DOGE

 Unless you have been living under a rock, you are now familiar with or at least heard of the acronym “DOGE.” The aforesaid acronym stands for Department of Government Efficiency. I would be remiss if I didn’t point out that “Government Efficiency” is as about as glaringly obvious an oxymoron as one will ever stumble across. Wikipedia describes DOGE as an initiative of the second Trump administration tasked with reducing federal spending. Besides carrying out spending cuts, it aims to modernize federal technology and software to maximize governmental efficiency and productivity. DOGE is scheduled to be dissolved on the nation’s 250th birthday - July 4, 2026. Some parties hope it will die a violent death before the United States Semiquincentennial.

Before further opining on the subject matter, I believe it is requisite to issue a couple of disclaimers. First and foremost, I have been a long-term proponent of small and limited government. In that light, I am generally supportive of anything that reduces spending and removes government intrusions from the lives of Americans. The second disclaimer concerns my biases accrued over the past half century when comparing the public sector workforce to the private sector workforce. Opinions tend to be a product of our cumulative experiences. Granted, my public sector employment was extremely limited, while my private sector employment in the world of commerce was both lengthy and extensive. I am thus predisposed to support DOGE and pro-business policies in general. I consider the private sector to be the productive portion of the economy with the public sector for the most part being the unproductive portion.

Supporters of DOGE point out that besides seeking a reduction in spending - fraud, waste, and gross incompetence are all being targeted. With annual government expenditures now over $7 trillion, there is no doubt waste and abuse that can be mitigated to a certain extent. While shocking headlines may be generated by DOGE’s findings, there will not be enough overall savings to move the needle. When the dust eventually settles, there could be $250 - $300 billion in savings in discretionary spending. This represents a measly 3.5% of total spending. I’ve said it before and I’ll say it again: the only way to cure the spending problem is to go after the Big Boys: Defense, Social Security, Medicare, and Medicaid. Another point I would like to make is that government employees are inherently inefficient. Without a bottom line and the necessity to be profitable to retain employment, there is not an incentive for government employees to be efficient.

Practically every president since Teddy Roosevelt has campaigned with the promise of rooting out government waste and keeping a lid on federal expenditures. There is  always a surplus of proclamations and bold talk before the issue quietly slinks away after the election. Even the renowned  conservative, Ronald Reagan, tried and failed miserably in his endeavors to shrink the government. Although I fully expect Trump to similarly fail in his efforts to stop or slow down the expansion of the federal government, I give him credit for at least talking about dramatic changes and at least initially doing something to curtail Big Government. Unfortunately, I feel an economic crisis will derail real fiscal reform and the runaway train will start gathering steam again.

One can make the argument that fiscal motives were not the only reason to unleash DOGE. The ruthlessness and expediency of the job cuts tells me something else is at play. Trump and his policy wonks see government employees, especially those in certain agencies, as being diametrically opposed to his free-market orientation and capitalistic roots. He also thinks, and probably rightfully so, they opposed him during his first term as President. One aspect that MAGA Republicans and traditional conservatives share in common is their disdain for the federal bureaucracy. They mutually view it as a sprawling, unaccountable monolith with multiple tentacles choking out the lifeblood of American businesses and citizens. A heavyweight brawl will soon be front and center. In one corner will be Donald J. Trump representing the Executive Branch of our federal government. The opposite corner will be the  professional managers and their  unions  representing the federal bureaucracy. I anticipate the Supreme Court having an extra-busy  docket over the next few years as they adjudicate various cases coming out of this epic conflict. It was only a matter of time before a chief executive aggressively pushed the boundaries. I look forward to the Court determining the parameters of the extent of power wielded by the Executive Branch.

I’ve made it to the near end of this spiel without even mentioning the country’s $36 trillion debt and annual deficits representing 6% - 7% of our Gross Domestic Product. Anybody with half a brain knows these numbers are unsustainable and a direct threat to the continued prosperity of the United States. Tick, Tick, Tick….the debt bomb is ticking. Americans want this issue addressed, but greatly prefer somebody elses ox be gored. The next blog I churn out will offer some suggestions to avoid a crisis. It will be universally reviled because  everybody’s ox will be gored.

