In response to Is the Fed Deflating?
I received several reader question similar to this one from Mike:
you for your analysis. Could you please tell me, and others, what we
should do to protect ourselves per your warning below?
"Those who ignore the warnings are likely to drown."
for the question Mike. It's a good question and not often discussed
enough. Let's add two more words to the very end of the above warning
then see if we can answer your question: "Those who ignore the warnings
are likely to drown in debt
best way to avoid drowning in debt is to not get into debt in the first
place. Those who are in debt should attempt to get out of it as quick
as they can. The way to do this is simple: Live within your means or
better yet live below your means.
Those who carry credit card
balances from month to month are not living within their means. Far too
many people treated their house as an ATM, taking out cash to pay off
credit cards, only to run up credit card or auto loan debt time after
time. The housing ATM is now shutoff but consumers keep buying more
than they can afford. The result is that credit card debt is soaring
The number one rule in all of this is:
Don't Buy Stuff You Cannot Afford
Click here to see one of the funniest Saturday Night Live
In this tenuous jobs market (see Moonbats Active Again in Massive Jobs Disaster
one needs to be prepared for the loss of a job. It can happen at
anytime in any industry. The housing spillover has just started. It is
highly likely the financial sector will continue to get hit. A downturn
in commercial real estate and retail appears to be starting.
The Wall Street Journal reported Durable goods orders declined 4.9%
. Target and Lowe's both warned. See Target Warns and Blames Florida - Lowes Blames Dry Weather
as the housing problem spread from subprime to Alt-A to prime, job
losses are highly likely to spread from housing, to commercial real
estate, to retail. To protect oneself from a loss of income, it is
imperative to have actual cash savings in a money market, short term
treasuries, or short term CDs. Those barely able to make home payments
now and who have no cash savings, will be in serious jeopardy if they
lose a job. Don't be one of them.
Have a Years' Worth of Living Expenses in Cash
thinking about vacations, new cars, or even investing, I would
recommend for people to have 12 months of living expenses in cash,
short term CDs, or short term treasuries. Those who say "cash is trash
" have never lost a job for an extended period of time.
I have and I know what it's like.
a decision to have "emergency cash on hand" as sound financial planning
and as an additional means test on purchases as well. Can you really
afford an expensive vacation, a boat, or a new car if such purchases
would deplete your savings leaving nothing for emergencies like the
loss of a job?
Buy Food On Sale
prices seem to be soaring. Get an electrically efficient freezer and
buy what's on sale. Food can easily last three to six months or longer,
if properly wrapped in plastic and/or freezer paper. My parents did
this. Mom would buy what was on sale, dad would wrap it in freezer wrap
and label and date the package. It seems to be a lost art.
as non-sale prices seem to be rising, sale prices on meat (the largest
part of our food budget by far), have hardly budged for six years. I
routinely get center cut pork chops for $2.49 or so but the regular
price is now often $4.49 or higher. Whole chickens, vacuum sealed so
they don't even have to be wrapped can be purchased on sale for .49 lb.
or so. I wonder how they can raise them for that price.
week I bought round steak for $1.49 lb. Round steak was a loss leader
at .99 lb when I worked in a grocery store in 1971. That's hardly any
inflation in over 30 years! Many stores will grind meat for free. Why
pay $3.98 lb for ground round when you can pick up a round steak for
$1.49 and have the butcher grind it for free? It's the same thing with
ground chuck. Besides, you also know exactly what you are getting that
way as opposed to buying a package of ground beef wondering "what the
heck is in this and how fresh is it?"
Prime rib on sale is $4.99
lb not on sale is $10 lb. A 20 oz bottle of White Rain shampoo is .99.
If you buy the advertised name brand shampoo it will cost over 5 times
a much and it won't clean your hair any better.
