Most Investors Don't Understand Risk

In terms of your investments, risk can be defined as any uncertainty that has the potential to negatively affect your financial welfare. Risk offers the possibility of complete loss of capital. It is my contention that the majority of investors consistently misunderstand the concept of risk when making investment decisions. Many investors mistakenly view risk as market volatility - the day-to-day or year-to-year swings in asset prices. However, long-term investors should care more about the risk of losing purchasing power over time due to inflation or a permanent loss of capital. Volatility is the chance of sudden and unpredictable movement. Volatility can actually be an opportunity for an investor to buy more shares at a lower price during a downturn. Some fairly recent examples of negative volatility would be: 1.) Dot.com bubble of 2000 when the stock market dropped 40% over 3 years; 2.) Great Financial Crisis (2008-2009) when the market dropped 37% in one year; 3.) Black Monday (10/19/87) when the market dropped 21% in one day; 4.) Covid-19 fast and furious recession (2020) when the market dropped 30% in 3 months. Shrewd investors were able to take advantage of these market swoons and profited greatly when the stock market recovered and resumed its right and upward trek.

Not properly understanding the underlying risk of an investment can lead to some unfortunate outcomes. In addition, allowing human emotions to determine asset allocation is a recipe for disaster. Many investors, whether due to social influence or the fear of missing out (FOMO), will buy or sell assets based on what others are doing. This "herd" mentality often leads people to participate in market bubbles and sell during crashes. We have all heard the adage, "buy low and sell high," but the reality is that many investors do just the opposite. If you buy a stock when the market is hot and prices are high, you will have greater losses if the price drops for any reason compared with an investor who bought at a lower price. There are a couple of human nature biases that can nudge investors into potential risk traps. One is referred to as recency bias - the tendency to assume that recent trends will continue indefinitely. The other bias is known as loss aversion bias. The pain of losing money is psychologically more powerful (by a power of two) than the pleasure of gaining it. Aversion bias can cause investors  to make irrational decisions, such as holding on to a losing investment too long or selling a winning investment too soon.

The fundamental error that many investors make with their risk assessment process is that they limit it to determining a binary outcome and do not include the element of probability in the equation. Risk is reduced to either yes/no, win/lose, 0/1, good/bad. In other words, all-or-nothing thinking void of nuance and without a middle ground. Instead of avoiding risk, an investor, or his advisor, should strive to manage risk. Smart risk-taking involves making investments where the potential upside far outweighs the possible downside. There is nothing wrong with risking modest amounts of capital for the chance of significant gains, without betting the farm. Think of it as risk with a safety net.

Investors who hold too much of their portfolio in cash or ultra-conservative investments are vulnerable to a guaranteed, long-term loss of purchasing power due to inflation. This will especially be the case if inflation creeps higher over the next decade. The argument can be made that the government intends to run the economy hot with higher inflation and financial repression being utilized to mitigate the federal debt level problem. Investors should thus avoid long-term bonds like the plague. The rate of return on Bank CDs and U.S Treasury securities will end up less than the rate of inflation. In other words, the poor saps who invest in fixed-income instruments will lose significant purchasing power over time.

In general, higher risk is associated with the potential for higher returns, and lower risk with lower returns. However, higher risk does not always translate to higher returns. The returns for certain investments are high for a reason. It is important for the investor to spend some time and energy on a risk/reward analysis. But before identifying specific investments, an investor needs to determine the amount of his assets, outside of blue-chip equities and stock indexes, he is willing to put "at risk." Following are suggested risk allocation levels for different investor profiles: 1.) Conservative - 1% to 5%; 2.) Balanced - 5% to 10%, 3.) Aggressive - 10% to 20%. Real-world examples of some alternative investments with inherent risk would be precious metals, stock options, speculative stocks, and cryptocurrencies, in particular, Bitcoin. It should be noted there is one overriding rule when pursuing assets of this nature: Never risk more than you're willing to completely lose.

Selecting assets perceived to be riskier than normal but resulting in outsized returns is both a challenging art and requires some brain work. On a personal basis, I remain a work in progress, ever-striving for a higher lifetime batting average. This may not be an apt analogy, but in many respects, the decision-making process is similar to the bets made by a professional blackjack player who has the skills necessary to hold a slight edge on the house. Like the blackjack player, an investor can take small, calculated risks when the math works in his favor. If successful, this can drive portfolio growth without threatening financial security. In theory, losses are capped and gains are uncapped. By allocating only a small percentage of capital to higher-risk opportunities, even multiple losses won't significantly impact overall wealth. The key is to suffer modest losses on some risky bets, but more than make up for the losses by capitalizing on a few big wins when the probability of success is favorable. An investor's risk allocation percentage is dynamic over a lifetime and never static. As wealth grows, the dollar amounts grow but the percentage allocated to risk assets should align with risk comfort and life stage.

As I wrap things up and tie a bow to this blog, I would be remiss if I didn't mention a few other ways to mitigate investment risk. My basic premise thus far is that there is more risk being overly conservative instead of accepting and managing selective risk when conditions justify such and opportunities present themselves. In that light, investors should not lose sight of sticking to the basic principles of broad asset allocation and diversification. A common mistake is when investors over commit to one asset class or individual security and fail to rebalance when there is exceptional appreciation. There is nothing wrong with realizing some gains when a holding far exceeds expectations and is disproportionately represented in your portfolio. Trimming back to the original allocation percentage makes sense in such a situation. Also, although there is some added cost to your investment, there are times hedging provides protection to downside risk. It would also be wise in general to avoid leverage to fund investments. Lastly, instead of fearing risk, embrace smart and timely risk and manage it closely.

 

How Much Gas is Left in the Tank?

The American economy and the American stock market have never been more bifurcated. While the economy appears to be running on fumes, the stock market keeps going like the Energizer Bunny, reaching new all-time highs on seemingly a daily basis. However, if one looks closely, there are cracks either forming or widening. Another analogy would be flags (red for danger) denoting the pin placements on golf greens that are appearing. There is no doubt more than 18 flags, but following are stock market flags for an 18-hole golf course:

1.) The Buffett Indicator (stock market value divided by GDP) is currently 217%. This is the highest on record.

2.) The S&P 500 Price to Sales Ratio is currently 3.35. This is the highest on record.

3.) The Schiller Cyclically Adjusted Price Earnings Ratio is 39.84. This is not the highest on record, but pretty darn close.

4.) The United States' fiscal situation is a runaway train approaching a wreck in slow motion. The projected deficit for the fiscal year ending 9/30/25 will fall in the $1.8 - $1.9 trillion range. This is about the same as the previous fiscal year and the highest ever outside of the Covid pandemic era.

5.) Margin debt for investors is $1.023 trillion. This is up 26% in the last year, and the highest level ever. 3X Leveraged ETFs have drawn significant interest. These products are designed to deliver 3 times the daily return of their underlying instrument.

6.) The interest in purchasing call options has surged over the past couple of years. This is a sign of an excessive bullish outlook.

7.) There is a lack of breadth in the stock market. The seven tech companies that compose the "Magnificent Seven" represent 30-35% of the market.

8.) Reports indicate a significant upswing in corporate bankruptcies in 2024 and 2025, reaching levels not seen since the 2010 post-recession period.

9.) Many consumers are tapped out on their credit cards. Also, new TransUnion data shows almost 30% of student loan borrowing in repayment are delinquent on their payments and facing a "financial reckoning."

10.) The housing market is effectively frozen. Sellers are reluctant to lower their elevated asking price,and buyers, especially first-time home buyers, simply cannot afford to buy at those price levels.

11.) For the most part, leading economic indicators show the economy continues to slow. Job additions have stalled, and there was a massive (800,000) downward revision a couple of months ago.

12.) Passive investing now represents over 50% of the inflows into the market. In Mike Green's parlance, this "Giant, Mindless Robot" has destroyed the pricing mechanism of the market and goosed returns. An increase in unemployment or increased demand for retirement plan withdrawals could reverse the previous momentum and head in the opposite direction.

13.) People mistakenly associate a yield curve inversion as a sign of a pending recession. The uninversion is the actual indicator. The yield curve uninverted this month.

14.) Wall Street has experienced an uptick in Initial Public Offerings (IPOs) and Special Purpose Acquisition Companies (SPACs).

15.) Goldman Sachs' Speculative Trading Indicator (STI) has risen sharply, hitting levels only seen during the dot.com and pandemic-era bubbles.

16.) Partly due to FOMO (Fear of Missing Out), retail investors have continued to blindly buy the dips while institutional investors have taken a more measured approach. FOMO can be best explained by the phrase: "Nothing is worse than watching your neighbor get rich in the market."

17.) The jury is still out, but I believe history will treat the Trump tariffs as bad economic policy. Tariffs are a tax and thus a drag on the economy. They are paid by either American importers or American consumers. Some of the high tariff items like steel and aluminum are incorporated in manufactured products that are intended for export. The added expense makes it difficult for many American exporters to compete in the world market.

18.) Artificial Intelligence (AI) is the story that has captured the market's imagination. Much of the gains over the past couple of years can be directly attributed to the promised productivity gains enabled by AI. This in turn is supposed to boost corporate in a powerful way. We shall see. Many smart people are questioning whether the massive capital expenditures in pursuit of AI can ever be monetized to the extent necessary to recoup the aforesaid capital expenditures. Like the Internet, AI will change the world. Also like the Internet, it won't happen overnight and not everybody will be a winner.

