Juggling Dynamite

Life is full of risk every day in every way.  Acknowledging this is not pessimistic; it allows thinking people to be proactive.  Risk management requires that we hope for the best while trying to drownproof an uncertain future.

Cultivating health is job number one.  Beyond our bodies and environment, this means minimize debt, keep costs and spending well below our income, buy insurance, maintain liquidity and direct longer-term savings in ways that enhance future resources.

Over the past year, I have encountered many well-intentioned people who have come to believe that the best way to help young people is to assist them in buying homes priced at 5 to 15 times their household income.

Many have borrowed personally to help with downpayments or co-signed to enable off-spring into properties they will struggle to maintain and indebtedness that will last decades.

Few have considered the probability that home prices may be flat or considerably lower a few years hence than they are today, and that many may need to sell before prices recover.

Already, recent surveys show that 20% of Canadians regret how much they’ve borrowed, and 45% doubt they will be able to cover living expenses without going further into debt.

The best time to prepare for both difficulty and opportunity is before they arise.   The best time to reduce spending and risk is before we are forced to.   Solid financial plans require optimism and drownproofing.

As Ben Graham pointed out in 1959, the typical experience of the speculator is one of temporary profit followed by ultimate loss. Yet, those who buy corporate securities without regard for valuation are speculating, whether they know it or not.

Another generation is learning old lessons the hard way; see How Millennial Investors lost Millions on Bill Ackman’s SPAC.

And it’s not about a lack of smarts; in fact, intelligent, educated people are just as prone to classic errors of over-confidence and reckless ‘investment’ choices:

“Just because I have specialized training doesn’t mean I can’t be just as much of a fool as the guy next door.”

Also, read the very lucid The Critical Importance of Confidence Diversification to Today’s Investment Portfolios:

It is very rare to see the kind of extreme confidence we have today in so many financial assets at once. Moreover, it is a potentially precarious situation. Overconfidence is inherently fragile, and, looking at most portfolios, there are few holdings with low or uncorrelated sentiment to buffer losses should confidence soon drop. When it comes to mood, portfolios are woefully unbalanced. Not only is everything is on the same side of the sentiment ship, but extremely so.

While investors are now debating what might happen to future asset prices because of macroeconomic forces like inflation and growth, I think they are focused on the wrong risks. What will drive prices ahead will be a function of what happens to the synchronous euphoria now present in what were once confidence-uncorrelated markets. Given the collective extreme in confidence, if sentiment drops, it is likely that all asset prices will fall sharply in unison. Investors won’t reap the benefits of diversification they believe they have in their portfolios.

Inflation has always been a lagging economic indicator and as transitory as financial bubbles.

In the last forty years, the National Bureau of Economic Research (NBER) reports that the low in inflation readings occurred an average of 15 quarters (3.75 years) after the end of each recession. The average number of years from the beginning of the recession to the low in bond yields has been four.

The most extended lag followed the recession of 1991 when inflation bottomed 29 quarters (7.25 years) after the economy. The shortest lag was six quarters after the recession ended in June 2009 when inflation bottomed in the last quarter of 2010. (Hoisington Management).

The start and end dates for recessions are officially proclaimed many months post in retrospect. But even if the 2020 economic contraction optimistically ended in April 2020, it would be typical to not see an inflation low this cycle for several months and possibly years yet to come.

In the latest US CPI estimate for July 2021 (here), BLS reported that non-seasonally adjusted consumer prices increased 5.4% year-over-year, down slightly from June. US CPI peaked at similar levels in June, July, and August 2008 before slowing to 4.94% in September 2008 as asset prices began to tank.

Over the last 12 months, most notable was a 41.8% rebound in gasoline prices, 19% for natural gas, a supply-constrained 41.7% rise in used vehicle prices, 6.4% for new, and 2.8% for the shelter index.  Apart from these extreme and passing price pressures induced by the pandemic, the underlying inflation trend appears to have peaked in April (as charted on the left) just as Treasury prices predicted.   See Jeff Snyder’s latest Inflation More Than Hints ‘Transitory’:

“…should inflation rates continue to play out as they have, each simply the predictable results of, yes, transitory factors having their day and then fading away into ugly history. From supply problems to base effects and mostly Uncle Sam, these aren’t permanent changes to the situation no matter how many times the last of those is called “stimulus.”

Instead, easily foreseeable, once those recede sufficiently what’s left is what was there underneath the entire time – and, as we keep finding in global evidence, the basis and basics behind the US economic rebound may not have been nearly as awesomely robust as (inflationary) advertised. On the contrary, all of that fluff (Warren Buffett’s second shot at “red hot”) mainly the product of those, yes, transitory artificial factors.”

The consensus seems to have sensed this shift and moved on to new worries.

Full round trip in @GoogleTrends searches for #inflation @FT pic.twitter.com/olqbGI6kvB

— Liz Ann Sonders (@LizAnnSonders) August 12, 2021

Public and private employers planning to significantly cut employees’ pay who work remotely full-time seems likely to be the next wake-up call.  After the last year’s debt-fuelled goods and housing frenzy, less consumption was inevitable.  Pay cuts will surely depress it even more.

At the highest valuations in human history, asset markets have vastly overestimated the rates of growth and inflation possible for the next couple of years, at least.  As shown in the S&P 500 real price index below since 1870, such periods of extreme delirium have never gone unpunished.