Wealth and Income Inequality

 There is generally a high degree of correlation between wealth and income. The reason is obvious - for the most part, financial assets generate income in the form of interest, dividends, and capital appreciation. The more assets owned by an individual, the higher the level of income generation. There are of course some exceptions to this close relationship between wealth and income. An investor sitting on a pile of gold receives zero income from his precious metal holdings, but could have a significant net worth. Another classic example would be the occasional NBA superstar who earns tens of millions of dollars per year for a finite number of years. However, due to a profligate lifestyle, income tax obligations, and incompetent, if not outright unscrupulous, agents and managers, finds himself in bankruptcy court when his playing career comes to an end. For the purposes of this blog, I'll be making the assumption that high wealth and high income are interchangeable. My goal is to outline a thesis detailing how economic disparity is viewed by Americans and then explain why the discrepancy has widened so much since the Great Financial Crisis (2008-2009).

Like practically every other political issue these days, conservatives and liberals typically hold dramatically different viewpoints on income inequality. Progressives tend to claim that Americans with high incomes don't pay their "fair share" of taxes and promote extensive redistribution (income) efforts. I've never heard or read what redistribution advocates define as "fair share." Many conservatives, including myself, offer a counter-argument pointing out in no other country do the rich bear a greater share of the income tax burden than they do in the United States. In terms of federal income taxes, the top 1% of taxpayers in the U.S. pay 40% of taxes paid, the bottom 20% have negative tax rates. Over 40% of households pay no federal income tax. When the data are adjusted to account for all government programs that transfer income, the U.S. is shown to have an income distribution that aligns closely with its peers. It seems both unfair and illogical to demonize and target the taxpayers who tend to be the smartest, hardest working, and most productive participants in the economy. All that said, I take the position it may be wise to tweak the tax code and various government programs at the expense of the wealthy and to the benefit of low and middle income Americans. History tells us that a society needs a release valve when a significant portion of the population is falling further and further behind the well-to-do. Otherwise, social unrest and violence is all but inevitable.

As with many of my previous financial blogs, I intend to place the blame for growing wealth/income inequality squarely on the monetary policies of the Federal Reserve Bank and the fiscal negligence of the United States Congress. Zero or near-zero interest rates in the wake of the 2008 financial crisis (2008-2015) and the Covid-19 pandemic (2020-2022) are coming home to roost in a most distressing manner. ZIRP (zero interest rate policy) that was aimed at stimulating economic activity ended up serving the needs of big government, big business, and owners of financial assets, while ordinary savers received almost no return on their savings for more than a decade. The largest borrower in the world is the U.S. government. The Treasury reaps the benefit of borrowing at a reduced cost when interest rates are held down. Large corporations are beneficiaries of Fed largesse when they can borrow money cheaply to buy back their own shares in the equity markets. By artificially increasing the earnings-per-share, they raise the price of their stock. Because many top executives have compensation packages linked to their companies' share price, this maneuver rewards these executives. Wealthy individual investors are especially well positioned to benefit from "accommodative" monetary policy. They borrow funds at extremely low interest rates and proceed to arbitrage high returns from pumped-up equity markets against a low cost of borrowing.

It's abundantly clear that monetary policy can channel financial benefits to some members of the population at the expense of others. While interest rate manipulations by monetary policymakers offer up a speculator's paradise for those who can grab quick profits by trading derivatives and currencies, these manipulations make life considerably more challenging for people who must function in the real economy. In her 2021 book, "The Engine of Inequality: The Fed and the Future of Wealth in America," financial consultant Karen Petrou explains: "Ultra-low rates fundamentally eviscerate the ability of all but the wealthy to a gain an economic toehold; instead, they lead investors to drive up equity and other prices to achieve return-on-investment objectives, but average Americans hold little if any, stock or investment instruments. Instead, they save what they can in bank accounts. The rates on these have been so low for so long that these thrifty, prudent households have in fact set themselves back with every dollar they save."

The main impetus for the aggressive post-GFC expansion of the country's money supply was to spur faster economic growth. In addition to keeping rates at effectively zero, the Fed utilized QE to purchase government debt securities. To the surprise of many economists and policy wonks, the economy remained sluggish. Even more surprising, inflation all but disappeared for the second decade of the 21st century. Normally inflation results when the money supply dramatically increases. Where did inflation go? The answer is that inflation from 2010 - 2020 was concentrated in asset values, primarily equities and real estate. Inflation in goods and services did not appear until the government mailed stimulus checks to Americans during the Covid-19 pandemic. To finance this massive outlay along with all the other Covid-19 relief programs for businesses, Uncle Sam had to issue a boatload of debt securities. A good portion of this new debt was purchased by the Federal Reserve Bank. The burden of paying this debt will fall on future generations. Government debt securities are claims on future tax revenues derived from wealth yet to be created and incomes yet to be earned.

