Good thing we’re diversified.

We haven’t (yet) responded to recent market turbulence by altering our portfolios. We’ve simply been maintaining our current very diversified allocations, which aren’t fully invested in the U.S. stock markets. As I wrote in my last posting, long term holding is a very decent tactic. And right now we’re a little bit allocated towards safety. From this position, it’s OK to ride out short term news.

However, this weekend’s blog on “Wolf Street” is interesting. Read it here.

While we watch financial markets surging today, in an apparent relief rally from not being blown up by North Korea over the weekend, it’s also true that earnings in the S&P 500 are not as good as they seem to be. Quote:

“Aggregate earnings per share (EPS) for the S&P 500 companies on a trailing 12-months basis rose for the second quarter in a row. That’s the foundation of the Wall Street hype. But here’s the thing with these EPS: they’re now back where they had been in… May 2014.”

Thanks to the Fed, the S&P 500 has gone up anyway, and the money we’ve made is real. But good thing we’re diversified.

The Ten Year Anniversary of the day the world changed.

Ten years ago today, French mega-bank BNP Paribas announced it couldn’t place a value on its US-created collateralized debt obligations, complex toxic “derivative” investments, and thus was suspending client withdrawals from the funds which held them.

That was the first indication that the most gigantic financial panic since the Great Depression in 1929 was about to unfold.

The world has changed a lot since then. But many of the same structural flaws remain, patched and propped but not repaired by governments or by central bank intervention. Vastly greater debt loads are even more of a potential problem than they were in 2007.

The greatest lesson of the 2007 Financial Panic was that central banks transformed the investment markets by intervening. Perhaps they helped, perhaps they hurt, perhaps in a variety of ways they did both. But there’s no denying that the central banks are now involved in our financial markets in ways that would have been unthinkable before August 9, 2007.

Another key lesson of the 2007 Financial Panic was that many sophisticated investors did just fine, thank you, while others got hammered.

Yet another lesson was that we all muddle by. If you stayed invested through the carnage of that awful event, you have probably done well, despite it all.

Read more here.

Everyone expects to be a winner (and all children will be above average)

I’m reposting this here from the Heisenberg Report. According to this study, essentially everyone thinks the stock markets will finish higher in one year.

Such a high level of optimism is some kind of record.

My guess is that we got here because EVERYONE expects the central banks to intervene forever. Having painted themselves into this particular social expectation corner, it’s going to be interesting to see what the central banks do next.

Way back in the days of free markets, we were taught that extremes of market consensus are danger zones, and that “the consensus is often wrong”. But as I wrote on August 1st, traditional diversification has been proven unnecessary for so many years that investors could be forgiven for it’s just gonna stay like this forever.

My plan is to stay diversified and keep searching for bargains.

It probably isn’t what you think it is.

I’m back from a week in Maui with the family, with sun-browned skin despite the twice-daily application of reef-friendly sun block, and with my head brimming with fascinating ideas.

Such as how Kamehameha, a relatively minor chief, was able to conquer all the islands between the years 1789 and 1810, because of a new technology: the flintlock musket.

And how, after his death, the ali’i…the nobility…of Hawaii sold out their own nation’s resources and financial stability to foreign nationals to enrich themselves.

And how foreign governments, including the United States, were inexorably drawn to take advantage of imperial Hawaii’s weaknesses.

Yet individual families survived and even thrived, despite government.

Now, here I am, sitting at my desk, contemplating that the current state of national and state governance is in fact somewhat normal, in the long term. Kleptocracy by whoever is in power is inevitable. Under the veneer of culture and rationality, we live in a world in which people will exploit weakness and take what they can. The assumption that things are different because we are equipped with cell phones and the Internet may or may not be correct.

As evidence, here’s an interesting article about our health insurance debate.

You and I, like the families of Hawaii, are mice among the elephants. We must continue to create success, health, and wealth in our own relatively small ways despite what the oligarchs may do.

It seems likely that the Trump Presidency will accomplish much less than expected. It seems likely that the major goal of Congress is to enrich itself at the expense of the rest of us. All this will happen despite the political party in power. All the political words which empower and energize us are simply tools to enlist us to their fight, for their benefits.

With this in mind, we need to continue to save, continue to nurture our families, and press onward regardless of all the social and governmental chaos. What happens in Washington or Brussels or Beijing will probably not define our lives. In the long term, people seem to thrive DESPITE government, and not because of it. On we go.

A problem with reality

Is that sometimes it is so irrational. The financial markets are currently radiating “market bubble” and I’m reading a very well written quarterly update by the managers of the Forester Value Fund. It captures all the data which suggests that we are currently at market highs and we are at risk of a coming downturn in both the bond and stock arenas.

But there’s a problem. Forester Value Fund TOTALLY ROCKED our stock market declines in 2000 and 2008. And they also lagged horribly while markets recovered. Why? Probably because they are rational, intelligent, insightful managers who have managed their mutual funds with thoughtful awareness of market indicators. In other words, they’ve done everything courageously, and right. We don’t own the fund now, because we couldn’t lag like that. Instead we’ve used asset allocation mutual funds and international mutual funds to successfully participate at least partially in growing markets.

Yes, Virginia, the financial markets are bat-spam crazy, and many of our politicians are beyond incompetent. But the lower interest rates delivered by central banks have trumped everything else, so markets have continued to rise. By staying diversified and partially invested we’ve accrued a substantial part of the financial markets’ gains. But even as I watch us making good money, I have to shake my head.

Read Forester Value’s superb quarterly update here.

Overvaluation and a Dysfunctional Society

A recent analysis by Goldman Sachs does a rather good job of summarizing the challenges of our current over-valued stock markets. Read it here.

Essentially, domestic stock markets are overvalued, but supported by very low interest rates and a perception that central banks will forever intervene in any downturn. International stock markets are less expensive but subject to some unusual geopolitical risk.

Watching the recent news with President Trump’s new unnecessary squabble and insult-trading with Morning Joe talk show hosts reminds me that U.S. political risk remains large. I’ve never seen a presidency as vulgar, scattered, and puzzling as this, and I doubt you have either. So our executive branch may self-immolate at any time. Or not. We honestly don’t know. It’s also worth reflecting that the recent trend to off-the-charts anger and crudeness in public discourse probably reflects our society’s inner turbulent personality in some way. What does that imply?

It’s entirely possible that overvalued conditions in our stock markets could go on for years, and still possible that the Trump Presidency could get its act together. For us, the bottom line is that stock markets may continue to rise for years, until something external derails upward momentum. For that reason, attempting to dodge out of the way, beyond our current level of diversification, doesn’t seem to add value.

Happy 4th of July! It’s a great time to reflect on why we are all here, and what we want to accomplish.

We’re doing great! Now let’s stay cautious.

I’m reviewing clients’ portfolios this afternoon, and given that most of us are relatively conservative I’d say we’re on track for a nice finish for the 2nd quarter. I’m saying this while crossing all digits and holding my breath.

Our international holdings, especially our emerging market holdings, have done great so far this year, which is quite emotionally rewarding since after we bought them last year they laid down like raccoon road kill for some months, and were mostly a drag on our portfolios. Now, however, they have recovered, and more.

Likewise our decision to double down on health care has been rewarding, and our decision to stay in tech has been profitable as well.

However I remain nervous like a cat in a room full of pit bull dogs. As I wrote last week, this has been a very thin market especially domestically. Political risk remains high. Markets are overvalued.

So let’s stay cautious, please.

Read more scary stock market predictions here, hopefully with a small glass of oak-aged rum. Predictions do NOT all come true. However they ARE evidence that we should be careful.

Meanwhile we’ll stay invested and stay diversified. It’s a marathon, not a sprint.

U.S. stock market gains are incredibly concentrated.

