The Aftershock Investor: A Crash Course in Staying Afloat in a Sinking Economy (23 page)

Remember, as we have said in every chapter of this book, buy-and-hold investing is over. Completely over! If you stick with a conventional buy-and-hold portfolio, you will eventually experience
buy-and-lose
.

Let’s start with what
not
to own. First, we know that weaker bonds will be the first to crash. This includes less creditworthy
corporate bonds, municipal bonds
that are not government insured, and
high-yield bonds
. Don’t be lured in by their higher coupon rates. The very real risks are not worth the potential rewards.

The next big red flag is all
long-term bonds
, which are more sensitive to interest rate changes than short-term bonds. Interest rates are probably already as low as they can realistically go. This is due to the artificial demand for bonds created by the huge number of government bonds purchased by the Fed in recent years via QE (money printing). Any increase in interest rates is going to hurt long-term bonds the most, so sticking with shorter-term bonds works to limit risk and can ease the pain when interest rates do rise.

So with these caveats, what does that leave us?

Generally speaking, we want to stick with the lowest-risk, government-backed, short-term bonds for the sake of capital preservation. The point here is not to chase high interest rates, but to maintain wealth in a well-diversified, actively managed portfolio between now and the Aftershock. In the short term, before the Aftershock, bonds to consider are:

We said that real estate would be the first area hit and that many mortgages would go under. But remember that Ginnie Mae bonds in particular are federally guaranteed, and while that guarantee won’t mean much down the road in the Aftershock, it will be helpful before the federal government comes close to default. There will be plenty of warning signs in the meantime. So government-sponsored mortgage-backed securities can actually be a good option for capital preservation
in the short term
.

Again, these won’t have the most attractive rates, but they are much more reliable than corporate or municipal bonds. While the Fed cannot print money forever, it can keep it up long enough to make these investments very safe from credit risk in the shorter term. They may still lose some value from inflation, but because these mature faster, than shorter term bonds, that helps to limit the negative impact. Also, because they roll over so frequently, you can repurchase them at the new higher interest rates.

TIPS be among the most resilient bonds. Since the principal is indexed to the CPI, their value will go up as inflation rises, both in principal and in market value. Even if the yield is very low, these bonds can hold up very well and for significantly longer than other types of bonds. But even TIPS will eventually be a bad idea. Most importantly, the CPI may significantly understate the true rate of inflation, so you will be losing some purchasing power. Also, when the government eventually does default on its debt, adjustable-rate loans, such as TIPS, will be among the first to be repudiated. So it’s important to keep an eye on the situation and get out of TIPS before it is too late. In other words, even TIPS require active investment management.

Timing each stage of the demise of bonds is tricky and depends on many moving parts that are hard to predict in a book that will be published before many of these events will take place. We know what will happen but we don’t know the exact moment that each new development will occur. In the short term, you can reasonably assume that getting the timing perfectly right is unlikely. That means you are either going to be a bit too early or a bit too late. Too early seems like a much better choice. Therefore, exiting all bonds sooner rather than later is not such a bad idea.

But if you are not ready to get out of all bonds yet,
Table 5.2
summarizes our current thinking about bond risk, with a ranking of A, B, and C at each stage prior to the rapid crash of bonds to XXX at the start of the Aftershock.

Table 5.2
When to Exit Bonds

Most previously issued bonds will be essentially worthless in the Aftershock. Clearly, you will want to be out of
all bonds
before their A, B, or C score crashes to XXX. Please don’t let all your bond investment capital go to Money Heaven before then. Remember to keep your eyes open and stay alert as these vulnerable markets evolve. You can also follow our thinking in real time by visiting our web site at
www.aftershockpublishing.com
.

When the U.S. real estate bubble began to burst in 2007 and 2008, a lot of people were taken by surprise. We were not among them. Our first book,
America’s Bubble Economy
, warned in 2006 that home prices were rising too rapidly relative to incomes, and that of our six big fat, colinked bubbles, the real estate bubble would likely be the one to pop first.

At first, the conventional wisdom (CW) “experts” said it was nothing more than a subprime mortgage problem, but soon the subprime mortgage problems spread to non-subprime mortgages and then to real estate in general, as prices began to fall. No subprime mortgage problem could have done that if we didn’t already have a big fat real estate bubble, vulnerable to a pop.

And even when that happened, the CW experts
still
told us not to worry; recovery, they promised, was imminent.

So far, that has not happened. Instead, the falling real estate bubble has been very painful. Disappearing equity has put many mortgages underwater. Shockingly, 15.7 million mortgages in May 2012 were underwater, according to Zillow. That is nearly one out of every three mortgages in the United States! The falling real estate bubble has also pulled the plug on the housing-bubble-driven consumer spending bubble, and kicked off the domino multibubble fall that led to the global financial crisis of late 2008 and is continuing to put downward pressure on the bubble economy.

While all real estate is unique to your particular location and situation, in general, home values have not returned to previous highs. Prices have recently stabilized or picked up slightly in some areas, while in other areas prices continue to fall.

It may be tempting to think that falling real estate prices have hit bottom, but unfortunately that isn’t true. The primary reason that home prices have not dropped much lower yet is that massive money printing by the Fed and massive government borrowing are helping to keep the partially popped bubbles temporarily afloat. When this massive stimulus begins to cause serious inflation and rising interest rates, the bubbles, including the real estate bubble, will fall.

This is not a comforting thought for real estate owners, but avoiding reality will not help. If you own property of any kind, you have two choices: see the falling real estate bubble before it’s too late to protect your equity; or see it later, after the value of your property falls further and there are far fewer willing and able potential buyers. We are not saying that you must sell now; we are saying that you must face reality now, so you can make your own wise decisions about what to do.

It’s easy to think that real estate prices should always go up over time. But there are real fundamental economic drivers behind rising real estate prices, and without those fundamental drivers, the only way to push up prices is by inflating a bubble. What fundamental economic drivers moved real estate prices up in the past, and what changed to create an overblown real estate bubble?

Centuries ago, most people lived on farms, with more or less everything they needed within close proximity, even if a great deal of labor was required to keep it going. This arrangement changed dramatically in the nineteenth and twentieth centuries, with three fundamental economic drivers giving us a period of long, sustained growth in real estate prices that continued nearly uninterrupted for generations: