In an interview on Consuela Mack’s Wealth Track (which I highly recommend and listen to nearly every podcast) Rob Arnott made several pertinent and compelling arguments that should make most investors think long and hard about how their portfolios are positioned. The video is embedded below.
Summary and Snippets
“The loser is the trend chasing, comfort seeking investor. The market doesn’t reward comfort. It rewards discomfort.“
The seeds that delivered the global financial crisis– there are more and they are bigger than ever.
Deficit, Debt, and Demographics (3D hurricane)
We are spending more than we produce as a nation, which is leading to a build up of debt to be paid for by a shrinking workforce as a percentage of the population.
DEFICIT: officially the deficit is 10% of GDP vs. the 2.5% it has averaged for the last 25 years. However, that is only tip of the iceberg. If the Government had to use Generally Acceptable Accounting Principles (GAAP) we would need to add:
- Off balance sheet- pre-funding of social security and medicare– takes us from 10% to 14% of GDP.
- The GSE obligations, Fannie Mae and Freddie Mac takes us to 17% (the potential liability is unlimited and not counted as national debt).
- The unfunded portion of social security and medicare takes to us to 18% of GDP.
DEBT LEVEL. We have a government and a society that is addicted to debt-financed consumption.
Federal debt=90% of GDP, when you add
+ State, Local and GSE= 143%
+ Unfunded Portion of SS and medicare, TOTAL GOV’T DEBT= 420% of GDP
Combined Private Debt (corporate= 320% and household=100%) = 420% of GDP (the largest in the world)
Aggregate DEBT= 840% of GDP– over 8x annual income–
If you make $100,000/year how comfortable are you owing $840,000 in debt?
Inflation. Pre-position your portfolio for inflation. It’s cheapest to insure when expectations for inflation are low. He recommends TIPS. Also Commodities– lots of price volatility, use the drops. Buy during recessions.
Arnott thinks we are headed back into recession. Why? Tax receipts. Down 6%– also incomes are down. We don’t really have a recovery. GDP growth is all inventory restocking, not real demand.
Taxes. History suggest 1% higher taxes leads to 3% lower GDP. Taxes are going to go up.
Investing in light of these facts–
Most investors have 90% of their assets in MAINSTREAM stocks and Bonds. Reflation– multiples collapse and yields go up. Must use a broader toolkit.
- International and EM stocks and bonds
- Commodities, REITS, inflation linked bonds
- Absolute Return Strategies
The issues of the day are large and often scary. They should not give us anxiety. Ups and downs in the markets create opportunities to make tactical changes. To do what might be uncomfortable and produce good results.
What You Pay Matters
“Stocks are like any other asset class. Buy them when they are cheap and you don’t have to wait for the long run. You’ll be happy pretty soon.”
Buy when they are expensive, your long run may be very, very long. Stocks can underperform for very long periods of time. At the trough of the financial crises, you could go back 40 years! and government bonds would have outperformed stocks. Over VERY long periods of times, stocks beat bonds 2.5%/ year which includes the bubblicious 1990s (ex that time, it’s only 1.5%).
“we have this widespread view that stocks loft from new high to new high to new high, interrupted by inconveniences known as bear markets. And, in fact, we find those bull and bear markets are subsumed within longer cycles, secular bull and bear markets that span decades, not years.”
The secular market low of 1982, adjusted for inflation, brought us back to levels first seen in 1905. 77 years earlier! The crash in 1987… levels seen in the high of 1929.
What you pay matters and stocks are not immune to that simple fact. There is no pre-determined rate of return.
A transcript can be found here.