Paul gives a market update as we close out 2021 together. Listen along as Paul gets into Black Friday and end-of-the-year consumer habits, an unexpected 2% drop in the market, inflation, and how market volatility affects investors. Later in the show, Paul shares a cautionary tale of a couple who got slapped with a huge tax bill after stretching the limits of their IRA.
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Paul Winkler: And a big welcome to “The Investor Coaching Show.” Can you believe it’s December?
Lovectecus, do I get Christmas music?
Lovectecus Allen: I was just about to ask you that.
PW: You didn’t ask me.
LA: No, it’s just dawned on me.
PW: No, no. It’s never on the opening, but in between—it’s December.
LA: ‘Cause I was going to ask. I’m like, “When do you want Christmas music? Like next weekend? Today?”
PW: No, no, no, it’s good now. It’s good now. Yeah.
I was just … I was actually noticing one of my guys was driving by one of the local banks. A big line at the bank, and he’s going, “What on earth is going on? Is it a run of the bank?”
He is joking. He’s really joking, folks.
I mean, is it a run of the bank? But I said, “I don’t know, but Mama Dollar and Papa Dollar need to make babies real soon.”
And I don’t know if he caught that yet, but anyway, it’s that time of the year. “It’s a Wonderful Life,” if you don’t know what that reference is.
It’s that time of year, so yeah, bring it on. We go to these breaks, just throw some stuff at me.
It’s been—oh, and a lot of stuff to talk about, market-wise, investing-wise, and things going on after Black Friday. Black Friday was a market down …
I did a video on Sunday because I thought, “Gosh, I’ve been doing this radio show for 20 years, and I just know if I don’t …”
And I’ve probably covered everything under the sun when it comes to markets and ups and downs and what to expect and go, “This is kind of the way stuff works.”
Markets do this, and if they didn’t do it, we would have returns of Treasury bills in stock markets, is kind of the way I look at it. So when markets go through gyrations—it was down like 2.5%, most areas of the market.
And a lot of them, they moved together that particular day because they had this, “Oh, the new variant!” Omicron or whatever, I don’t know.
It’s just what … I can’t even keep up with all the different variants out there and how they’re supposed to affect things. And I’ve got a lot on that actually, today, that I’ll talk a little bit about.
I got a lot on it, but I’ll talk a little bit about it because it gets old after a while. But there was … I did this video.
And some of the data that I bring up every time I talk about this is just some data that I update every single year and goes back to the 1950s.
And it’s just talking about, we had a 2.5% drop in the market that day. And then you have Monday too, and you have kind of this mixed week, this past week.
And I said, “Hey, look, 5% declines happen on average three times of the years. Three times a year.”
And if you look at it and go, “5% decline, okay, the market goes down that much, big deal.” Three times a year. Happens quite frequently.
On average, lasts about 43 days, the most recent data on that. And the last time it happened was in October 2020.
Then we got to 10% declines. That happens about once a year.
So you can pretty much expect once a year, you’re going to have a 10% decline in the stock market. It’s going to drop in value that much.
And it’s not a big deal because, you think about it, how does it affect you? It only affects you if you go and sell everything at that point in time.
That’s the only real effect that it has on you.
It’s actually an opportunity, because if you’re managing a portfolio and you’re rebalancing, you got money flowing in and you’re buying, you’re using rebalancing the way it ought to be done, not the way mutual fund companies actually put it out there.
Fidelity has on their site, they have, “Go rebalance your portfolio.”
And you go there, and what it does is, it tells you, “Okay, how do you want to change your mix?” That’s really what it is.
No, I didn’t want to change my mix. I just want to bring it back to what it was before.
If I had 10% of my money in large U.S. companies, then I want 10% of my money back in large U.S. companies. I don’t want to change it to 5% because I think it’s going to go down, or I change it to 20% because I think it’s going to go up.
I mean, that’s just tactical asset allocation. It’s just market timing in disguise.
And you’re betting, if you want to increase the percentage there, you’re betting that area of the market is going to take off. And you’re betting that it’s going to go down if you decrease the percentage.
But rebalancing, when you’re taking your money out of your bonds, your fund pays dividends or something like that. And it goes … and you take the dividends, and you redirect them to whatever is under what it’s supposed to be.
It’s opportunities when you have market declines like that. If you look back at the end of March in 2020, when you had that big market decline, it’s like, what do we do?
And most people are like, “That’s crazy.” Thirty percent of people, 30% of investors, yanked all their money out of the market that particular month just because they just freaked out.