The structure of our economy has fundamentally changed over the second half of the 20th century and first quarter of the 21st century. We are no longer a productive economy that makes products of substance. The United States is now a financialized economy, where the financial sector and its priorities have become increasingly dominant in all aspects of the economy. The U.S. financial sector grew from 10% of GDP in 1950 to 22% by 2020. In 1950, manufacturing had 40% of all profits and 29% of the nation's jobs; today, financial enterprises have 40% of the nation's profits with 5% of the jobs. The real economy and financial markets have reached the point where they are practically totally detached and fundamentally at odds. While Main Street has lagged or even retreated, Wall Street has thrived. Growth rates of the economy since 2008 do not in any way support the valuations of the stock market.

Policies introduced by the Fed and other central planners have enriched elites at the expense of poor and middle-class Americans. No where in the Constitution does it say that money shall be regulated in such a way that some groups benefit more than others in accordance with decisions made by the nation's central bank. It is blatantly inconsistent with founding principles to allow monetary authorities to deliberately debase the dollar in order to achieve what they construe to be "price stability." Perhaps the Fed should simply serve as the lender of last resort and allow the free market to determine levels of interest rates and the country's money supply. As evidenced by multiple surveys over the past 15 years, faith in our institutions and capitalism is waning. When citizens believe the system is "rigged" to reward those who are already at the top in terms of wealth and income, this belief feeds an attitude of resentment and cynicism. As we have recently evidenced, an environment of this nature is a rich breeding ground for political populism.

Is Buy and Hold Dead?

For the context of this blog posting, the term "buy-and-hold" specifically refers to an investment strategy whereby an investor buys equity securities with the intent to hold them long-term with the goal of realizing price appreciation. This is strategy endorsed and often utilized by historical investment icons such as Jack Bogle, John Templeton, Peter Lynch, and of course, the legendary Warren Buffett. Although, in the past few years, it appears Mr. Buffett has liquidated and converted to cash many of his holdings in various companies. The majority of professional participants in the investment world now believe buy-and-hold is basically dead and gone. I don't believe buy-and-hold is dead and gone, but it's definitely on life support.

One reason buy-and-hold has fallen out of favor is that the strategy implies the risk of assets is always justified by the reward. The idea that every year is a good year to own equities is patently false. The risk of buying and holding securities is not justified by the reward under certain conditions. Another problem with buy-and-hold is the implication that prices don't matter because the strategy requires you to buy-and-hold at all times regardless of price or valuation. Is there any other buying decision in your life where price doesn't matter? The answer to that question is glaringly obvious. Besides completely ignoring the essential investment concept of managing risk, buy-and-hold requires little intelligence, skill, or serious effort. Combined with the ongoing trend of passive investing, this is a recipe for disaster.

There are additional reasons why a buy-and-hold strategy, while not complete nonsense and outdated, is a risky endeavor these days. It totally misses the dynamic evolution of the world - everything changes throughout time and the speed of change is ever-increasing. The number of variables at play also is increasing at a geometric rate. Another risk is the reduced lifespan of a business, even originally successful businesses. The lifespan of large, publicly traded companies has significantly decreased over time, with some studies indicating a current average lifespan of around 15 years or less. More stocks have vanished or gone to zero than have survived to this day. One of the chief reasons buy-and-hold isn't king anymore is due to the new, more extreme conditions in the market. Although currently in hibernation, volatility and the Bear have not gone extinct. Through greed and lack of attention, our markets are sometimes built on inflated bubbles. I can make the argument that is presently the case. Furthermore, while timing the market to perfection is improbable, if not impossible, wise investors tend to reduce their exposure to stocks when the market is expensive relative to the fundamentals, and keep their exposure down - if need be, for years - until the market becomes much cheaper. It then involves increasing exposure, and keeping it high, again for years, if necessary.

As mentioned, the market is more dynamic than ever. Investors will miss out on gains from shorter term movements if they rely exclusively on buy-and-hold and do not hold capital for shorter term investments. Buy-and-hold is a purely offensive investment strategy that ignores the defensive half of the investment equation. At times it makes sense to take a short position in a stock. Warren Buffett was mentioned earlier. Probably no other investor has been more closely associated with buy-and-hold than Mr. Buffett. His baby, Berkshire Hathaway, has recently sold a substantial amount of stocks and is presently sitting on a record $325 billion cash pile as a result. Old Warren believes equities are severely overvalued and a market crash is possible. He is wisely waiting for bargain basement opportunities. This is not the behavior of a true blue buy-and-holder.

  

Optimum Asset Allocation Model?

