The Aftershock Investor: A Crash Course in Staying Afloat in a Sinking Economy (10 page)

But given the dramatic slowdown of export-led economies like Brazil (whose growth has fallen to near U.S. levels), Canada, Australia, as well as Asian economies that are closely tied to China, especially Hong Kong (which is nearly in recession), it’s very unlikely that the Chinese economy is really growing at nearly 9 percent as the government claims. Falling Chinese demand will take a big toll on commodities over the next few years, so we would expect some downward pressure on commodities in 2012. The International Energy Agency just announced that it expects very limited growth in oil demand this year due to the slowdown in the world economy. China is terribly important in commodities such as steel. As an example of that, China now consumes more steel for its construction industry alone than the demand for steel for all uses in the United States, Europe, and Japan
combined
. As further evidence of its voracious demand, it uses almost half of the cement production in the world. A big decline in Chinese construction demand would have a big effect on commodities.

Offsetting this to some degree will be money printing by the Fed, which could cause a temporary upturn in commodities. Of course, as inflation begins to get stronger, commodities will push upward even with declining demand.

A Note on Oil
: The big variable with oil is Iran. Political tensions have been heating up between Iran and the West lately. As this escalates, it could lead Iran closer and closer to war. If war with Iran does occur, oil prices will skyrocket.

No investment outlook written in mid-2012 would be complete without some mention of our upcoming presidential election. Of course, by the time you read this book, you will likely know much more than we do right now, so we (once again) are going out on a prediction limb to tell you what we think will happen and why—in this case, not about who will win in November, but how whoever wins will likely impact the economy in the short term.

While many people will find this disappointing, the truth is that the outcome of this election will likely have very little
long-term impact
on the fate of the U.S. economy. However, there are a few short-term potential impacts worth mentioning. Before we do, we would like to remind you once again that we have no political agenda in writing these books; we are simply trying to provide you with the correct macroeconomic point of view so you can come to your own logical conclusions about the direction of the economy and what you can do to protect yourself.

If Governor Romney becomes president, he will likely try to reduce the deficit by cutting spending. However, as he would soon discover, that is a lot easier said than done. What spending could Romney realistically cut? Will he try to cut Social Security? Not likely. What about cutting Medicare? No one is going to like that too much. How about trimming defense spending? That’s definitely out. Romney will soon find that significantly cutting almost any government program will be politically very hard to do, hard even for a Republican Congress to go along with, if the Congress also happens to become mostly Republican.

Perhaps, if Congress is mostly Republican, they will try to cut some of the more Democrat-favored programs, such as welfare. But to get any real mileage out of just a few cuts, the spending reductions would have to be very deep, and the Democrats would surely fight that, using the same filibuster rules that allowed the Republicans to block so many Democratic initiatives in the past four years. Of course, if Congress remains mostly Democratic, deep spending cuts will be even easier to block.

Meanwhile, it is very unlikely that any Republican president will try to increase revenues to the government with any new taxes. Instead, the money printing and the borrowing will continue. Money printing will continue because without it, the stock market and overall economy will decline. Nobody wants that, least of all investors and the business community, who may have supported Romney.

So, with continued money printing, continued borrowing, few spending cuts, and no new taxes, the longer-term outcome of having a Republican president, even with a Republican Congress, won’t be much different than the outcome of not having a Republican win.

However, in the shorter term, many investors will likely feel more optimistic having a Republican in the White House, and we could easily see the stock market doing well right after the election and continuing to do well for perhaps several months, assuming there is no bad news coming in from Europe, Iran, China, or other negatives that could end the Romney stock market honeymoon early.

If President Obama retains the White House, we can expect to see no big changes from today. The Federal Reserve will continue to print money, the government will continue to roll over the debt with more borrowed money, there will be no big spending cuts, and probably not much in the way of new taxes because, the Republicans will continue to block such attempts, as they have done before.

If Obama keeps the presidency but the Republicans become the majority in Congress, we can expect to see even less change, and nothing much new will get done that either side would like. The budget deficit will remain about the same, and our total debt will continue to grow.

If the Democrats keep the White House, investors will likely be less optimistic immediately after the election than they would be if Romney gets in. The stock market could become more volatile in the following months, and that could lead to an earlier next round of money printing by the Fed than we might have seen under Romney, but either way, the Fed will print more—it’s only a question of how soon.

As we said, the 2012 election will make little difference for the falling multibubble economy in the
longer term
. No matter what happens this November, falling bubbles cannot be propped up forever. Various delaying tactics will be tried, and some—like massive money printing—will temporarily, marginally succeed in the short term. But none will be able to ultimately stop the coming multibubble pop and the Aftershock that will follow.

Overall, 2012 should bring us short bouts of excitement followed by long periods of relative boredom—kind of like 2011. Europe will likely provide the biggest source of unwelcome financial excitement. China will play an increasingly sinister background role, slowing down the world economy, especially toward the end of the year. And American politics will likely provide some more financial excitement, with Congress trying to wrestle with the debt and our presidential election at the end of the year.