Like the weather, predicting the movement of the stock market for more than one to three days in the future is a fool's game. However, that doesn't stop some of us from making bold predictions. You might want to take my forthcoming prediction, more guess actually, with a grain of salt. Although not a Perma Bear, I have called for a severe (more than 30%) drawdown multiple times over the past decade. None have come to fruition. Anyway, here goes nothing: Over the next 6 months, I think the S&P 500 will appreciate an additional 10% and top off around 7,250. During that 6-month period, there will be a 5%-10% correction at some point before rallying to 7,250. Between 6 and 12 months from now, the market will run out of gas and swoon a minimum of 30%. I end with a classic quote attributed to the famous English economist, John Maynard Keynes - "The market can remain irrational longer than you can remain solvent." 

Bonds and The U.S. Bond Market

 According to the AI overview on a Google search, bonds are defined as debt investment products where you lend money to a government entity or company in exchange for periodic interest payments and the return of the original principal when the bond matures. A bond is in effect a contract that promises repayment in accordance with the rules that are set when the bond is issued. Bonds are often referred to as "fixed-income" investments because they provide investors with a specific income stream in the form of semi-annual interest payments. Whereas stocks are considered ownership or equity in a business entity, bonds are essentially loans, extensions of credit that often serve as a way for the issuer to finance large projects or fund operational cash flow. Bonds are normally less volatile than stocks and in most cases are significantly less risky than equities (stocks). They can help diversify an investment portfolio as well as preserve your initial investment, particularly in a declining market. Government-issued bonds are considered low risk because the issuer has the power to tax. Insofar as bonds issued by a corporation, in a corporate bankruptcy, bondholders receive payment before the corporation's shareholders.

Bonds issued by government entities provide favorable income tax treatment for the interest income generated by said securities. Interest from Treasury securities is taxable at the federal level but exempt from all state and local income taxes. In an act of reciprocation, in general, interest income from state bonds is exempt from federal income taxes.

Although considered safer than equity investments, bonds are not free of risk, even the vaunted "safest" investment in the world - U.S. Treasuries. This risk of default on bonds is normally confined to non-investment-grade corporate bonds. The global speculative-grade default rate approximated 4% in 2024, with the U.S. high-yield default rate a bit lower at 3% during the same period. Of course, these default rates can significantly increase during economic downturns (recessions). For example, the high-yield default rate hit 13.7% in 2009 during the financial crisis. Higher than expected interest rates and inflation can also pose a risk to bond valuations. The amount of value decline is contingent upon the remaining term until maturity. In a rising interest rate environment, the value of a U.S. Treasury Bond maturing in 25 years will be negatively affected much more than a Treasury Note of a like amount reaching maturity in two years.

Like every major asset class, bonds have their own subset of terms, expressions, and language. To understand how bonds function, one has to have at least a basic understanding of a handful of words associated with this type of financial instrument. When a bond is first issued it is sold at its face value, otherwise known as par value. For instance, you pay $1,000 at issuance for a bond with a par value of $1,000. Subsequent to issuance, bonds are tradable instruments and extensively traded on what is known as the Secondary Market. Since interest rates are constantly changing, bonds in this market are normally sold at a premium or at a discount to par value.

A bond sold at a premium is one sold for a price higher than its par (face) value. This occurs when the bond's coupon rate is higher than the prevailing market interest rates, making it more attractive to investors. For example, you pay $1,250 for a bond with a par value of $1,000. A bond sold at a discount is one sold for a price lower than its face value. This occurs when the bond's coupon rate is lower than the prevailing market interest rates. For example, you pay $850 for a bond with a face value of $1,000. At maturity, the investor always receives the bond's face value. There is an inverse relationship between bond yields and bond values. When yields go up, bond values go down. When yields drop, bond yields rise.

There are rating services that grade the credit-worthiness of bonds - Moody's, Standard & Poor's, and Fitch Ratings. The highest quality bonds are called "investment grade." These would include U.S. Treasuries and high-quality companies with strong balance sheets. Many institutional investors have parameters in their respective investment policies that restrict bond purchases to those of investment-grade quality. Bonds not considered investment-grade are called "high-yield" or "junk bonds." This label doesn't necessarily imply the high probability of a default. That said, investors have to be careful and mindful of the risk when chasing yield.

There are multiple factors that determine the market price of a bond. First and foremost would be the credit quality of the bond issuer. Interested buyers want to know with a certain degree of certainty that they will receive the agreed upon semi-annual interest payments along with the principal amount at maturity. The length of time until maturity is also extremely relevant. On a normal yield curve, the longer the term, the higher the interest rate. The logic involved here is that the longer the time to maturity, the higher the chances of an adverse event influencing financial conditions to the downside. The interest rate (coupon rate) affixed to the bond in comparison to the general interest rate environment will also be a factor when the market is determining valuation for a specific bond. Lastly, the perceived future rate of inflation by bond market participants will contribute to establishing valuation. Higher inflation expectations will raise yields and thus lower valuations.

