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What Do You Do With A Drunken Sailor?

Spending all you have and more… a lot more

Volatility is increasing…and that’s a warning sign. After a long period of relative calm, the wild gyrations are back. The combination of higher oil prices, inflation and the end of the Fed’s Quantitative easing programs has investors jittery. Nevertheless, we have been operating on borrowed time as the “borrow and spend” mentality of individuals and the government alike can’t last forever.

When the last spending boom ended about 10 years ago, the baby boomers were aging fast and quickly passing their peak spending years. Because any growing economy needs more spenders to boom, this would have been the perfect time for the natural cyclical economic slowdown our economy needed to reset to the new equilibrium lower supply due to less demand. However, American’s don’t like to do without, even if it’s in their best interest. So we devised a brilliant plan to keep people spending like a drunken sailor and our economy growing: Lend the people money who are in their peak spending years, even if they couldn’t afford to pay it back or even the ridiculously low interest rate on it. Never mind that this group of American consumers was just a fraction of the size of the Boomers.

That was the last bubble, and that bubble ended the way every bubble does, in a fiery burst comparable to a super nova, destroying everything in its wake. So what is a good government to do? Well, with the help of Helicopter Ben Bernanke at the Federal reserve and his financial puppeteers, you create yet another bubble….and you better know how to play with bubbles. How do you do this when the consumer is tapped out? You replace private sector borrowing with public borrowing.

Not a bad plan if they can borrow at very low rates and continue to have folks who will lend to them. This creates demand, albeit artificially, for goods and services in our economy where little would otherwise exist. This does work for a short period of time, as it gives consumers a break, provided they are still in their peak spending mode. The problem comes when it is not a short period of time until the next wave of consumers comes along that will create enough demand in the economy to generate lasting growth.

And that’s where we are today…at the end of a generational cycle with a sizable lag between the baby boomers, the last large consumer group and the Echo Boomers, the next large consumer group made up of the kids of the baby boomers. The good news is that the Echo Boomer generation is actually larger than the baby boomers. The bad news is that they are 5-8 years away from their accelerated spending years. 

So, can the government borrow and spend long enough? Not a chance! Either interest rates will rise too high (we’re just about there now) and/or the people that lend us money will stop doing so because we are no longer a good credit risk or they will demand a higher rate of interest in return. For many years Americans have bought less-expensive Chinese made goods, and in return, China turned around and used all those dollars to buy up U.S. Treasuries and other dollar-denominated assets. But now after years of reckless spending, America’s debt level is nearing a breaking point and can no longer rely on foreign capital as a last resort.  As Pimco’s Bill Gross recently stated, “When a country reaches a certain debt level, confidence in that country’s ability to repay that debt becomes jeopardized,” citing the work of Ken Rogoff and Carmen Reinhart in “This Time Is Different.” When the Fed ends the free money party, you better be the sober one with their keys in their pocket.

Investor Strategy

Although the situation is dire for the longer term, there is still opportunity in the now. There’s a lot of catching up to do for many investors out there. All that money that flew into bond funds the last two or three years, is just lazy investors who were afraid to go into stocks, and not long term investment money. There’s going to be a catch-up rally, where people “panic buy”, and that’s going to be the top. That could coincide nicely with the growing fear of inflation, rising interest rates or the end of the Quantitative easing programs.

There’s no way to know if the bubble will burst in a matter of weeks or months, yet people must be properly invested right now while remaining conscious of the inevitable Tsunami ahead. We continue to focus on high dividend paying stocks and bonds, and we can still get 8-10% yields. The key is to  be tactical with an active allocation strategy, similar to our Top-Down Tactical TDT™ strategy which seeks to outperform during rising markets while avoiding the laggards that drain performance, and then preserving those gains during the inevitable market declines by having a defensive risk management strategy and a personal exit strategy.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.