The Road Ahead: Investment Perspectives, Part I

October 16, 2013

"The Winds and waves are always on the side of the ablest navigators."
-Edward Gibbon

Were Nostradamus around today, he'd write an investment newsletter. Providing thematic investment ideas centuries in advance. Plenty of time to save for and benefit by his sage advice.
Alas, Nostradamus is no colleague of mine. Yet, one's business card need not read "soothsayer" to take an analytical look into the future. In fact, unless you're utilizing all available facts and data to infer specific future outcomes, you're flying by the seat of your pants.
We have decided to focus the following five Weekly Market Reviews to a thematic summary of the events and circumstances affecting today's investors. Further, we will provide four specific strategies for enabling investment capital to stay ahead of the curve throughout the coming cycle.
Let's begin with some of the scenarios currently impacting future investment returns. These are developments that have already begun to reveal themselves. Accordingly, investors should educate, acclimate and prepare.
First, the United States will incur another debt-driven economic crisis at some future point. Two years? Twenty years? Anyone's guess. But the U.S. government, Treasury and Fed have collaborated on leveraging up the nation's balance sheet as no nation has ever done. Following WWII, the U.S. was the world's economic engine, and its largest creditor. 65 years later, the U.S. has become the biggest debtor nation the world has ever known.
The current national debt is roughly $17 trillion. Add the unfunded mandates our government has promised, like Social Security, Medicare and Medicaid, and that figure rises above $126 trillion. That's a liability of more than $1 million per U.S. citizen.
As of now, the debt service is manageable. Barely. The $3 trillion we'll pay in interest this year is simply $3 trillion that will not be spent on education, infrastructure, research, defense, or the poor.
Unfortunately, counter-posing whirlwinds are conspiring against us.
China, our largest creditor, has lately been in open revolt (here). Demanding that we get our financial house in order. Can't blame them. They have invested roughly $1.3 trillion in U.S. Treasuries, only to watch the stewards of their capital bicker like spoiled school girls over simple budgeting matters.
Soon, China will simply stop buying Treasuries. Which will quickly lead to our day of financial reckoning. Or, the Chinese will force us to pay considerably more in interest. Which we are in no financial position to do.
Further confounding the issue is the Fed's tapering scenario.
At some point, we have to take the U.S. economic patient of life support, lest he forget how to breathe on his own. That means an end to the monthly bond purchases. Probably in Q1 2014. That also means the Fed will need to raise interest rates. 2015? At any rate, we can ill afford the $3 trillion in interest now. At the current pace by which our entitlement payments are growing, coupled with a rising rate environment, the CBO forecasts that the economy will need to incur an exponential growth increase in the over the next two years, or the nation's debt service will simply be unsustainable.
The problem? Most reasonable economists (including those of the Congressional Budget Office) realize that we are likely at the back end of the growth cycle. It has simply been an economic cycle featuring slow growth. Further hampered by policies enacted at the Federal level (my opinion).
In other words, growth is not about to dramatically increase in the near term. It may, in fact, slow before it is capable of markedly expanding.
Now, let's walk that dog a bit further.
Were the U.S. to find itself in an debt spiral, we would likely seek to further devalue our currency in order to pay off our creditors (China, Europe, Saudi Arabia, Kuwait, Dubai, Russia) with fewer dollars. But, China has already begun to openly politic for an end to the regime of the U.S. dollar as the global reserve currency. Incidentally, other nations are taking notice.
Was the U.S. to lose its role as the world's reserve currency, the central banker to the world, then America's future economic prospects change overnight. Not for the better.
The U.S. would no longer be able to print its way out of economic difficulties. Like Russia, Mexico, Venezuela, Germany, Argentina, Bolivia and every other over-leveraged debtor nation that has defaulted, we'll be forced to deal with the ugly consequences of our decisions. Simultaneous economic, banking and currency crises. Loss of monetary sovereignty. Recession. Depression. Or worse.
Ultimately, following the ensuing ugliness, we'll have to run the nation's budget like any other enterprise. In a balanced fashion. A dollar in for a dollar out.
Unfortunately, even as the average collegiate macroeconomic student discerns these oncoming events, our political brain trust continues to see pie in the sky through rose-tinted shades.
How has our government managed the escalating debt crisis?
The Treasury has issued massive amounts of debt in order to purchase private assets. The Fed then purchases an equal amount of Treasury debt with newly printed money. The politicians remain in office by agreeing to bigger, more expensive government programs. The electorate continues to vote themselves bigger and bigger handouts.
As a nation, we're rather like one of those couples you occasionally meet. Individually? Both are sensible, intelligent and responsible. As a couple? Total goat rodeo.
Well, that's our political and economic system. Ideologically? Very impressive. But, integrate the D.C. dynamic, career politicians, lobbyists, the Fed, and a largely ignorant (that's right) and unawares electorate? It's a big hot mess.
So, how might investors use these facts in charting a prospective near-term market direction?
In a recently released report, Société Générale's asset allocation team considered the U.S. economic conundrum. They then extrapolated their findings out in terms of how these issues will impact the U.S. stock market.
Their results call for a 15-percent correction in Q1 2014, followed by a "multi-year journey back to where the index sits today."
The report, entitled "S&P 500: -15% in sight, then the big sleep," explains how an end to the Fed's easy money policies, as well as the ongoing dysfunction in Washington, will cause the U.S. stock market to languish.
That is not to say that these near-term forecasts are baked in. In fact, I'd say that the market is just as apt to rally to 1900 by December 2014.
The point is, our current political, economic and monetary headwinds are intertwining in a potentially malignant means that could catalyze the onset of larger, more ominous threats.
As a nation, we're in uncharted waters. And our skipper, navigator and crew are drunk and incompetent. Some, none or all of the above could happen. And to varying degrees. The time frame? Sooner, later or never.
The bottom line? These potentialities are likely to occur at some point, to some degree. The intelligent investor will be prepared. The unprepared will lose a lot of capital. As they did in 1901. 1907. 1929. 1937. 1987. 1989. 1997. 2000. 2008. Mid-2011.
What's an investor to do?
Educate. Acclimate. And prepare. Have a plan. Or plan to lose. And for the millions of investors preparing for, or already in retirement, with little access to attractive bond yields, the idea of making little to nothing on invested capital is unacceptable - regardless of how probable.
In the coming weeks, I will define four areas of the market in which we are firmly convicted regardless of upcoming market cycles. These are investment opportunities that rest beyond the gale force winds facing the U.S. markets. These opportunities have economic, demographic and technological momentum behind them. Their best times are ahead.
Most importantly, these investments will enable the competent, forward-looking investor to step away from the Lemmings, even as they continue their suicidal charge over the oncoming cliffs.

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