The United States bond market is massive. Although the stock market gets most of the attention and glamour, the bond market is larger than the stock market. The outstanding value as of May 2025 was $55.3 trillion. This represents 40% of the $145 trillion global bond market. U.S. government securities are the biggest piece of the overall bond market, approximately 60% of all U.S. debt securities. The government borrows a lot of money - both to refinance older debt as it comes due and to fund new spending. At the end of the first quarter of 2025, $29 trillion worth of Treasuries were considered tradable, more than twice the amount of corporate bonds. An additional $6.6 trillion of U.S. government debt was not considered tradable due to the fact that it sat on the balance sheet of The Federal Reserve Bank. Besides borrowing a lot, the federal government borrows frequently. Treasury bills (maturity of one year or less) are auctioned as often as weekly. While Treasury notes (maturity of 1 - 10 years) and Treasury bonds (maturity of more than 10 years) are sold on a monthly or quarterly basis.

New Treasury securities are sold at public auctions. The Treasury announces the auction date along with the specific maturities and amount to be sold. There are both non-competitive bids and competitive bids that can be tendered. Individuals can only submit non-competitive bids. These bids are processed through the Treasury Direct website. Individual investors are guaranteed to have their bids accepted at the yield determined by the auction. There are 24-30 institutional investors that are authorized to participate in the auctions. These entities are known as Primary Dealers and are composed of large commercial banks and brokerage firms. The Primary Dealers submit competitive bids specifying the rate, yield, or discount margin they are willing to accept. The Treasury reviews the various bids and awards the securities to the winning bidders.

There are some concerning trends currently percolating in the market for U.S. Treasury securities. The average rate on all interest-bearing Treasury debt is now 3.36%. This is the highest average rate since October 2009, and more than double the most recent low (1.56% in January 2022). With a federal debt balance of $38 trillion, this translates to an annual interest expense of $1.28 trillion ($38 trillion x .0336 = $1.28 trillion). Interest expenses will soon be the largest expense item in the fiscal budget, representing 18% of all annual federal expenditures. Spoiler alert: that incredible amount will in all probability be expanding in the future. Another trend is the shift from long-dated notes and bonds to short-term Treasury bills. The demand for long-dated bonds from central banks, pension funds, life insurers, commercial banks, and individuals is in decline. This shift by the Treasury is a gamble, especially in an environment where higher inflation and higher interest rates appear to be on the horizon. 

My parting thoughts are not optimistic in nature. Our bond market was fortunate to experience a 40-year bull market that started in 1981 and ran until 2022. The 30-year U.S. Treasury bond yield went from 16% in 1981 to the 1% - 2% range in 2020 -2022. Since the federal government will ultimately have to utilize inflation to meet its obscene debt obligations, I can almost detect the guttural growl of a bear coming from the bond market.

 

Economic Illiteracy

 Political scientists have documented that roughly half of all U.S. citizens do not know that each state has two senators and that only a quarter realize the senators serve six-year terms. In a similar theme, the unfortunate reality is that more than half of the electorate also suffers from economic illiteracy. The problem is not that voters lack doctoral-level expertise in economics, or that they make an occasional error. Most voters lack even an elementary understanding of economics. This glaring intellectual deficiency potentially can lead to problems, if not outright disaster, both on an individual and society-wide level. One of the primary roles of government is to determine economic policies. Sound and intelligent policies are unlikely to emerge if the voters are economically illiterate. An economically illiterate population will fail to hold elected officials accountable for public policy that makes society poorer. How a society organizes its economy is vitally important. Economics is not about how to get rich or make money in the stock market. It's about understanding eternal truths about human actions and the implications derived from how human beings make choices in a world of scarce resources.

In an age where financial decisions have far-reaching consequences, it is imperative that young people advancing through our educational system understand the basics of money management, savings, investments, and credit. High school is the time when some students are exposed to the discipline and study of economics. Unfortunately, only about 50% of secondary schools require an economics class to graduate. For those high schools teaching this subject, in general, their track records range from poor to abysmal. The reasons for the sub-par performance are many. There is a chronic shortage of qualified teachers who have any knowledge involving the subject matter. Economics can be complicated and at times involves a healthy dose of mathematics. The methodology of teaching economics and a lack of instructional materials are often cited as factors contributing to the deficiency in this area. A passionate economics instructor combined with interested students who believe learning the basic principles of economics is relevant is a rare occurrence. Various school districts might want to consider retaining retirees from the business world to teach courses in economics and finance. And here's a terrifying statistic: only 17% of college graduates are able to correctly provide the basic reasoning as to why "free markets secure greater economic prosperity than government centralized planning." This blind ignorance goes a long way in explaining how an avowed socialist like Zohran Mamdani will probably be elected the next mayor of New York City in November.

Mamdani and his followers are avid supporters of price controls, in particular, rent price controls in NYC. They are apparently blind to the fact that price controls never have worked, and never will work. It is ludicrous to even consider their implementation. While rent control appears to help current tenants in the short run, in the long run, it decreases affordability and supply of new units. Invariably, price controls facilitate shortages. Not only do price controls fail to cure the problem, but they also accentuate the problem.

