of text, and after last night's writers block, it's much easier to give Jason Haver credit while raising my hand to say "me too!"

For the last 4+ years, I've been of the opinion that the risk of being invested in equities is far greater than the potential reward. The reason is simple, everything that politicians and central bankers have done to try and fix the global economy address the symptoms of the disease and not cure the disease itself.

So what is the disease? Too much debt.

What are the symptoms? Lack of consumer and business demand. Lack of credit available to individuals, banks, businesses, and governments. What is the political/central banker solution? Stimulus packages, bailouts, low interest rates, refinancing operations, quantitative easing (QE), and more borrowing & lending.

How do these solutions address the symptoms?  Let's review Table 1: Solutions Addressing the Symptoms.

 Table 1: Solutions Addressing the Symptoms

Solution	Objective	Complication
Stimulus package	attempt to stir up consumer and business demand by getting them to spend money the government either taxes or borrows.	The problem though is higher taxes reduce demand by reducing the money consumers have. The problem with borrowing is once the money runs out, consumer and business demand fall again plus overall debt has now increased.
Bailouts	prevent losses to bank bond and equity holders, which in theory encourages lending.	Taxpayers pay for poor risk management decisions yet never receive any benefit or profit from good decisions. In times of crisis, credit is tight regardless of bailouts.  People that need credit cannot get it, people that can get credit do not want it.
Low Interest Rates and Refinancing Operations	enable banks to receive cheap funding which they can then lend out for a profit.	Low interest rates and refinancing operations rob savers. Interest payments due to them gets paid to banks, which borrow from savers at 0.25% and lend at 2%+.
Quantitative Easing (QE)	create (print) new money to buy bonds from investors, which in theory stimulates economic growth by encouraging further investment.	The Federal Reserve has no control over what investors do with the new money. Investors always look for the best rate of return.  Since money is more abundant now, they invest in everyday items such as food and energy commodities causing prices to rise - think about that next time you buy gas and groceries.

Please note that none of the above "solutions" reduce debt. The only cure for too much debt is paying it off, restructuring it or defaulting on it - not bailing out, borrowing up, or easing. Those solutions work wonders in equity markets as I can sorely attest to missing the better than 100% gain since the market bottom in 2009. Yet until policymakers deal with curing the disease, the problem of too much debt remains, which means that the stock market crash and recession of a few years ago can happen again.

The time for prevention is long gone, it's time for an ounce of cure. And then I will invest.

So Here's What I'm Pondering Over


It's tough out there. For what it's worth, I know I'm not the only person out there that feels this way. I've had friends that know my interest in investing ask me what's going on, what should I do, where should I invest? Believe me when I say that I'm asking myself the same questions.

So as we all struggle to find our way through our present financial journeys, let me share the risks I see in the following investment classes.

• Stocks - were a roller coaster last year with almost the same starting point and ending point. This year, they're on fire. My trouble though is how quickly things can turn if a crisis erupts. Stocks get sold as people lock in profits/limit losses. If they fall far enough, margin calls go out and more assets (whether it's stocks, bonds, or gold) get sold. When this happens, investors do not always get to choose what they sell.
• US Government Bonds - did well last year due to the flight to safe assets by investors around the world. Foreigners buy US bonds not just to finance our spending habits, but also because they are thought of as a safe haven when world stock markets are falling. However as alluded to in James Bond Isn't the Only Dangerous Bond, bonds are not risk free. The US cannot keep borrowing at low costs forever. Once foreigners can earn a better return in their home markets, they will demand more of a return in order to keep their money in US bonds. When that happens, bonds will lose money - potentially a lot of money.
• Corporate Bonds and Municipal Bonds - are tempting because they always pay a higher interest rate than US government bonds as they are deemed to be slightly more risky. Yet they still have to obey the same credit market as government bonds, which means that when interest rates rise, corporate/municipal bonds will lose money too.
• High Yield Bonds - otherwise known as junk bonds, provide potentially high returns, but are among the first to get whacked when credit markets tighten.
• Inflation Indexed Bonds - pay a small interest rate plus additional interest based upon the US consumer price index (CPI). As they pay more when the CPI increases, I favor these over the other bonds. However I have a tough time thinking that these are more than a nice house in a bad neighborhood.
• Gold - whether it's gold, gold ETFs or gold miners, I am invested here to insure against too much QE and/or too much additional borrowing by the US government. Plus, gold held up pretty well during the last crash. Gold miners are attractive to me because they have a relatively fixed cost per ounce of gold retrieved. Any price increase in gold is profit.
• Commodities - are attractive to me for the same reason as gold, it's a hedge against money debasement. I especially like one thing we all need - food. Energy is also attractive though if there is a worldwide recession, it will take a fall until demand is restored. The only downfalls of this asset is there are relatively few choices for small investors. Also the choices available tend to be costly when compared to an index mutual fund.
• Cash - is a legitimate position. People will say that you lose money to inflation, which I do not deny. However I sleep better at night knowing that potentially large losses from a market crash are not possible.

I'd like to reiterate that my thoughts above reflect my attitude towards my 401k retirement money. As I am no longer employed, I no longer contribute to my 401k. Hence I cannot dollar cost average into lower priced shares when the market falls. In that regard, I like to compare my situation to that of a retiree. Capital preservation is key for me right now.

If I were still employed, I would be contributing to mutual and money market funds.  Dollar cost averaging with regular contributions is a powerful method to come out ahead once our economic problems are solved. I strongly recommend this strategy to everyone.

With that said, don’t let your investments keep you up at night. If they do keep you awake, you are taking more risks than you are comfortable with. Talk to a professional about reallocating to less risky investments so that you can sleep. During your conversation with said professional, ask why they believe that their recommendation is less risky. If you are not convinced by their explanation, don’t invest. Remember:

1. It’s your nest egg.
2. Opportunities are easier to make up than losses.

Disclaimer: Please remember that I’m just a guy sharing information on a blog, and this is NOT official investment advice. Any action that you take as a result of information, analysis, or advertisement on this site is ultimately your responsibility. Please consult your investment adviser before making any investment decisions. During your conversation with said investment adviser, ask why they believe in their recommendation. If you are not convinced by their explanation, any action that you take or forego is also your responsibility. Just in case you missed that, you are responsible for your investments.