If you can't
afford to eat out, then don't. Even if you can afford to eat out there
is nothing wrong with cutting back on the frequency and saving for a rainy day
Consider Wants vs. Needs vs. Affordability
Do you really need
an SUV? Can you afford
one? What about the cost of filling it up? Auto sales persons, real
estate agents, and in fact nearly every sales person's job is to
convince you that what you are looking at is affordable
If one has to stretch a car payment out to 5 years to be able to
"afford" it, the car is simply not affordable in my book. But even if
the car is affordable what about the increase in auto insurance? The
salesperson is 100% guaranteed not to mention it.
and boats are depreciating assets. If they are depreciating faster than
you are able to paying off the loan, then they are not really
affordable. It's best to pay cash for such items. But if you can't do
that, at least make sure you are not upside down in the loan a few
years down the road.
Interest only loans and teaser rates on
houses do not make houses affordable either. Many are finding that out
the hard way right now. Perhaps the sales agent forgot
to point out escalating association dues, hurricane insurance costs, property tax, and heating bills when considering "affordability
down mortgage debt is a reduction in leverage. It's a good idea. In
contrast, some financial advisors are recommending that people take out
home equity loans and buy stocks. This advice is based on the premise
that the stock market always goes up over time. The current advice is
to Aim High. I disagree.
Didn't we just hear the same thing about home prices?
20% down homes are already highly leveraged. Increasing leverage for
the purpose of investing stands a good chance of losing twice. All it
takes is a continued decline in home prices and another bear market in
equities. Both are likely. Risk is a two way street. It is not always
rewarded. Leveraging up and throwing the rest into stocks is simply
poor financial advice no matter how it turns out.
and housing prices fell for 18 years in Japan. The same can happen
here. I'm not saying they will, I am saying they can. There certainly
have been many 10-20 year periods where stocks went down to sideways.
It's a huge mistake to judge things from the recent bull market.
Consider Retirement Plans
closer one is to retirement the more risk avoidance is likely to come
into play. The key here is to understand your timeline as well as your
risk tolerance. Someone five years from retirement does not have ten
years or longer to break even if the market takes another slump.
Someone in the S&P and holding from 2000 is just now back to even.
at LBOs now being balked at by Citigroup (NYSE:C
), Lehman (LEH
), Goldman Sachs (NYSE:GS
), and Bear Stearns (NYSE:BSC
). As long as
they could securitize the debt they were fine in pumping it. Buyout
Bingo has now stopped. If Citigroup does not want the debt or the deals
why should anyone else?
One of the reasons that earnings have
been high is underwriters were able to pass the CDO and mortgage trash
to pension plans and foreign investors, collecting enormous fees along
the way. Another reason was that people continued to buy stuff they
could not afford, primarily on the belief that home prices would
Investors needs to understand how the credit
binge affected earnings as well as the likelihood that the credit binge
grinds to a halt. Traders have no such considerations.
really knows for sure if stocks are going to drop or not drop, but they
certainly are nowhere near as cheap as most make them out to be.
Historically stock market returns with this backdrop have been weak to
poor. Is this time likely to be any different?
Bear markets have
a way of exposing fraud and all sorts of other problems. One look at
housing should be proof enough. The stock market is not immune either.
Risk has increased and one should factor that risk assessment into
Challenge Traditional Thinking
past several years have been rather amazing. Nearly every asset class
around the globe rose in unison. This is not normal market behavior.
What was correlated on the way up can easily be correlated on the way
down. In that regard, diversification does not guarantee
success nor does traditional thinking.
Traditional thinking still boils down to a recommendation of buying a mix of stocks and bonds (with bonds
specifically meaning corporate bonds
Unfortunately there is no magic formula that can properly allocate
stocks and bonds in a portfolio by a person's age as some attempt to
do. And if the economy is headed into an economic slowdown, default
risk will rise and corporate bonds (especially junk bonds) are likely
to be punished.
In general, corporate bond spreads are simply
too low vs. treasury yields to make them a good buy at this juncture.
But that has not stopped advisors from recommending them.
are ways to hedge stocks but those ways are seldom mentioned by
advisors. And there is nothing at all wrong with seeing increased risk
and pulling some chips off the table. There are also currencies,
commodities, and precious metals to consider.
Advice on all
these issues has to be given individually and that advice also needs to
consider the goals, risk tolerances, and timelines of the investor as
well. That is what we do at Sitka Pacific Capital Management