Although it has been transformed into society's biggest punching bag for practically all problems, the dominance of social media is at least partly to blame for the widespread ignorance on financial issues. Research indicates that a significant percentage of Gen Z individuals utilize TikTok "finfluencers" for investment advice. There are numerous downside risks associated with relying on TikTok for investment advice. Many of these finfluencers do not possess formal qualifications or extensive experience in finance. This raises concerns about the accuracy and reliability of the information shared with followers. A study cited by Fast Company found that 63% of financial advice on TikTok was misleading, and 95% lacked disclaimers about investment risks. Some influencers may promote high-risk strategies without providing adequate context or highlighting potential dangers. TikTok has been identified as a platform susceptible to "pump-and-dump" schemes, where influencers might promote certain stocks only to sell them off once their followers invest, causing the stock's value to plummet. In addition, financial advice on TikTok is often generalized and may not be suitable for individual circumstances, goals, or risk tolerance.

The commonly held perception of corporate greed is another example of economic nescience. When the price at the pump rises appreciably for gasoline, a lop-sided fraction of the public - 74% - places the blame on oil companies for trying to increase profits. Most people believe that prices go up when businesses suddenly start to feel greedier. Economists, in contrast, expect businesses to be greedy, year in and year out, but only if supplies have gone down (or demand has gone up) can they increase prices without losing business to competitors. Free markets give people choices. You can go elsewhere if a greedy corporation fails to satisfy you. Thus, the best way for the corporation to pursue self-interest is to be attentive to the consumer's needs.

I retain minimal optimism that the general population will suddenly grasp a few of the fundamental principles of economics. Unfortunately, the policies economists deplore often turn out to be immensely popular with voters. Why should we think politicians will fail to listen to the voice of the people when heeding the voice of the people is the usual path to political power in a democracy? Politicians listen all too well, and as a result, they heed a host of economically illiterate demands. A case in point would be we now have a president who at times says things that directly contradict some of the most basic and incontrovertible economic principles. Perhaps he either fell asleep or skipped his Econ 101 class while attending Wharton.

Ten Important Macro Economic Metrics

 1.) S&P 500:

Also known as the Standard and Poor's 500, the S&P 500 is a stock market index tracking the stock performance of 500 leading companies listed on stock exchanges in the United States. This index includes approximately 80% of the total market capitalization of U.S. public companies, with an aggregate market cap of $50 trillion as of March 31, 2025. The S&P 500 is a capitalization-weighted index with the Magnificent Seven composing roughly 30% of the market capitalization of the index. In other words, for every $1.00 an investor plunks into a S&P 500 Index Fund, $.30 is allocated to the likes of Nvidia, Microsoft, Alphabet, Amazon, Apple, Meta, and Tesla. Because it is broad and capital-weighted, the S&P 500 is far and away the most relevant stock index to follow. The Dow Jones Industrial Average only consists of 30 companies, less than 10% of the number of companies in the S&P 500 Index. The S&P 500 is reviewed and potentially adjusted every quarter. Dogs tend to be drop-kicked with up-and-coming new companies taking their places. Around 20-25 stocks are typically replaced on an annual basis.

2.) Debt-to-GDP Ratio:

Debt-to-GDP measures the financial leverage of an economy. The debt-to-GDP ratio is the ratio of a country's accumulation of government debt relative to its gross domestic product (GDP). For example, if the United States owes its creditors $36 trillion and its economy is generating total annual GDP of $30 trillion, the debt-to-GDP ratio would be 120%. A ratio at that level would be considered high, and if it isn't already, should be setting off some alarm bells. Also, with the exception of Japan, a ratio of 120% is higher than any of the other major economies in the world. The U.S. has not seen this level of debt relative to its economic output since the end of World War II. Besides posing a greater risk of default, elevated debt-to-GDP ratios will act as a drag on the growth of our economy.

3.) U.S. Dollar Index (DXY):

If you haven't done so yet, I recommend adding Ticker Symbol "DXY" to your Iphone "watch" list. Referred to as the "Dixie," it is an index of the United States dollar relative to a basket of foreign currencies. The Euro and Japanese yen are weighted at 70% of the total, while the Pound Sterling, Canadian dollar, Swedish Krona, and Swiss franc compose the remaining 30%. This metric was established in 1973, soon after the demise of the gold standard and the Bretton Woods system. The Index goes up when the U.S. dollar gains value compared to the other currencies. The opposite is the case when the dollar loses value. At its start in 1973, the value of the U.S. Dollar Index was 100.00. It has since traded as high as 164.72 in February 1985, and as low as 70.69 on March 16, 2008. The value as of July 11, 2025, was 97.95. The value of the dollar normally correlates with global interest rates. Also, because most commodities are traded in U.S. dollars, a drop in the dollar's value often results in higher commodity prices.