 If not an outright trick question, the title of this blog is misleading. The optimum asset allocation can only be determined in retrospect, for nobody can read the future. At least not accurately. When establishing an asset allocation model for an investor, one size does not fit all. Multiple variables come into play when establishing an investor's customized asset allocation parameters. Besides personal preference and financial goals, the next most important component would be somebody's level of risk tolerance. A person who can't psychologically deal with a stock market correction (down 10%) or a Bear Market (down 20%) should have minimal portfolio exposure to equities. Other important factors to take into consideration would be an investor's age, health, and level of current and expected interest rates.

Before looking at different allocation models, let's delineate the major asset classes. These asset classes would be as follows: 1.) Cash and Cash Equivalents (includes Treasury bills); 2.) Equities (stocks); 3.) Fixed Income (bonds); 4.) Real Estate; 5.) Precious Metals (gold and silver); 6.) Commodities; 7.) Foreign Currencies; 8.) Cryptocurrencies; 9.) Collectibles. It goes without saying many of these categories could be further divided into sub-classes. For example, Fixed Income could be broken down into U.S. Treasuries, corporate bonds, and municipal bonds. Real Estate could be further divided into residential, commercial, and agricultural real estate. For our purposes, we'll stick with the general classes in order to avoid getting stuck in the mire of excessive details.

Historically, 60% equities and 40% bonds has been the most common allocation recommended by financial advisors. This has been considered a balanced portfolio and has been the standard for decades. Quoting songwriter and crooner, Bob Dylan - "And you better start swimmin', Or you'll sink like a stone, For the times they are a-changin'." There has been an evolution away from 60/40 and toward other investment allocation options. The primary reasons away from 60/40 would be high equity valuations, Federal Reserve Bank monetary policies, increased risks in bond funds, and low prices in the commodities' markets. Many experts are now saying that a well-diversified portfolio must include more asset classes than just stocks and bonds. Besides those asset classes itemized in the previous paragraph - private equity, venture capital, and private credit are now often incorporated in the modern investment portfolio.

There once was an old rule of thumb that utilized the investor's age to determine the stock/bond allocation in a portfolio. For a thirty-year-old, the recommendation was to hold 30% in bonds and 70% in equities. For a fifty-year-old, the recommendation was to hold 50% in both stocks and bonds. Thus, for a seventy-year-old, the recommended allocation was 70% in bonds and 30% in equities. In our topsy-turvy world, older investors these days often turn this approach on its head and flip-flop to 70% equities and 30% bonds. The percentage Baby Boomers are allocating to stocks is at an all-time high. These folks are ill-prepared to weather a 30%-50% down market.

I've always been partial to the 30/30/30/10 allocation model allocated as follows: 1.) 30% - stocks; 2.) 30% - bonds; 3.) 30% - real estate; 4.) 10% cash. The double-digit percentage in cash would be applicable when short-term interest rates are depressed as they were during the Covid-19 pandemic. Otherwise, I would take cash to 5% and increase equities to 35%. In an environment where the continued debasement of our currency is a distinct possibility, I would be comfortable with the following allocation: 1.) Equities - 40%; 2.) Fixed Income - 20%; 3.) Real Estate - 25%; 4.) Gold and Silver - 8%; 5.) Bitcoin - 2%; 6.) Cash - 5%. Equities, real estate, and precious metals total 75% in this scenario and offer some protection against inflation. If major inflation and loss of purchasing power are a strong possibility, the 12/20/80 asset allocation rule may appeal to some. In this scenario, an individual holds 12 month's worth of expenses in safe, liquid funds. Then, the remainder of his assets are divided between equities (80%) and gold (20%).

For those investors with a contrarian bent and a morbid fascination of market crashes, I suggest extending consideration to what I'll refer to as a "Black Swan Portfolio." In the context of finance, a black swan event is used to describe a rare, random event that nobody sees coming that poses a significant risk to the stock market and economy. Some historical examples would include 9/11, Great Financial Crisis (2008), and the Covid-19 pandemic (2020). The term is closely associated with the trader and author, Nassim Taleb, and founder of the hedge fund Universa, Mark Spitznagel. The "Black Swan Portfolio" is quite basic in its application and has been widely successful in the rare times it has been implemented. The first component of the strategy is to go long the S&P 500 Index for 97% of your investment portfolio. Using the SPDR S&P 500 ETF Trust (ticker symbol SPY) is an instrument that can be used. Next, with the remaining 3% of your portfolio, buy deep out-of-the-money put options on SPY (60-90 day expirations), and do this on a regular basis. By doing this you are effectively shorting the market, tail-risk hedging, and possibly realizing a windfall if a Black Swan event materializes. Be prepared  to suffer small losses for literally years before the money spent on the constant purchase of put options pays off. As mentioned, the Covid-19 pandemic was a Black Swan event and the market tanked in March 2020. The aforementioned Mark Spitznagel's hedge fund (Universa) made a return of 3,612% for that month alone, and over 4,000% for the year 2020. I have to assume Universa's investors were elated to benefit from a 40 bagger in 2020.

