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Time the Market for Risk
Economics provides basic instructions when it comes to investing.
First, decide how to divide your financial assets between safe assets, i.e., TIPS (Treasury Inflation Protected Securities) and risky assets (domestic and foreign stocks, domestic and foreign nominal bonds, REITs, commodities, private equity, etc.), while ignoring dominated assets (e.g., Melania’s meme coin).
Second, diversify your risky financial asset holdings.
Third, carefully consider the tax implications of selling appreciated assets held outside your retirement accounts.
Fourth, hold financial assets that are more heavily taxed, e.g. bonds, in tax-deferred retirement accounts and hold those that are less heavily taxed, e.g. stocks, which pay no dividends, or munis, whose return is largely, if not entirely tax free, outside of your retirement accounts.
Fifth, time the market for risk not return.
Is this a Period of High Risk?
The VIX index is a measure of the stock market’s volatility based on the pricing of options. The current level of the VIX is not particularly high. So, the market doesn’t consider stocks to be particularly risky. I disagree not based on the record-high value of the S&P, but on the President’s pronouncements with their dangerous economic and geopolitical implications.
The President has so far done a host of extreme things that he promised to do during the campaign. He just freed criminals who violently attacked Capital police on January 6th. He’s appointed completely unqualified people to run the Defense Department, serve as Director of National Intelligence, lead Health and Human Services, and head other agencies. In addition, many members of his economics team, like Peter Navarro, are virulently anti-China and, indeed, seem to be raving xenophobes.
What He Says Is What He Does
Trump says he will levy huge — 25 percent — tariffs on Canada and Mexico — our two largest trading partners, increase tariffs on China, and levy tariffs on all other countries to the tune of at least 10 percent.
Then we have him threatening to use force to retake the Panama Canal, attack drug cartels in Mexico, make Canada our 51st state, and grab Greenland. Yesterday, a major political figure in Denmark, a member of the European Parliament, publicly told Trump to “F… Off!” Today, the FT reported on a screaming match between Trump and Denmark’s Prime Minister over Greenland.
Here’s what Trump just said in a talk to the WEF at Davos:
My message to every business in the world is very simple: Come make your product in America, and we will give you among the lowest taxes of any nation on earth. But if you don’t make your product in America, which is your prerogative, then very simply you will have to pay a tariff. Differing amounts, but a tariff.
Trade War
Threatening tariffs to incentivize good behavior, mitigate bad behavior, or enhance national security makes sense. But Trump makes threats with no economical rationale. What can threatening Canada with a 25 percent tariff buy us?
Trump’s extreme decisions to date — both his executive orders and many of his nominations — presage imminent extreme economic moves.
Listen to Me or Listen to Jamie Dimond?
When lightning is forecast, smart people head for cover. Personally, I think economic lightning is about to strike. But I’m not Jamie Dimond, head of JP Morgan, who pulls down tens of millions in salary for being all knowing — including incessantly predicting a major recession during Biden’s Administration, which never arose.
Now Dimond is saying “Get Over It” when it comes to tariffs. “Tariffs can be a good thing.” Well, yes, if they are for a sensible purpose. But there is no purpose here other than pretending to raise revenues from foreigners when, in fact, tariffs comprise a hidden tax on the general public. The need for revenue is, of course, to justify extending the 2017 tax cut, which has many positive features, but disproportionately favors the rich.
Just Imagine
Suppose Trump levies his threatened tariffs and the same day the rest of the world responds by levying tariffs of equal size on the U.S. This will be the 1930s all over again in terms of international trade. Trump’s Manifest Destiny will be to shoot our economy in the head. China could, for example, announce that any country that trades with the U.S. cannot trade with China. South America would likely comply as its trade with China is greater than with the U.S. trade. Europe might do so as well. This would surely destroy NATO, produce a collapse of Ukraine, leaving an underarmed and unprepared Europe to fight Russia in the Baltics, Finland, Poland — you name it.
Of course, absent international trade, Trump will get his wish. We’ll be a manufacturing country again, specializing in what we do worst in an asinine attempt to overcome the law of comparative advantage.
Run for Cover?
In short, a major economic storm may be heading our way. Do we go for a walk in the park or do we park some of our exposed equities in TIPS?
The 30-year TIP is currently yielding 2.6 percent real — a 22 year high. I’m not a RIA, CFA, CFP, or any other of FINRA’s designated financial professionals who have no formal training in finance, but are still authorized to tell you exactly to invest. Nor am I the head of the world’s largest bank who is gifted at mis-predicting our economic future, including the course of financial markets.
No, I’m like you — someone who wants to play the market, but also play it safe. Personally my wife and I have moved half of our stocks into TIPS. We may lose out on another great Trump rally, but a 2.6 percent real return on 30-year TIPS is a damn good consolation prize. So is investing shorter term. The 10-year TIP is yielding 3.4 percent real and the 5-year TIP is yielding 2.0 percent real — all very high historically speaking.
Upside Investing
Personally, we’ve switched to the Upside Investing modeled in my company’s MaxiFi.com economics-based financial planning tool. It provides the holy grail educational (our company doesn’t provide investment advice) investing solution for most older households.
The idea is simple. Specify your stock investments and your start date for converting them to TIPS. In addition, invest in a ladder of TIPS to secure a floor to your living standard.
Under Upside Investing you only spend out of TIPS, treating your stocks as lost until they are found, i.e., sold off according to your plan and converted to TIPS. MaxiFi runs Monte Carlo simulations showing the range of upsides to your living standard floor from this process of raising you sustainable spending down the road as you make your risking assets safe.
Upside Investing conveys a basic, but basically overlooked financial fundamental — Controlling your future living standard risk depends not just on how aggressively you invest, but also on how aggressively you spend.