4.) 10-Year U.S. Treasury Yield (TNX):

Bar none, the most important financial metric in the world is the yield on the 10-Year U.S. Treasury note. Media and investors tend to focus on the Fed Funds (overnight) interest rate range that the Federal Reserve Bank can control and modify, but the 10-year rate is the more relevant indicator of economic conditions. It is also a benchmark for various financial products such as mortgages and corporate debt. Higher yields mean higher borrowing costs for consumers and businesses. Additionally, when yields rise, investors may find Treasury securities more attractive than stocks, potentially leading to a decrease in stock prices. Conversely, lower yields can encourage investors to seek higher returns in the stock market. Fluctuations in the 10-year yield can have significant implications for the long-term sustainability of government debt. Higher yields translate to increased interest payments on the national debt.

5.) National Financial Conditions Index (NFCI):

This index is generated by the Chicago Fed on a weekly basis. It provides an update on conditions in money markets, debt and equity markets, and the traditional and "shadow" banking systems. Basically, the level of the NFCI reveals the extent of liquidity in the financial system. Positive values of the NFCI have been historically associated with tighter-than-average financial conditions, while negative values have been historically associated with looser-than-average financial conditions. Levels of liquidity are a vitally important factor when determining risk-asset valuations. Bull markets will constrict and eventually croak when liquidity evaporates.

6.) There are multiple Price Earnings (PE) ratios published for the S&P 500. My personal favorite , which I believe is most indicative and relevant, is the Shiller PE Ratio. This particular Price Earnings ratio is based on the average inflation-adjusted, earnings from the previous 10 years. It is also known as the Cyclically Adjusted PE Ratio (CAPE Ratio). The minimum historical Shiller PE Ratio was 4.78 in December 1920. The maximum would be 44.19 in December 1999. The historical mean is 17.25, with the historical median at 16.04. The Schiller PE is presently at 37.90, which is 40.6% higher than the recent 20-year average of 27. The recent 20-year low is 13.3 and the recent 20-year high is 38.6. The implied future annual return is 2%.

7.) Credit Spreads:

Credit spreads are considered a canary in the coal mine for near-term economic conditions. When used in the context of bond investing, they refer to the difference in yield between corporate bonds and U.S, Treasury bonds with the same maturity. U.S. Treasury bonds are considered virtually risk-free because they are backed by the U.S. government. Corporate bonds, on the other hand, carry the risk of the issuing company defaulting on its debt obligations. To compensate investors for this additional credit risk, corporate bonds generally offer higher yields than Treasury bonds with comparable maturities. This extra yield is the credit spread. Narrower spreads suggest economic optimism and a lower perceived risk of corporate defaults, leading investors to favor corporate bonds for their higher yields, thus tightening the spread. Wider spreads often signal economic weakness and increased risk aversion among investors. This is because in uncertain times, investors seek the safety of Treasury bonds, driving their yields down and widening the spread.

8.) U.S. 10-Year/3- month spread:

This metric refers to the difference between the yields of 10-Year Treasury constant maturity securities and 3-month Treasury bills. A positive spread indicates a normal, upward-sloping yield curve, while a negative spread (when short-term rates exceed long-term rates) suggests an inverted yield curve. An inverted yield curve, particularly when the 10-year/3-month spread turns negative, has historically been a reliable indicator of potential economic recession. As of July 3, 2025, the 10-year./3-month spread was at negative 0.07%. The spread was negative 1.11% a year ago. Look for this spread to widen and be inverted even more as the Fed lowers short-term rates and the bond market does fall in line on the long end.

9.) Consumer Price Index (CPI):

The CPI is a statistical estimate of the level of prices of goods and services bought for consumption purposes by households. In other words, the annual percentage change in the CPI is used as a measure of inflation. The data is released on a monthly basis by an agency of the federal government. Similar to the monthly unemployment data, the CPI information is deeply flawed and biased in favor of making government policymakers look good. The formula has changed over the years and is now riddled with multiple assumptions in lieu of simply using the hard data. I normally look at the published inflation rate and multiply by 1.40. So, if inflation is disclosed at 3.0%, my computations say it is actually closer to 4.20%.

10.) The Buffett Indicator:

Named after legendary investor, Warren Buffett, the Buffett Indicator expresses the value of the U.S. stock market in terms of the U.S. economy. In the formula determining the ratio, the numerator is the total value of the stock market, and the denominator is the Gross Domestic Product. Itemized below are Buffett Indicator ratio ranges and how they are classified:

Ratio                                       Classification    

less than 86%           -             Significantly Undervalued    

86% - 111%             -              Moderately Undervalued

111-135%                -                Fair Valued

135%-160%            -                Modestly Overvalued

greater than 160%    -               Significantly Overvalued

The Buffett Indicator is currently at a staggering 209.5%. This is a historical high, practically off the charts. Gees, what could possibly go wrong?                                                                                                                                                

Is Social Security A Ponzi Scheme?

