Columnists Opinion

ON THE MONEY: ‘Melt Up’ arrives, meaning melt down may be next

By John Grace

Contributing Columnist

The stock market has been responding positively to better than expected earnings.

“The ‘Melt Up’ is officially here,” said Steve Sjuggerud of Stansberry Research. “This is the boom we’ve been waiting for and this phase should last 12 to 18 months.

“The Melt Up will propel U.S. stocks to fantastic heights. The Melt Up is the final push of a bull market. It’s when the leading companies of this near decade-long boom really take off and propel the overall market dramatically higher.”

As I have written before, do not be complacent, you must be vigilant. Please enjoy the Melt Up as you prepare for a melt down. I don’t know what the catalyst might be for a reversal of fortune, but we all see the huge elephant in the room.

Charles Sizemore of Dent Research puts a trade war in historical perspective.

“The Great Depression didn’t start out as ‘great,’” he said. “It was a deep, but not necessarily extraordinary, recession. That is until Sen. Reed Smoot and Rep. Will Hawley pushed through the Smoot-Hawley Tariff in 1930, one of the highest and broadest tariffs in U.S. history.”

Of course, the intent should sound very familiar in this case. By imposing a 40 percent tariff on 20,000 goods to breathe new life into the American farming industry that has been struggling for some time.

We are not in a trade war yet. So far we’ve seen a war of words. But as the tit-for-tat escalates, all bets are off. It’s “a tariffically bad idea,” according to the Economist.

As a child, I was always amazed to hear about the families enjoying fireworks on their street celebrating the Fourth of July who noticed, after all of the excitement, that somehow someone accidentally put their own house on fire. Playing with fire is fun until the result becomes a catastrophe. Unintended consequences are my real concern with a trade war.

No matter what the market may do, Linda Ferentchak of Proactive Advisor Magazine, put forth two very realistic scenarios. She points out that for those with a 2005 starting balance of $500,000 in the S&P 500 who didn’t take any withdrawals, the account would be worth about $1.1 million by year end 2017.

But if it were the case that you retired that year by setting up withdrawals of 6 percent a year or $2,640 per month, by 2017 your year-end value would be less than $355,000. Withdrawals total $406,560, “but another bear market could easily result in the account running out of money.”

Ferentchak goes on to say, “While the long-term trend of the market has historically been to the upside, it is very difficult for a retiree to recover from a market decline if the individual also needs to be making withdrawals from the portfolio to meet living expenses. The drag from withdrawing funds from a retirement portfolio can quickly turn a market downturn into retirement shortfall.

“It’s all a matter of math,” she added. “If your portfolio declines by 40 percent, it takes a 67 percent gain to return to its prior high. Add in the drag of steady withdrawals and recovering becomes even more difficult.” If not impossible.

The combination of one severe market loss and annual withdrawals can quickly reveal that investors could well run out of money before they run out of time.

The difference is the result of changing the investor’s portfolio from passive management to active management. Instead of holding risk assets, most notably during 2008, actively managed accounts went from shares to cash, then back into risk assets in 2009 as the market enjoyed volatility to the upside.

While passive accounts may have taken nearly four years to get back to even, actively managed accounts may have taken less than two years.

Active investment strategies can be applied to bond and fixed-income portfolios as well as to help reduce market losses.

Once the funds are gone for whatever reason, be it market losses or withdrawals or some combination of the two, it doesn’t matter how quickly the market recovers. If a downdraft combination becomes minus 60 percent, the investor needs a gain of 150 percent to get back to even.

Now we’re talking a hail-Mary pass just to get back in the game. Clearly, such odds are a long shot at best. When an investor can keep losses and withdrawals to 20 percent, a gain of 25 percent is needed to get back to the starting value. Those are losses from which you may recover.

At least the odds are more in your favor. “Active management: Don’t retire without it,” Ferentchak said.

John L. Grace is president of Investor’s Advantage Corp, a Los Angeles-area financial planning firm that has been helping investors manage wealth and prepare for a more prosperous future since 1979. His On the Money column runs monthly in The Wave.