The Almighty U.S. Dollar

 Unless you were born more than 80 years ago, you have never lived during a time when the United States dollar was not the undisputed dominant currency in the world. The Bretton Woods Agreement entered by the major economies in July 1944 formally acknowledged what was already generally accepted - the dollar would serve as the world's principal reserve currency. Furthermore, it would be the currency of choice for most countries to utilize when transacting international trade. 

Per the Bretton Woods Agreement, the dollar was convertible to gold at the fixed rate of $35 per ounce. The majority of countries in turn pegged their currency valuation to the U.S. dollar. This monetary system dissolved in 1971 when President Richard Nixon terminated the convertibility of the U.S. dollar to gold. From 1971 henceforth, the dollar and other major currencies have experienced a floating exchange rate. This is a system where the currency price of a nation is set by the foreign exchange market based on supply and demand relative to other currencies.

The dollar was and remains the obvious candidate to serve as the world's primary reserve currency. Similar to the end of the Second World War, the American capital markets continue to be deep, open to the world, and highly liquid. In addition, there is a track record of stability supported by investor protections and the rule of law. The U.S. represents practically 25% of the world's $115 trillion (annual) economy. Foreign governments and central banks around the world hold dollar-denominated assets, usually U.S. Treasury securities, as reserves to manage the foreign exchange value of their currencies or to weather economic shocks. Dollar assets comprise about 60% of global foreign currency reserves, down from 70% in 2000. The next highest reserve holdings would currently be the euro at 20% of the total.

Very few Americans truly grasp the benefits and significance of the dollar serving as the world's primary reserve currency. The dominant dollar has been called an "exorbitant privilege." And it is that, and more. A generous supply of dollars combined with strong global demand allows the U.S. to borrow money at a lower cost than if the dollar was not the world's principal reserve currency. A dollar at the top of the food chain reduces the cost of imports paid by American consumers. A strong dollar induces foreign direct investment in the United States. Long-term investment in businesses and property has been significant. The dollar's reserve status allows the U.S. to export inflation to a certain extent. While domestic consumers receive vast amounts of physical products of substance, in exchange foreign exporters receive vast levels of fiat money that has a history and future of debasement. The dollar has lost 98% of its purchasing power over the past century.

History tells us the U.S. dollar will ultimately be displaced as the world's dominant currency. Since the demise of the Roman Empire, there have been more than a dozen different currencies that sat at the top of the heap for varying tenures. The Dutch guilder succeeded Spain's silver dollar and dominated for the 17th and 18th centuries,. The United Kingdom's pound sterling was the primary reserve currency of much of the world in the 19th century and first half of the 20th century before being bumped off its throne by the U.S. dollar. There is no question that the dollar will eventually be replaced as the kingpin by either a different currency or an entirely new monetary system. The only question is when - will it be in two years, twenty years, or 200 years? I would lean toward the twenty-year scenario and I'll proceed to defend my thesis below.

Myself and many others predicted the imminent demise of the dollar in the past couple of years due to reckless, undisciplined fiscal policies and continued abuse of economic sanctions leveled on other nations by the U.S. It is time to eat some crow. I was wrong, and so were many others. We were caught-up in all the hub-bub surrounding proclamations that the BRICS' nations were about to unleash their own currency backed by a basket of commodities including gold. This may eventually transpire, but it probably is a ways off. I also failed to take into account higher interest rates in the U.S. and a robust stock market over the past two years. This induced foreign capital inflows which further supported the dollar. The fact of the matter is, currently there aren't any viable reserve-currency alternatives. The euro, Japanese yen, or Chinese renminbi are not in a position to replace the dollar. The dollar remains the cleanest shirt in a drawer full of dirty shirts.