 Although it shares a couple of rough similarities with infamous financial scams conducted by the likes of Bernie Madoff and Charles Ponzi, the Social Security program is definitely not a Ponzi Scheme as claimed by some. It makes for a great soundbite and garners instant attention, but it's a fundamental mischaracterization. A Ponzi Scheme is a form of financial fraud that lures investors with a promise of high returns, in many cases, extremely high and way above-market returns. Instead of earning those returns through legitimate investments, the scheme pays earlier investors using money collected from newer ones. Eventually, the model collapses when there aren't enough new participants (suckers) to keep it going, leaving most people with significant losses. Social Security, on the other hand, does not promise high returns, it promises a modest, inflation-adjusted monthly benefit to support retirees, people with disabilities, and surviving family members of deceased workers. The program is fully transparent and participants know exactly where the money is going and know what to expect when benefits are distributed. They also know that the program is funded by payroll taxes that total 12.4% - 6.2% taken out of each paycheck and 6.2% simultaneously contributed by the employer.

Like practically everything else in our polarized age, the future of the 90-year-old Social Security program is both cloudy and a source of contention among various political factions. Regardless of points of view - cold, cruel math indicates that Program reserves are projected to run dry by 2033. If Congress does nothing, benefits will be automatically cut by at least 22%. Long-term, the balance of the century, Social Security is facing an estimated $30 trillion funding shortfall. When the time comes when benefits that are due exceed the proceeds from payroll taxes, the difference will have to be financed by raising taxes, borrowing, creating money, or reducing other government spending. As detailed previously, that "time" is projected to arrive in less than a decade.

Social Security has received a surplus of attention and wild claims as it steams toward insolvency. Since it's the largest expense item in the federal budget at $1.5 trillion per year (22.4% of federal outlays), that is not surprising. Some crackpots have claimed undocumented workers are eligible to receive benefits, or that Congress has stolen funds from the Social Security system. Neither of those rash statements are remotely true. There have also been claims that millions of dead people are receiving benefit payments. False. While fraud at Social Security does exist, it's not rampant and widespread. Only a small percentage of payments are considered improper, and a significant portion of these are due to administration errors rather than intentional fraud. Improper payments represent less than 1% of total disbursements.

Next, we'll look at the actual culprits contributing to the approaching crisis in the funding of Social Security. Far and away the most glaring issue would be the changing demographics. In 1950, there were about 16 workers paying into Social Security for every retiree. Today, that number has dwindled to just 2.7 workers per retiree, and it's projected to fall further to 2.4 workers per retiree by 2035. Besides a lower worker-to-beneficiary ratio over time, life expectancies have risen. Meanwhile, the U.S. birth rate has been in steady decline for years and even accelerated post-pandemic. The birth rate currently stands at 1.6 births per woman, well below the replacement level of 2.1. This trend has profound negative implications for the economy and Social Security. The system relies and will continue to rely on a healthy level of net legal immigration into the United States. The Trump Administration in conjunction with Congress would be wise to triple legal immigration on an annual basis. Still another factor has been more earned income escaping taxation due to increasing income inequality. In 1985, 88.9% of all earned income was subject to payroll taxes. But as of 2022, only 82% of earned income was applicable to the payroll tax.

Besides the huge challenges posed by changing demographics, the United States Congress, acting in the true fashion of politicians, has contributed greatly to the present problem. Congress has a long history of both expanding benefits for Social Security recipients and expanding the pools of people eligible to receive benefits. This has especially been the case come election time. A couple of the more popular, and expensive, expansions of the program involved adding spouses and survivors of workers. Early beneficiaries of Social Security made out like bandits starting in 1940. The first person to receive a monthly Social Security payment was Ida May Fuller, who received her first check on January 31, 1940 at age 65. Ida lived another 35 years, hitting the century mark. She also received 1,000 times what she had paid in payroll taxes. Seniors have historically claimed they "earned" their benefits. They have not. They only paid for part of what they have gotten. They have redistributed tens of trillions of wealth to themselves from those younger.

While not a Ponzi Scheme, in many respects, politicians, program administrators, and the media have misled the public about certain aspects of Social Security. We hear about the sacred Social Security "Trust Fund." Sorry, but whatever label is affixed to this pot of assets will not alleviate the fund from being drained. The link between the payroll tax and benefit payments is part of a disingenuous game to convince the American public that what the SSA calls a social insurance program is equivalent to private insurance. Claims are made that "the workers themselves contribute to their own future retirement benefits by making regular payments into a joint fund." Bullshit! Taxes paid by today's workers are used to pay today's retirees. The Social Security Administration avoids using the term "guarantee" for benefits, preferring the word "obligation." The term "obligation" implies that benefits are determined by current law. Social Security benefits are not a legally binding contract or property right, but rather a statutory entitlement. At any time, Congress can modify the program's provisions, potentially impacting benefit levels or eligibility.