“Oh my gosh, this is terrible! Market’s gone down.
“It’s going to keep going down. I keep hearing about this virus and how bad it is, and how we don’t have a cure for it.
“We don’t have any kind of treatment for it. We don’t know what to do.
“People are dying …” And the rumors are all over the place.
And I said, “Oh, well, you know what? Market’s down. Let’s rebalance. Let’s put some money back into it from our bonds and just keep going.”
And of course, the rest of the year, it’s huge—up—and it turned out to be a great thing. But that’s … you approach markets in the most non-emotional manner that you possibly can, which is so hard.
It is so hard to just go, “This is my money. I can’t be emotional? I’ve got to be emotional about it.”
No, you don’t. If you’re emotional about it, then you are going to shoot yourself in the foot.
It’s kind of like anything in life: when your emotions are running the ship, the ship’s going to sink.
You kind of take a deep breath and count to 20, and then you speak, rather than speaking what is on your mind the moment that your emotions are triggered.
And it’s the same thing with markets.
You just go, “Eh, you know what? This is what I’m supposed to do. I’m not going to think about it.
“I’m just going to go and do what I’m supposed to do, and it’ll be fine. I know that markets go through these things. They always do.”
About once every three years, you’ve got a 15% decline and the—and I’m just talking about the S&P 500 right here. If you’re looking at other markets, it’s going to be a little bit different.
But you look at 20% declines, which is huge. I mean, think about it—20% decline every six years on average.
And March of 2020 was the last time we actually had that. So that is fresh in people’s minds.
So that is something that I’m always trying to remind people of, just simply because it is such an emotion-laden thing. And the latest thing is, you got the virus.
But you also have the Fed. The Fed can’t decide whether inflation is here to stay or whether it’s going to be transient.
It’s a transient type of thing. It’s going to be here for a little bit, and it’s going to be gone.
And there are people that are on both sides of this. That’s the amazing thing.
If I walk through some of the things that I’ve been looking at during the show today, you’ll see that people are all over the place on this. And inflation is something that we always have, we’ve got to be concerned with.
So I thought what I’d do is just take a couple seconds and talk a little bit about a Wall Street Journal article about that very topic. Because that’s it.
Do we increase interest rates at the Fed? That’s what they’re looking at doing is not purchasing bonds or actually selling off some of the bonds.
And if you sell off some of the bonds, what that does is it drives the price of bonds down. You’re actually selling something which there’s only a limited demand for.
And when you have a lot of stuff—whether it be bonds, whether it be cars, whether it be toothpaste or toilet paper, whatever, you’re trying to sell a lot of whatever—you’re going to drive the price down of whatever you’re selling.
Well, with bonds, when you drive the price down, that drives interest rates up. And the reason that you want to drive interest rates up is simple.
If we have higher interest rates, people don’t buy as much stuff.
And a lot of people look at it and go, “Well, that’s because the government’s renting money.”
Well, I’ll talk about that today. I’ll get into that a little bit, but it’s also a factor of you only have so much supply of stuff.
You still have the chip thing going on. That whole thing with cars is still going on, which is driving the price of cars up.
And that’s a problem. You can’t get these chips in the cars to get them off the lots and sell them.
Then you’ve got people that need cars and want cars and are ready to replace. Well, it’s highest bidder.
Same thing with houses.
You only have so many houses to go around, and you got a lot of people wanting to buy houses. You drive the price up.
Well, how do we decrease demand? Well, we decrease it by increasing interest rates.
Because if you have higher interest rates, then it becomes less affordable to go and buy a house.
Or if you’re—God forbid—you’re buying cars on credit … I typically recommend that you don’t do that. But if you’re doing that, you’re not going to be able to borrow as much because the payment’s going to be a lot higher.
And therefore, your desire to go out and buy a car is going to be less. And you might milk the one you got for a little while longer.
So, hence, that is why interest rates are such a big deal.
Now back in the 1980s, we had peak interest rates at—in 1981, where you had a very, very high, over 12% inflation rate—and you had interest rates going up 15%, 20% for mortgages.
So what people would do is they go and get a balloon note where you’re just paying the interest on something.
And then at some point in the future, a few years down the road, you basically had to pay the entire principal back, the money that you borrowed. But you kept the payment much lower by just paying interest.
So, hence, people were trying to figure out, “How can I get the house that I want without huge payments?” And they got real creative or they had variable rate interest.
So you had a lower interest rate on a variable so that the interest rate could change from time to time, and you were hoping like anything that interest rates would come down in the future when you refinanced it. And you were hoping the same thing with the balloon note, that that would happen.
