I am still bearish on the stock market, believing that the GDP and growth forecasts will continue to be cut, both for the second half of 2010 and those for 2011. Even then, I’m picturing a stock market that is flat and volatile for the next 5-10 years, much like that of the late 60’s and early seventies, with no long term gains to hold on to.
Rosenberg’s newsletter included some of his household income data today, and I think it will help explain my reasoning:
- The aggregated household debt-income ratio is at 126%, it peaked in Q1 2008 at 136%, and the pre-bubble norm was 70%.
- The debt-to-asset ratio is 20%, it peaked at 22.7% in Q1 2009, and the pre-bubble norm was 12.5%.
- Classic Bob Farrell mean-reversion would mean a further $7 trillion of debt extinguishment.
The consumer typically accounts for about 2/3 of GDP. It will take years before debt loads are down to a point where they can stabilize or grow again. These debt levels don’t typically reach a steady level and stabilize either, but overshoot downward significantly and then build up again. This is a long-term cycle, which Rosenberg says lasts from 15-20 years, which works as follows: debt reduction puts headwinds on the economy that only encourage people to save more, until eventually inflation becomes the big concern encouraging consumers to re-leverage to acquire products and assets again.
In addition to private sector debt, we have a massive amount of public sector debt and obligations which now have to be dealt with, which will involve tax increases and budget cuts, and will be another long-term drain on the economy. State and local governments have already been cutting back. Some states have been complaining that their required payments for the federal Medicare program taking up 30% of their budgets and are contemplating legal ways to cut that back. Pension obligations are also getting out of control, as the funds can no longer reliably earn as much as they used to with such low interest rates, and some of them such as CalPers lost a lot of money in the real-estate crash. Any way you look at it, this will take a long time to cycle through and should not be ignored.
One last long-term cycle that we should be paying attention to is the asset reallocation of the boomers, as they near retirement. Much of the wealth of the baby boomers was tied up in real estate and the stock market and is being slowly reallocated into more fixed-income assets. The losses of recent years is also why the only age group that had increasing employment rates over the past few years is the 55+ group, as people delay retirement plans or come out of retirement to make up for damages to their 401k’s.
In the current environment I really like a mixture of gold and income-generating assets. My portfolio in my Roth IRA right now has 50% gold in GLD, and the rest is divided between the high-yielding VZ and OTTR (telecom & utility), C-PF and HYK (Citibank and Goldman exchange-traded preferred shares), CEG-PA and PRD (exchange-traded debt with ~9% yield). Gold is one of the few protections against money devaluation through quantitative easing, because it acts as a currency rather than being demand-based, and it does well in a low interest-rate environment. Fixed income securities will give decent returns regardless of economic performance. Corporate balance sheets are fairly cash-heavy and healthy right now so they will likely be able to pay these obligations regardless of the uncertain economy.
In my regular account, I personally like covered calls. I’ve been selling covered calls on MPEL (Casino in Macau) regularly for 2 years now, and even as the stock price drifted down from $10 to under $4 I have been making decent returns doing this. A couple of weeks ago, I sold the October calls for $0.20 / share, with a $5 strike and a stock price of $4. This gives me a 5% premium over the next 3 months, and if the stock goes north of $5 in that time I will still get a 20% gain from the stock. Volatile markets make options expensive, which makes it worthwhile to consider being a seller. Another strategy which I want to do, but cannot do until I get a margin account, is to sell naked puts on companies that I want to purchase at a lower price. For example, if you really like Intel, but you don’t want to pay the market price of $19 for it, then you can sell a put, say for $17, collect the premium, and end up buying the stock for $17 if the price dips below that at expiration. This is a good way to make some money on the cash sitting in your trading account waiting for a buying opportunity, and to potentially get a stock you want at a cheaper price. I don’t recommend option-buying strategies for anyone as they are in many ways gambles rather than investments. Even if buying puts for portfolio protection, the protection is expensive and only makes sense for a leveraged hedge-fund.
The main thing to remember for this market though, is that you don’t want to buy and hold stocks for capital gains that will likely fail to materialize in the next 10 years. The same holds for real-estate by the way – consider a house as more purchase than investment, and only consider it an investment if it generates income because the same forces are at play here and to a greater extent than with stocks. Instead, buy and hold income generating assets, like dividend payers and gold, which is the classic hedge against uncertainty and easy money policies from the central banks. Trading strategies may also work, but are always less predictable and more difficult to implement.