As the Titanic (Social Security) approaches the iceberg (fiscal cliff), anybody with half a brain can see that entitlement reform is requisite, and not optional. The United States should emulate recent developments passed by the Danish Parliament. Currently, the state pension age in Denmark is 67. A new law will raise that age to 68 in 2030, to 69 in 2035, and subsequently to age 70 in 2040. The reasoning is sound - consistent increases in life expectancy. I also believe it makes sense to consider reducing survivor benefits to a worker's spouse and/or dependents. It seems ridiculous that even an ex-spouse could be eligible for benefits at the death of a retiree receiving Social Security benefits. Another suggestion would be to introduce a process that helps alleviate abuse of the system in terms of disability benefits. My next suggestion to help "save" Social Security will be controversial, but I believe absolutely essential to the long-term survival of Social Security. I opine that there needs to be a means test - a financial assessment to determine if an individual qualifies for benefits, and if he or she does, the level of the monthly benefit as determined by previous employment parameters. There should be a transition away from an earnings-related benefit to a poverty- targeted benefit. It is time to confront the painful but necessary truth that no matter what story politicians have told, Social Security has always been an income transfer program, not a savings system. 

Yes - Another Gold Blog, Perhaps Timely

My late father was unashamedly a Gold Bug. I think it might have had something to do with his father railing against FDR when he issued Executive Order #6102. This decree issued by the President on 5/1/1933 required U.S. citizens to turn over their privately held gold coins and gold bullion. I don't believe I have reached Gold Bug status, but I find my interest waxing in that precious yellow metal that we can now legally buy and hold. Gold has experienced dramatic valuation increases over the past couple of years, but I believe there are both short-term and long-term tailwinds to further support higher prices. I detail these factors below:

Short-Term Factors -

1.) Due to the impact of the 2008 Global Financial Crisis on banks, a policy known as Basel III was introduced to improve the banks' ability to handle shocks from financial stress. Effective 7/1/25, under Basel III, gold will be classified as a Tier I Asset, joining cash and government bonds under bank capital regulatory requirements.

2.) The annual BRICs Summit will be held July 6th and 7th in Rio de Janeiro. Representatives from Brazil, Russia, India, and China, as well as representatives from another half-dozen member countries, will be in attendance. It's anticipated that work will continue with the development of an alternative to the U.S. dollar for settlement of global trade. This new currency would be backed by a basket of commodities, primarily oil and gold.

Long-Term Factors -

1.) The average American retail investor holds less than 1% in gold in his investment portfolio. The big buyers of gold in recent years have been the world's central banks and Asian (primarily Chinese and Indian) investors. With a prod from Wall Street, I expect at some point more American retail investors will increase their holdings in gold.

2.) With the failure of DOGE and the apparent inability of the Trump Administration and a Republican-controlled Congress to rein in profligate government spending, the United States economy continues on a collision course with a reckoning. The only question that remains is when it finally goes off the rails. It doesn't take a rocket scientist to see where this is headed. The powers that be will be faced with two choices. The first option would be a direct default on government debt. Owners of U.S. Treasury bills, notes, and bonds would receive a "hair-cut" and not receive the full amount of principal and interest promised in the debt instruments. Although this would be the preferable approach, our leaders will not choose this route. No, they will opt for a gutless, sneaky, indirect default. The playbook that will be used is familiar to those who closely follow the capital markets. The Fed will reintroduce ZIRP (zero interest rate policy), followed by a couple aggressive rounds of Quantitative Easing (QE). The Fed's balance sheet will go from $6.5 trillion to something like $15 trillion. This flood of liquidity and boost to the money supply will goose risk asset (primarily equities) valuations to super-bubble levels. Financial repression and yield control measures will be imposed by The Fed and U.S. Treasury. Although nominal interest rates will be extremely low, real interest rates will be positive, and maybe significantly positive. The creation of inflation and the continued debasement of our currency offer an escape hatch for the gross negligence perpetuated by our government. A few years of artificially repressed interest rates combined with high inflation can do wonders for a country's unsustainable debt levels. Creditors, especially holders of long-duration U.S. Treasuries, will take it on the chin. The government will never accept responsibility for a situation that it alone created. Like the 1970s, the dollar could lose 75% of its purchasing power over the decade of the 2020s. Gold and other hard assets that can't be printed will shine.

As I wrap up this diatribe, it would be a good idea for me to issue a couple of final comments, or maybe disclaimers would be a more fitting word. I am not taking the position that everybody should run out and buy gold and/or gold derivatives. Different people have different investment preferences at different times for their respective portfolios. What I am saying, however, is that it would be advisable to at least have a conversation with your financial advisor concerning the pros and cons of gold. Lastly, some investors hold gold for speculative (make money) reasons, and some investors hold gold for insurance purposes. Homeowners insure their residence in the event it burns to the ground. Some investors, including me, hold gold in the event the American dollar burns to the ground.