Columnists Opinion

ON THE MONEY: Our economic Ponzi scheme may cause the next crash

By John Grace

Contributing Columnist

Despite 39 years in the securities business, it always catches me by surprise when investors proclaim they do not have the stomach to even use the words “market loss.”

Now I come from a fine family of Pollyannas, but I have learned to look both ways more than once when crossing the street. That’s every street, every time, no exceptions.

What makes the conversation even more interesting is when we get to the math on money in the bank. Some investors have gotten so risk averse they have a very hard time recognizing that money in the bank only preserves principal. But that’s all it is doing for you.

As the banks make money on your money, after inflation and income taxes on your earnings, you are accepting a guaranteed loss every year and you will not make it up with volume. So let’s keep it real. Do you prefer a guaranteed loss or a possible loss?

Some investors are taking advantage of new technology that allows you to quantify your threshold for loss. This work is followed by developing a customized portfolio that may perform within your win/loss parameters. Investors can even review portfolio performance over the past 10 years.

This is meaningful as it is valuable to see, unlike most investors, how bad the losses were and how long it took for your account to fully recover. When you can see how you might have weathered the last storm, it does afford you some confidence that you may be better prepared for the next hurricane.

Rather than blindly repeat the past, let’s see what we can learn to be better prepared for the good, the bad and the unforeseen.

Former economics professor, now president of Hussman Investment Trust, John Hussman claims the economic system today is “dysfunctional.” Hussman has become known as a “perma-bear” partially due to his forecast of a market decline exceeding 60 percent as well as a full decade of negative returns. Only time will tell, but he says the economy is setting the market up for unprecedented failure, according to Business Insider.

If there is any combination of withdrawal and market loss that produces a 60 percent drawdown, you need a gain of 150 percent to get back to even. In sharp contrast, if the drawdown is 20 percent, the gain needs to be 25 percent to get back to your starting value.

I am encouraging you to place your bets where you can see the loss might be limited. This way you can stay in the game as opposed to running out of money before you run out of time.

As we have discussed previously, good strategy preparation is particularly important when income must be taken from retirement accounts. After age 70 you cannot stop taking income and in fact, such income from traditional retirement accounts must increase every year for the rest of your life. Your account recovered thanks to a strong market and contributions when you were working.

After sustaining a 60 percent loss, what was $1 million becomes $400,000. Take another withdrawal and your chances of complete recovery may well be zero.

Harry Dent of Dent Research asserts the politicians and central bankers are doing everything in their power to keep the artificial bubble in the air. I sure hope Dent is an accurate forecaster when he opines, “These politicians will be roasted in history, not just for creating the greatest bubble ever, but for extending it far beyond any logic.”

Before the last election, Dent did say no matter who becomes president, the musical chairs will stop between 2017 and 2020. He went on to say whoever takes office will not be re-elected.

Now the Republicans will likely lose the House, perhaps the Senate, and there hasn’t been a crash or downturn yet.

That tax cut that favored business profits, along with the top 1 percent to 10percent who tend to own them, is not working so well. So let’s have another one.

In this nine-year bull market companies don’t need tax cuts, let alone more.

Dent explains the primary reason, “Wages and salaries, as a percent of gross domestic product, peaked in 1970 at 51.7 percent and fell dramatically to 42.1 percent in late 2011. They are currently around 43 percent. That’s a fall of 29 percent. From 1945 to 1974, wages in the last great boom and bust average about 50 percent of gros domestic product. They were more stable and hence no extremes in income inequality or stock crashes greater than 20 percent happened during the Bob Hope boom from 1942 to 1968.”

When I actually paid attention in my high school history class on World War II I will always remember the statement, “A convoy has to travel at the speed of the slowest vessel.”

The top 1 percent to 10 percent have enjoyed a majority of the wage and wealth gains in past decades. Mergers and acquisitions don’t do much for every day Americans. Look out below. Hussman’s expected market losses may turn out to be conservative.

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.