Of course, there is always the chance that the financial situation might get surprisingly bad this year. We don’t think that will happen in 2012, but we certainly can’t entirely rule it out. Also, there is always the chance for a Black Swan event, Iran being an obvious example. We’ll be keeping our eyes wide open for any sign of a big surprise or for more incremental evidence that we are moving along toward the inevitable Aftershock ahead.

For years, Conventional Wisdom (CW) money gurus have been telling us that buy-and-hold investing is the way to go. All you have to do to grow yourself a nice nest egg is to get some high-quality stocks and bonds in the right mix to match your age and goals, and then like those infomercial ovens on TV, you can “just set it and forget it.”

The easy CW approach to investing naturally worked very well in an overall rising multibubble economy. As long as you stayed well diversified with a collection of average performing stocks and bonds, you could count on earning a good profit in the stock market and a steadily rising total return in the bond market, especially from the 1980s to 2000. With the Dow rising 1,000 percent in 20 years and falling interest rates pushing bond prices ever higher, investors could practically throw a dart at a stock page and end up with some good gains eventually. That’s because CW investing in a rising bubble economy is nearly effortless.

Then, beginning in 2000, all that started to change. Bonds still did okay, but that 1,000 percent growth in stocks got replaced by a big fat zero percent growth for the Dow and a 50 percent decline in Nasdaq stocks over the next decade. Nonetheless, the CW gurus seemed unfazed, plowing ahead with their CW investing as if America’s multibubble economy would always continue to rise. They didn’t see the bubbles, only the growth. And if that growth happened to occasionally experience a bit of a “down cycle,” they could always just relax and wait for an inevitable “up cycle,” That’s because the rising bubble economy had convinced them that economic growth was virtually guaranteed if you just had patience and waited for a while. CW has faith and CW doesn’t quit.

So when the real estate bubble started to pop in 2007 and kicked off a global financial crisis in 2008, along with a stock market drop of nearly 40 percent, many CW investment experts were quite shocked and confused. Without the correct macroeconomic view of what was occurring, they held even more tightly to their faithful buy-and-hold mantra. CW investing had simply not prepared them for moments like this. They used phrases like “Black Swan event” and “highly unpredictable” to describe the 2008 stock market crash and global economic downturn, when in fact it was all
very predictable
(and by the way, was predicted in our book
America’s Bubble Economy
in 2006). CW, however, saw the entire global financial crisis as unpredictable and beyond our control—as if an unexpected asteroid suddenly hit us out of the blue in late 2008, not something we systematically created ourselves over the course of decades.

Then, just when it looked like economic Armageddon, the U.S. Federal Reserve came to our rescue—at least in the short term—with massive money printing beginning in early 2009, as well as massive federal government borrowing. The enormous expansion of the money supply directly boosted the stock market and helped support the overall economy. However, it also left us with the specter of future rising inflation and rising interest rates dangling over CW investing like an unseen guillotine hanging by a thread.

So now the question is
what’s next
? Should we stick with the CW folks, like Warren Buffett and other previously highly successful investors, or does this new and evolving economy call for a new and evolving approach? Hmmm, can you tell which way we are going with this?

Before we get to the details of our Aftershock wisdom on how to invest in the new and changing economy, let’s take a close look at CW investing and why it’s so very hard for most people to give it up.

The key assumption behind all CW investing is pretty simple: What worked well in the recent past will work well today. It’s easy to understand, it’s easy to follow, and, most of all, it’s
very comfortable
. And for a very long time, it was also very true. Let’s look at some recent history to see why CW investing still has such powerful appeal.

Over the past century or so, the U.S. stock market has experienced solid, albeit slow (by the standards of the 1980s and 1990s) growth. Even in the Great Depression—a big economic collapse by any measure—most major corporations survived (many major corporations such as Caterpillar were even able to maintain profitability), as did most major banking and investment banking firms. The government entered the Depression with relatively little debt and little inflation. In fact, they probably printed too little money, contributing to deflation during the Great Depression.

Also, for the first half of the twentieth century, the economy was much less capital dependent and, hence, much less vulnerable to changes in interest rates. Leverage was less common for corporations and was certainly less common for consumers buying homes or cars. Most of our grandparents would not have even considered having more than a 10-year mortgage on a home, and they did not use credit to buy cars (even though that was becoming increasingly common). Use of debt had grown enormously since the late 1800s, but it was far less than today. In addition, there was much less consumer spending, partly due to less credit for such activities. As an example, credit cards really weren’t in heavy use until the 1970s and especially the 1980s. Thus, with less consumer spending, the earlier economy was more resistant to downturns in consumer spending.

The economy had also experienced only a few major bubbles prior to the Great Depression. The 1920s stock bubble was the biggest, but even that bubble was accompanied by huge real growth in the economy. Relatively speaking, it was a much smaller bubble than the combined stock, housing, private credit, and consumer spending bubbles that rose up beginning in the 1980s.