One of the hallmarks of mature U.S. stock markets is when index funds are doing better than actively managed mutual funds. That’s because the “rational” active managers are scared so they begin to avoid risk. The result is lagging returns relative to fearless, mindless index funds. I’ve seen this in 1987, 1990, 2000, and 2007. It can go on for years.

Another indicator of mature stock markets is when the market concentrates into only a few big players. This time, the big players are the FANG stocks (Facebook, Amazon, Netflix, Google). Citibank broadens them out to the FANTASY stocks (Facebook, Amazon, Nvidia, Tesla, Alphabet, Salesforce.com and Yahoo). However you label them, they are up a lot so far this year, about 30% by some estimates, and account for the majority of the broader indices’ gains. Doesn’t this sound familiar to anyone?

Also according to Citibank they have an average P/E of over 60, which is way up there in the bubble zone. That’s more than overvalued. And of course they are skewing the large indices’ valuations higher.

Combine this with the cryptocurrency markets and you’ve got looneytunes right here, right now. This has bubble written all over it. But it’s NOT a bubble in the entire financial system. Yet.

What happens next?

This may go on for years. My thought is that there’s no need to rush for the exits as long as we stay diversified. And if we sell early we risk being left far, far behind.

On the other hand a political event could trigger the inevitable landslide.

Meanwhile, economies are growing and valuations are much cheaper overseas. I’m examining that option.

Stay diversified. We are sure to have an interesting year.

For more evidence, read here.

The Biggest Iceberg Of Unrecognized Risk

It’s a ship-killer.

While we obsess about the stock market, an even-bigger financial challenge is possibly looming in the future. Yet few people are paying attention.

Debt has once again risen to outlandish proportions. Especially, state-driven debt and pension obligations may have reached a level which is impossible to pay back.

Read more about yet another state’s financial struggle here.

Why don’t we clearly know if these massive commitments are fundable?

Because we don’t know how much the economy will grow in the future.

Also we don’t know if sanity will emerge and spending will be reduced.

And, finally, we don’t know what actuaries will define as future contribution requirements for the large pension plans.

All this has deep implications for our economy and especially our bond markets. As investors, diversification is key, since we can’t really know where and when debt defaults might occur, if ever.

To help with this, we’re keep municipal bond investors diversified into nation-wide municipal bond mutual funds and not just state-of-residence-only mutual funds. Yes, you’ll pay a bit more taxes, but you’ll probably be safer.

In the taxable bond arena, we’ll keep most of our long term bonds in our asset allocation funds, so the managers have a non-bond place to run if a crisis suddenly pops up.

Most likely we’ll simply muddle by, as tends to happen. Patience, courage, and discipline.

Have a great weekend.

Legendary Investor Jim Rogers Predicts A Stock Market Crash, And The World Yawns

Legendary investor Jim Rodgers has often been right, and often been wrong, about the future of U.S. financial markets. He’s completely bullish on the future of Asia, and in fact now lives officially in Singapore.

Now he’s calling for the worst stock market crash in our lifetime. Read more here.

He may be right. Or not.

It’s worth noting that when the stock markets first began flashing indications of overvaluation, they were at about half their current levels. Had we gone to cash in 2013 as the statistics suggested, we would have missed out on at least 1 of every 4 dollars in our diversified portfolios.

Why didn’t the financial markets crash after 2013? The unexpected happened: the Fed and other central banks of the world intervened to support financial markets.

I have my own emotional reservations about that: when governments intervene in markets as the mood strikes them, then markets become unquantifiable. But the money which has been made is quite real.

So now Jim Rogers says that the biggest stock market crash in our lifetime is imminent, he may be right. Stock markets ARE very overvalued, and have been for years. My response for all of us has been to stay very diversified and be a bit cautious. The result has been that our investment returns haven’t beaten the stock markets, but we’ve at least participated while remaining realistic about genuine dangers out there.

I also remember that the Financial Panic of 2008 was followed by a market boom.

Genuinely, we don’t know what will happen. Let’s also keep in mind that we want to buy low, and sell high, and we want to persist. Investing is a marathon, not a sprint.