However, over the next decade or two, unless something dramatically changes, I foresee the dollar gradually declining both in purchasing power and global importance. It may be the last man standing, but if powerful current trends continue on an unabated path, it too will tumble. Since leaving the gold standard over a half-century ago, the dollar has been kept aloft by the tax-generating ability of a growing, productive economy and a defense structure that has safeguarded the economy's strength. Cracks are beginning to widen in the foundation of the dollar. Central banks across the world have been de-dollarizing and aggressively increasing their gold reserves. Investors, both domestic and foreign, will continue to purchase U.S. Treasury debt as long as they believe they'll get their money back and that money has successfully navigated the storm of unrelenting debasement. Since I harbor little or no trust in our federal government, I suggest hedging in the form of hard assets and quality equities. If the United States moves to the point where the preferred policy is one of financial repression that allows  inflating the debt away, the market will consider and pursue alternatives to the dollar as a store of value.

The timing of a policy shift to financial repression is difficult, if not impossible, to predict. I expect it will be implemented over time in different phases. Along with financial repression, I foresee the Federal Reserve Bank pursuing and implementing a central bank digital currency (CBDC). There is no stopping the digital train. We are heading toward a cashless society. Most governmental parties claim CBDC will work as a supplement to fiat money with cash still allowed as an option in the payment system. I don't believe this for a minute. Central bank digital currencies will allow governments to exert more control over their citizens and facilitate complete oversight over all financial transactions.

Before I wander off on that tangent and go on a rant, I should tie a bow on this blog posting and speculate as to the probable successor to the U.S. dollar. At some point, there will be a global financial meltdown that will make the Great Financial Crisis (GFC) look like a Sunday school picnic. The major economies - United States, China, Europe, Japan - will gather somewhere and eventually agree on a new monetary system. The U.S. will no longer be a hegemon; the world will be multipolar; and globalization will be on the upswing again. At that point, I see the establishment of an international digital currency. Of course, I've been wrong before in the arena of making predictions.

A Political Pivot, And Where The Economy Goes Next

 "It's the economy, stupid" is a phrase widely associated with Democratic strategist James Carville in 1992 in the run-up to Bill Clinton's successful 1992 presidential election against Republican incumbent, George H.W. Bush. As is often the case, the condition of the U.S. economy in 1992 (recession) was the primary reason Bush was not re-elected. Although immigration no doubt played a role in the 2024 election cycle, the Republican Party's sweep of the White House and Congress can for the most part be attributed to a surge in inflation and an economy that was portrayed as strong but was extremely weak below the surface. It's a well-worn adage, but people do tend to "vote with their wallets."

The Biden Administration and their co-conspirators in the mainstream media consistently presented the economy as a vibrant juggernaut hitting on all cylinders. This political spin could not have been further from the truth. Both inflation and unemployment rates were significantly higher (by 30%-50%) than the numbers reported by the Bureau of Labor Statistics (BLS). The antiquated models and inaccurate surveys used for determining those statistics are seriously flawed with subjective assumptions superseding objective facts. The cumulative inflation (at least 25%) that accrued between January 2021 and December 2023 especially took a toll on the family budgets of low and middle-income earners, and they have yet to recover. Besides a massive revision (downward) of 818,000 new jobs created in the 3rd and 4th quarter of 2023 and 1st quarter of 2024, the trend lines showed ongoing declines in full-time jobs in the private sector. The only job growth was an increase in part-time and government jobs. These are not signs of a healthy economy.

The U.S. economy was widely predicted to fall into recession in 2023. When this didn't come to fruition, many predictors claimed their timing was off a bit but that it would happen in 2024. It appears that  recession call was erroneous as well. So what happened? Why has the economy remained in growth, chugging along like the Energizer Bunny? There are two primary reasons that explain this surprising growth in the economy. The first one is the sheer abundance of liquidity that has been sloshing around the financial system for practically two years now. Although the Fed claims to have tightened conditions via boosting the Fed Funds rate in 2022 and 2023, and by implementing Quantitative Tightening (QT), the data and facts paint a different picture. The National Financial Conditions Index (NFCI) generated by the Federal Reserve Bank of Chicago shows non-stop, increasing levels of liquidity from March 2023 through the current point in time.

The other main reason triggering unexpected growth in the economy was unprecedented fiscal stimulus. The federal deficit in 2023 was $1.7 trillion, equal to 6.3% of Gross Domestic Product. The federal deficit for fiscal year 2024 was $1.8 trillion, equal to 6.4% of GDP. Deficits at this level traditionally are only seen during periods of war and economic recession. Simply stated, they are unsustainable and a threat to the long-term viability of the United States economy. Federal spending as a percent of GDP has also skyrocketed. For fiscal year 2024, government spending represented almost 35% of GDP. This binge of spending goosed the economy with many cynics believing it was done for political reasons.

