Revisiting My Cinco de MayoSubmitted by Guidant Planning on May 22nd, 2014
By Allen G. Yee
On May 5th I had the pleasure of attending HS Dent’s Road Show – The Great American Reset Tour at the Westin near LAX. Despite having my favorite margarita that day, it was an extremely sobering event. It was a day filled with ominously titled topics supported by chilling statistics. The day’s event featured presentations by Harry Dent; The Great Deflation Ahead and The Great Crash Ahead: Bubbles, Cliffs and Slowdown. Rodney Johnson – The Retirement Cliff and Adam O’Dell – Taming the Beast: A better Path to Profitability.
After having some time to digest all this information, I wanted to share a little of my experience with you.
The Great Deflation Ahead – Harry Dent
Harry highlights that babies are the key to the future, i.e. demographics. Ideally, a society that has an incrementally larger, younger generation waiting to replenish aging workers is better off. A large group of younger people working provides greater support for older, less economically productive members of society as time moves forward. However, the trend of westernized civilizations has been gravitating toward smaller families with fewer children over the decades. Coupled with longer living parents, many societies have the problem of an overwhelming discrepancy in the distribution of age groups. This trend causes a problem with which we have already become acquainted- a smaller demographic group supporting a larger, older retired group for a potentially long time.
Another main facet of the economic consequences of unbalanced demographics is the propensity for the relatively younger segment of the population to spend more than the elderly. Specifically, as Harry points out families with parents age 46-50 spend the greatest amounts. HS Dent charts these age cohorts and calls it the Spending Wave and he indexes this spending to a 47 year lag and forecasts it to the current date. At this age group, most families are at their greatest earnings potential, their babies are now young adults, and as Harry would say “eating them out of house and home.” Further, as these young adults enter college, many families are continuing in their normal consumption but adding the cost of tuition, multiple vehicles, vacation homes and mid-life crisis purchases. The tail-end of the Baby-Boom generation is exiting this age group of 46-50 and there just aren’t that many Gen-X individuals to offset the decrease in both workers and consumption. As the US Economy (GDP) is made up of 60% consumption, then the likely outcome is less GDP and slower economic growth. Through this demographic analysis and much more technical data, HS Dent Research forecasts and predictions point to a potentially deflationary period on the horizon.
The Retirement Cliff – Rodney Johnson
Rodney reveals his belief that the “average American” is in a dire situation. While the majority of my clients are not “average”, they along with all the other Americans will need to pitch in and help; likely through higher taxes. Further, the effect of the baby-boomers retiring will cause significant pressure on Social Security and Medicare, not to mention pensions, potentially leading to significant changes. The following could be potential changes to Social Security:
- Subjected to great taxation, i.e. increasing the 85% and 50% rates and/or lowering the thresholds.
- Increased retirement age
- Reduction of Cost of Living Adjustments (COLAs)
- Means Test
Next, Rodney touched on the dying 3rd leg of the retirement stool- the Pension. A rapidly dying benefit, most corporations have eliminated them and many public pensions are under financial pressure. Only 16 State pensions have 80% or greater funding. Further, there are only 2 States that has 50% or more of their health benefits funded. As a result, 18 States have already begun pension reform by either reducing benefits, increasing employee contributions or both. Likely, over time states will need to further cut State services (healthcare, education, etc.), continue with pension and healthcare reform, and increase State revenues (sales, income, business and excise tax) in order to meet its obligations.
With the prospects of fewer entitlements, greater taxes and an uncertain economy the retirement of many Americans will be under pressure without specific strategies and plans to prepare for the impeding challenges.
Taming the Beast: A Better Path to Profitability – Adam O’Dell, CMT
Adam began his presentation with an interesting and unique reasoning behind why people invest. His 3 reasons: Narcissistic Personality Disorder, Masochistic Personality Disorder (self-defeating) and Capital Gains (enjoyment of income). While almost seeming comical at first, O’Dell puts forth some compelling reasoning and support. He cites DALBAR studies that conclusively shows that individual investors vastly underperform most assets classes including falling behind the rate of inflation. He says it’s human nature and embedded in our DNA to flee from risk. As “man” evolved, the human race consistently avoided risk as a means of literal self-preservation, i.e. caveman survival was dependent on taking less risk or securing himself. With that process our fear and aversion to risk became rooted in the more primal areas of our brain that can override what we call the higher functioning areas. Now in a more civilized era, we sometimes innately and impulsively look for safety at the wrong time. There’s limitation of the human brain where heuristics (using rules of thumb, educated guess, intuitions, etc.) and cognitive biases (illogical interpretations, inaccurate judgment, etc.) causes irrationality leading to poor decisions. He continued to discuss behavioral finance issues:
- Confirmation Bias
- Gambler’s Fallacy
- Bandwagon Effect
- Hindsight Bias
- Narrative Fallacy
- Sunk-cost Fallacy
- Normalcy Bias
- Wishful Thinking
These are some of the many thought processes that affect our overall decision making process. If you have a history of making poor choices you will likely continue to make poor choices. If you a history of making good choices you’re luck maybe running out. The solution is to have a system. A system that is not dependant on emotion or “gut”. Just like the human-body has a multitude of systems (muscular, circulatory, digestive, nervous, respiratory, reproductive systems, etc.), investors need systems to create income, growth, reduce taxation, etc. As our physiological systems work together to keep us going, so must our financial systems.
