In the previous bull market cycle, Larry Kudlow of CNBC touted the perfect “goldilocks economy.” While not using the terms goldilocks economy, Michael Hanson, economist for Bank of America, is again touting a benign investment environment. He predicts that over the next several years the economy will grow at 2.5-3.5 percent, interest rates will remain low and inflation will be subdued. He also maintains that the growing federal deficit is the only “minor” concern. B of A’s wealth management approach appears to be the fairly standard mantra: emphasize tax efficiency, and diversify among various asset classes.
This blog does not provide advice as might your investment adviser, guru or astrologist. However, I find something deeply disturbing about the aforementioned advice and forecasts. The core of this philosophy is that past is prologue, and the next fifty years will look just like the past twenty-five. But asset diversification strategy did not take into account that in 2007 and 2008, with the exception of US treasury securities, all markets declined simultaneously. Robert Prechter of Elliott Wave called this phenomenon “It’s All One Market.” And indeed diversification assured portfolio losses of 40% or more.
The Real World Intrudes
Counter to the “goldilocks” world view espoused by CNBC and wealth management firms, messy facts keep cropping up daily. Recent cautions for any investor or policy maker:
More than a Million in the U.S. May Lose Job Benefits – Congress is concerned with federal deficits and extended unemployment benefits. They believe that these benefits are a disincentive to finding work, and they are disinclined to extend the 99 week ceiling. Thus, 1 million people face an immediate loss of benefits with an estimated loss of 400,000 per month thereafter.
Morgan Stanley: Strategic Defaults Reach 12% – These are the mortgage holders with the capacity to pay, and yet choose to default. Twelve per cent of all mortgage defaults in February 2010 were of the strategic variety. As I predicted, “bailout nation” has given license to strategic defaulters to just walk away from their underwater home values. See Flirting with Economic and Political Breakdown.
Is the UK Preparing to follow the PIIGS into the Abyss
Spanish Unemployment Rate Tops 20%
Containment Fails: European CDS Explode as Market Looks to Future Bail Outs, Bank Runs
Mainstream media keeps reassuring the public that the crisis in Greece is well contained. But just remember how Ben Bernanke assured the financial markets that our subprime crisis was also well contained. Government financial profligacy is having major repercussions in the European financial markets. Bailouts of private banks, out of control public sector salaries and pensions, overregulation, and (with the assistance of American investment banks) financial chicanery to hide public indebtedness debt have come home to roost. Credit spreads, the difference between the gold standard German bonds and other European government debt, especially the “PIIGS” (Portugal, Ireland, Italy, Greece, Spain), have widened to alarming numbers. Even the UK has experienced widening of credit spreads against German bonds. Eurozone unemployment is soaring. Despite EU and IMF efforts to bail out Greece, credit spreads again widened today and the Euro plunged.
Justice Department Opens Goldman Sachs Criminal Investigation Sources Say – The significance here is not whether or not the government can prove that Goldman committed crimes. Rather, the importance of the investigation is that the tide has turned. Financial firms will be on the defensive and unfortunately their most profitable products operate on the edge of the law. Inevitably, more government oversight will cut profitability and remove one more support from the already fragile economic recovery. See also Watershed Event in the Financial Crisis – SEC v. Goldman.
Uncertainty Abounds
Risk and reward need to correlate. Perhaps diversification and the rosy scenarios of years past will win out. But this small selection of troubling headlines suggests otherwise. I would view the diversification thesis very skeptically. As they used to say on television’s Hill Street Blues: “Hey, let’s be careful out there.”
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