InnOvation Capital & Management, LLC
IntelDigest
LAW – POLICY – FINANCE – MARKETS
INFORMATION FOR THE ENTERPRISE AND INVESTOR
SEPTEMBER 28, 2016
Contact Richard Power with comments or questions. IntelDigest is intended for the use of our clients and colleagues. Material may not be reproduced, forwarded or shared without express permission.
In this issue of IntelDigest, we focus on the National Debt, its consequences, and steps which you can take to protect yourselves from the likely 2017 recession. In reality, we have been in a recessionary environment for many months, but the artificial buoying of the stock market has clouded the perception of many investors.
We can start with the state of our official National Debt, which stands at approximately $20 Trillion. Additional future unfunded government liabilities … Social Security, Medicare, Medicaid … would increase the true National Debt to hundreds of Trillions of Dollars over the coming decades.
The official Debt can only increase, as the federal government continues to spend much more than it brings in. Boston University professor Laurence Kottlikoff has written that over 90% of federal tax revenues go to cover entitlement programs plus interest on the Debt. ALL other federal government expenditures … including the cost of the largest military in the history of the world … has to be funded from the remaining 8-9% of revenues, PLUS more and more borrowing.
Interest rates are expected to rise … VERY SLOWLY … beginning in December. Considering the state of the public debt, imagine what would happen if short-term interest rates rose to more “normal” levels, such as 4%. Sure, we would all be able to earn a reasonable return on our bank deposits. But, the federal government would have to spend more than $500 Billion per year on interest payments alone.
So, unless the Congress and president (both current and future) suddenly “get religion” and decide to make serious attempts at cutting and balancing the Federal Budget, don’t expect the Federal Reserve to raise interest rates with any speed or decisiveness. The Fed will also move very slowly in raising rates because of a general fear that moving too quickly will result in a stock market crash.
As we discussed in our August 24 issue:
“The Fed’s efforts to avoid small, cyclical recessions have created bubbles in the debt and equity markets, skewed the economy, encouraged consumers and investors to engage in extremely risky behaviors, and resulted in larger, more dangerous recessions, such as 2008. There is a high probability that a recession in the next year will dwarf the 2008 downturn.”
We also wrote that “… interest rates are not just the cost of borrowing liquid capital; ultimately, interest rates are the “price” of money.” The Federal Reserve and other major central banks tried to stimulate the world economy … mainly through interest rate cuts … and failed. Lowering the “price of money” to Zero, and printing “money” out of thin air, have done nothing to increase value or wealth.
The central banks’ actions created Trillions of Dollars worth of “credit” around the world, which is becoming a credit “bubble.” Many people see the flood of credit and confuse it with wealth, which it is NOT. It is “fake” money, which is not backed up by production or tangible assets.
The Current Situation
Negative Interest Rates are becoming more prevalent around the world. In major economies … Germany, Japan, France, Italy … 10-year bonds are already Under Zero. Other countries … United Kingdom, Switzerland, South Korea, India … are intervening in currency markets and lowering interest rates to Zero or Negative in attempts to fight deflation.
Here in the U.S., we are left with an artificially-inflated stock market … which is in danger of a severe fall in the coming year … and the inability to earn anything on traditionally-safe assets such as bank deposits. There is huge risk in the bond market, especially as interest rates begin to inch up, which will probably begin in December.
Many investors have already moved money to safer assets:
– U.S. Treasuries (as U.S. interest rates are still positive and the 10-year U.S. Treasury earns around 1.50–1.60%)
– raw land and rental real estate
– municipal bonds
– dividend-paying stocks (the dividend yield on the S&P 500 stocks is 25% higher than the 10-year U.S. Treasury)
Time To Take Care
Increased investments in dividend-paying stocks have driven certain sectors, such as Utilities and Telecom, to extreme highs, so investors should be wary of putting new money into shares which may be overvalued.
Increased investments in dividend-paying Real Estate Investment Trusts (REIT) and Master Limited Partnerships (MLP) have also driven these sectors higher, and there are dangers in these investments. In the most recent quarter, a substantial number of REITs have paid out dividends which EXCEED their net income; this is not sustainable. Be wary of investments in commercial real estate (growing bubble in this sector) and commercial REITs, as well as REITs heavily involved in mortgages and loans; a small rise in interest rates can stunt their profits.
In our August 31 issue, we set out the following advice:
Steps to Take Now
1. All investors should analyze their portfolios to determine if the dividend is sustainable in each of their dividend stocks. A sure sign of trouble is a company which pays more in dividends than it earns in profits.
2. Look for companies with proven dividend track records. For example, if a company has increased its dividend for more than 10 years in a row, you know it can manage its dividend through ups and downs of the business cycle. Those are the companies that we want to hold for the long haul.
3. Try to avoid companies with significant indebtedness. If there are serious problems in the economy over the next year or two, many companies will struggle to make money. Companies with too much debt may have to cut their dividend, or stop paying dividends entirely, in order to pay their debts.
4. In these “unusual” times, investors should have positions in gold, and should consider holding 10% to 15% of their money in gold. This small position could protect against catastrophic losses if stocks plunge.
As we enter 2017, we will “crash-proof” our portfolios. We will cut back our investments in companies which need a growing economy to make money … airlines, retailers, restaurants … anything which relies on consumer discretionary spending. We will hold more cash, so that we can employ it AFTER the stock market downturn to buy shares of the best businesses at lower prices.
We expect the values of gold and silver to rise substantially, so we will hold gold and silver … both in shares and in physical form … as well as shares of mining companies.
Finally, we will take a close look at the underlying investments in our money market accounts and mutual funds to be sure that we are not invested in dangerous instruments unknowingly.