Trump's victory in the recent presidential election, combined with the Republicans taking back the Senate and retaining a slim majority in the House, has seemingly revitalized the optimism and even animal spirits in the business and investment communities. While it is possible that the new administration and Congress will be able to thread the needle in terms of policy decisions, I do not share a high degree of optimism. I believe Trump is walking into an economic shitstorm and his proposed policies for the economy will only serve to exacerbate the problems.

Like traditional Republicans, Trump is always looking to lower taxes. Unlike traditional Republicans, Trump never appears to be overly concerned with the level of government spending as evidenced by an increase in the national debt of $8 trillion during his first term. Besides a continuation of the 2017 tax cuts, Trump has proposed lowering the corporate income tax rate (to 15% from 21%) and eliminating certain types of income subject to personal income taxes (overtime pay, tips, Social Security benefits). While I can live with an extension of the 2017 tax cuts, the other reductions mentioned make no sense whatsoever when the national debt is at $36 trillion with projected $2 trillion annual deficits. For those believing Messrs. Musk and Ramaswamy will save the day by finding ways to significantly reduce government expenditures - I wish them well but they have an almost impossible nut to crack due to the preponderance of non-discretionary budget items. The Department of Government Efficiency, an obvious oxymoron, will garner numerous headlines and possibly even save $200 billion - $400 billion per annum with their recommendations. However, those savings will be more than offset by increased interest payments on the national debt. Insofar as actually reducing spending, please wake me up when Congress decides to tackle entitlement reform (Social Security, Medicare, Medicaid).

At this point, I'm sure the reader can discern that I have little faith in the Trump 2.0 administration and Congress being able to slow down the runaway debt train. I see annual deficits being roughly the same for the next few years with the potential for even bigger deficits in the event we experience economic contraction. While the stock market is giddy with Trump and his policies coming on board, the bond market's response has been totally the opposite. The bond market sees inflation and problems for the economy on the horizon. Since 9/18/24, the Fed has lowered the Fed Funds rate by 75 basis points (.75%). However, the current yield on 10-Year Treasuries has increased by 60 basis points (.60%) since the Fed started lowering. Basically, the bond market was telling Trump and Kamala Harris, and now just Trump, that their respective economic platforms were inflationary in nature. Thus, investors in the bond market were/are demanding more term premium before they would assume the greater risk posed by potential future inflation on longer duration U.S. Treasury securities.

There are a couple other potential economic pitfalls lurking in the weeds if Trump elects to pursue certain major policy positions espoused in his campaign rhetoric. Massive deportation of illegal aliens is one such risk to the economy. If the estimates of 10-12 million illegals in the country are accurate, large-scale deportation would be a daunting and expensive task. It also would have the potential to harm the U.S. economy. With an aging population combined with below replacement level birth rates, immigration provides an obvious solution to keep the economy in growth and provide jobs for employers. The Immigration Reform and Control Act of 1986 provides a good blueprint for offering a path to citizenship for many of the immigrants who are in the country illegally. 

The imposition of tariffs on a large scale could also potentially cause more harm than benefits to the majority of American citizens. Economists and other free trade advocates absolutely hate tariffs. And for good reason. Contrary to the claims of the President-elect, rather than hurting foreign exporters, it is American firms and consumers who are the hardest hit by tariffs on imports. While the initial bill for a tariff is paid by the importer, the financial burden shifts to businesses and consumers in the form of increased prices. In other words, tariffs are considered inflationary. It should also be noted that China appears to be the target of Trump's most severe tariffs. Is it wise to start a trade war with a competitor that is arguably on equal footing with you both economically and militarily?

My pessimism in the new Trump Administration being capable of addressing the nation's economic challenges is grounded in math. For the first time ever the U.S. government spent more than $1 trillion this year on interest payments for the national debt. Twenty cents on every dollar spent by the federal government goes to debt service. The Congressional Budget Office (CBO) projects that annual interest payments will rise rapidly throughout the next decade and exceed $2 trillion by 2034. I see nothing to question the CBO's prediction. The cumulative probability of tax revenues exploding and Congress setting aside its spendthrift ways is about 2%.

The debt problem is not a political problem that can be easily resolved. It is an arithmetic problem. Whether it be in Trump's tenure, or his successor's tenure, I predict that the government through its central bank will resort to the playbook used during the Great Financial Crisis (2008-2009). The Fed will reintroduce Quantitative Easing (QE) to expand the money supply to buy U.S. government bills, notes, and bonds. This most likely will cause a spike in interest rates as investors demand higher yields to compensate themselves for the government's balance sheet risk. This leads me to further predict the government will then implement financial repression to cap interest rates and channel funds from the private sector to itself to facilitate debt reduction. Savers will earn at rates below the rate of inflation. Also, look for the government to require banks, insurance companies, and pension plans to hold significantly larger amounts of government debt than is necessary for prudential purposes. The picture I paint is not pretty. Look to hold hard assets for some protection from the continuation of the debasement of the value of our currency.