The Great Crash Ahead: Triggers for the Next Financial Crisis – Harry Dent
The global economy appears to sit on a precarious branch. This presentation examined asset gains over the last couple decades. While some asset gains were substantial, Harry points out that many were unprecedented and were not organic sustainable growth, but assets bubbles: Nikkei, Japanese Real Estate, Nasdaq, US Real Estate, Shanghai Index, and Gold. Each of these assets increased 2.2 – 6.8 fold only to lose 40-80% of those gains. Bubbles don’t deflate, they pop, and when they pop they will likely drop to the level before the bubble began. Given the delicate status of the global economy today, a serious of sequential bursting or current bubbles could have a disastrous effect.
Harry highlights the current bubbles that he contends exist today- US real estate, US stock markets, China, commodities, most global stock markets and real estate. Of these bubbles, Harry outlines three potential triggers to popping the current bubbles.
China is in his opinion is the most likely triggering event. The nation has been building at an unsustainable rate, particularly given that the consumption has not been for its citizens but for future growth. From what we can observe of China, they have been seen building (consuming natural resources) cities, roads, buildings, etc, yet many of these elaborate, and arguably unnecessary infrastructure investments have not equated to furthered economic activity. As the media has reported much has been spent to build cities complete with buildings, roads, and infrastructure only to be left completely vacant. Economically how can you perpetuate growth (GDP) by unnaturally synthesizing economic activity without further consumption from the population of Chinese citizens? As our GDP is based on 60% personal consumption, it is likely most other countries will depend largely on personal consumption to drive their GDP. China’s real estate is amongst the highest in the world when comparing home price to income ratio. This is despite an oversupply of housing. In 2011 there were 19m housing starts and only 5.8m in annual demand. Housing supply is outpacing demand by 3.3-1. This trend of under-utilized construction is further exacerbated by China’s many skyscrapers. Despite having significant vacancy rates, many new buildings are scheduled to be completed over the next two years. The country struggles with putting their citizens to work to build these impressive statements to the world of China’s rise. Yet these citizens are being put to work to build an infrastructure that they cannot even hope to afford to enjoy. The headwinds for China are its workforce growth, increasing bad loans, and increasing their GDP per capita, i.e. how much each citizen will earn annually. In 2012 the GDP per capital was $9,100 and it is forecasted to be $12,500 in 2025. How can an economy sustain itself when its citizens are barely beginning to realize wealth?
The next potential trigger is Germany. Harry points out that most people around the world believe Germany is not only stable but the bedrock of the European Union. However, examining their demographics, Germany may be facing the same age group discrepancy dilemma as the U.S. Based on their Spending Wave (population of citizens 46-50) the German Spending Wave falls off a cliff beginning in 2014-15. The Germans will face challenges similar to Japan’s aging population in1989. Like most other aging countries, the Germans will have a very high Old-Age dependency ratio, where many older Germans will be supported by fewer younger ones. The difference between the United States and Germany (or Japan) is immigration. The US enjoys larger immigration than Germany or Japan and is able to affect its Spending Wave by being selective and allowing young(er) people to immigrate to the US.
The third potential trigger is one we have heard about for a while now- real estate. The recovery already looks tired and many cities are already seeing a declination of pending home sales, reduction in mortgage origination and lending hits a 17 year low. Further, as our society continues to age, baby boomers will begin downsizing while trying to unload their 2nd homes and rental properties. This will cause a lag in demand for homes as the echo-boomer will not have the resources to purchase real estate for at least another decade.
After the conclusion of the presentation the three speakers opened an Q&A session and all attendees had ample time to ask questions. With the concluding question, “Harry, for the short and intermediate term, you don’t like stocks, bonds, real estate, gold etc. What should we buy?” Harry replied “If you have to buy something buy shotgun shells and bourbon. Someone will always buy or trade for bourbon… shotgun shells? Well, you’ll know if you ever need to use those!” Through the laughter Harry earnestly continued with, “Why must you buy something? Why can’t you wait until it’s cheaper?” He went on to say, “Sure an asset can increase another 10-25% but when it drops 50%+ wouldn’t it still be cheaper?”
The presentation was useful in the sense that it provided great information and insight on a particular perspective. While Harry’s views are unique and research conducted judiciously, I don’t subscribe to all/most of his ideas. Much of the data he presents is quite compelling, and as a result I continue to be tactical in my investment approach.
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Registered Representative offering securities through First Allied Securities, Inc. A Registered Broker/Dealer (Member FINRA/SIPC). Advisory services offered through Guidant Planning, Inc. and First Allied Advisory Services, Inc. Both Registered Investment Advisers. Guidant Planning, Inc. is not affiliated with First Allied Securities, Inc. and/or First Allied Advisory Services, Inc. Allen Yee, CEA, RFC, CA Insurance License #0747874