 

 

Short Selling Stock

 This blog will start the same way it ends - with a warning concerning the subject matter: Short selling is not for the inexperienced and faint-hearted investor.

Fundamentally, short selling is a way to invest so that you profit when the price of a security declines. Rather than buying a stock (called going "long") and then selling later, going short reverses that order. A short seller borrows stock from a broker and sells that into the market. Later, they hope to buy back that stock at a cheaper price and return the borrowed stock in an effort to profit on the difference in prices.

For those electing to take the plunge, the first step is to establish a margin account on your brokerage account. This will allow you to borrow money to short a stock. There needs to be enough margin capacity to support the loan, on which you'll pay interest. In addition, there's a fee paid to the broker for the service of finding stock to sell short. Lastly, you're on the hook for any dividends paid by the company. The interest cost, fee, and dividends are all rolled into your margin balance.

Probably the most important aspect of the process is selecting the right stock to short. This should only be done after extensive research and analysis. There should be powerful fundamental reasons why you are placing a bet in anticipation of a company's stock declining. To short a stock, you'll place an order to sell stock that you don't own. The short position will typically show up in your account as a negative number of shares (e.g., - 100 shares of XYZ stock). Ideally, the stock you shorted will decline in value, if not outright take a severe swoon. As the investor, you'll have to decide when to close the position and at what price. When you're ready to push the button, you buy the stock. This will automatically close out the negative short position. The difference in your sell and buy prices is your profit (or loss).

Short selling can offer some positives. First and foremost, an astute investor can make money when they discover an overvalued stock that comes back to earth in terms of valuation. It provides another tool in the investor's tool kit. Short selling also helps keep fraudulent companies from ripping off investors. Because of the intense research involved, short sellers can at times dig up financial information and data overlooked by long/passive buyers. Markets tend to be more orderly and function better when short sellers are in the mix. Besides providing liquidity for buyers, long-term investors can buy at more stable prices and amass stakes at lower prices. Lastly, shorting offers excellent hedging opportunities. Investors can sell their profitable positions for cash in a market drop, and then add to their long positions at lower prices.

Of course, short selling has its share of detractors and disadvantages. Since the stock market as a whole tends to go up over time, short sellers face a situation that's already stacked against them in the long run. Another potential hurdle is the fact that you can experience unlimited losses in the event the stock you've shorted keeps rising. You could lose more than you put into the trade since your risk is theoretically uncapped. Also, as mentioned earlier, there are ancillary costs involved with the short selling process. Lastly, and it primarily comes from less than knowledgeable investors, but there's often skepticism, animosity, and unfavorable stigma associated with short sellers. America admires success, and short sellers are betting against success.

I would be remiss if I didn't touch on a recent notorious "short squeeze" scenario. Specifically, the situation involving video game retailer GameStop in early 2021. A short squeeze occurs when the stock rises rapidly, forcing short sellers to close their position. As the short squeeze hurts more and more short sellers, they are forced to buy stock at any price, pushing the price still higher. This nightmare played out for short sellers of GameStop stock in 2021. Led by a basement-dwelling cretin known on the Internet as "Roaring Kitty," masses of small, novice investors put the screws to some hedge funds who had wisely shorted GameStop. There was no fundamental financial reason to bid up the price of GameStop. I found the whole incident disgusting. These small investors, if you can even call them that, were not heroes. They were nothing more than idiotic "pumpers and dumpers."

Personally, or as a fiduciary, I've never technically sold a stock short. I harbor no philosophical reservations about doing so, however. Lack of doing so is primarily attributable to a reluctance to establish a margin account and the various costs associated with the short selling process. That said, I have "effectively" shorted certain stocks and indexes by purchasing put options - with mixed results. One challenge, as mentioned previously, and it's especially been the case during this long-running bull market, is that stocks can stay irrationally overvalued for a surprisingly extended period. Long enough to test the solvency and patience of many investors taking a short position. My advice would be to favor put options over short selling, favor indexes over individual stocks, and to place short bets exclusively for hedging purposes. As promised at the onset, I end with this reminder: pure short selling is not for the inexperienced and faint-hearted investor.