Well, when you had those high interest rates, you had high bond rates. You had stock markets doing very, very well.
And you think, “Well, wait a minute, inflation’s supposed to be terrible for stock markets.” It can be in the short run.
And the problem is, I’m not a short-run investor. I’m not sitting here thinking, “Oh, what’s going to happen in the next month?
“What’s going to happen in the next two months? What’s going to happen in the next year?”
When I invest in stock markets, I don’t care if I’m 60, 70 years old, I’m thinking 20–30 years.
And the reality of it is, if you look back at when you had the market downturn, before we had the inflation … it was before the inflation really got bad back in the 1980s. You had the market downturn in 1973, 1974.
And you had market fluctuations. There were a few of them in the late ‘80s, er, late ‘70s.
It was in U.S. stocks, though. It wasn’t necessarily all over the world.
They weren’t moving in tandem with each other. Then you got in the 1980s and even late ‘70s—I mean, good grief, you had these huge moves up in the market.
And you go, “Well, wait a minute. What’s going on here?
“Why are we so worried about it? Because the last time we had high inflation, stock markets were great.”
And that’s true. And it doesn’t mean, necessarily, that markets are going to go down even in the short run.
It can in the short run. And then, over the long run, what happens is that prices, because they’re going up, companies have to make more profits.
So stock prices are a … there’s a multiple of the earnings. And I’m going to talk more about that today too.
I’m going to talk a little bit about how you have the multiples, what they are in various markets, because there’s all kinds of conjecture that markets are overvalued.
But The Wall Street Journal had “Fighting Inflation Without Getting Carried Away,” was the article from Jason Zweig this week:
“This year, inflation has become the risk everyone seems to want to be protected from. It’s always good to have insurance, but insurance can get expensive and slipshod when everybody wants it all at once.”
And it’s like anything, when you have, all of a sudden, people who go, “Hey, what’s going to actually get me out of this problem?”
And they look around for investments, and they drive the price up for the investments that probably will do well with whatever is coming.
But the problem is that everybody drives up the price. And the people that currently own that asset, whatever it is, won’t sell it to you for a low price because they’re looking at it going, “I’m giving up an asset that is supposed to be good under the current conditions.”
So you see, it’s really, really a challenging thing to go and buy something that’s going to protect you. Because all of a sudden what you do is you drive up the price, which drives down the future what? Returns.
So we literally shoot ourselves in the foot all the time. And that’s basically what he’s saying in the first paragraph.
“As you go about protecting your portfolio from inflation, the most important thing to remember is that no single strategy is a panacea. You will have to fight the risk of a decline in your purchasing power in several ways.
“This week, Federal Reserve Chairman [Jerome] Powell conceded that inflation might not be ‘transitory,’ as the Fed had long insisted.”
And who knows. There are people who are on both sides.
I mean, that’s just one person’s opinion. He’s a well-informed person, but that’s just one person’s opinion as to whether it’s transitory.
“‘It now appears that factors pushing inflation upward will linger well into next year.”
So you can make the point that it might be transitory in the long run. And it might come down two years from now.
And that’s—really, we don’t really know. And if we look at economists’ ability to predict things, it’s not great.
I mean, historically, we talk about that. It’s not great.
You look at interest rate predictions, as I’ve talked about before. “Interest rates are going to go up. They’re going to go down.”
They ask. They poll economists and say, “Hey, what do you think? Interest rate going to go up, going to go down?”
Well, 70% of the time, they get it wrong. And it’s a 50-50 shot: it’s going to go up or it’s going to go down.
So that was a study that was done one time. It was kind of comical.
They got a 50-50 shot at something, and 70% of the time, they get it wrong. As in, the direction.
Go figure.
“So far in 2021, through Oct. 31, exchange-traded funds specializing in inflation-protected bonds have taken $34 billion in new cash, estimates Morningstar.”
So what are investors doing? Chasing it.
What happens, though, when you chase something? You drive the price up, which reduces future returns, right?
That’s what investors are doing. They’re famous for it.
“That’s more than any other bond fund category.
“Treasury inflation-protected securities,”—we call them TIPS—“the basic building blocks of these bond funds, shield your money against inflation as measured by the Consumer Price Index. iShares, Charles Schwab and Vanguard offer ETFs that invest in TIPS.”
And annual expenses, very, very cheap.
And fund companies will let you shoot yourself in the foot for almost nothing these days. And it’s like, “What do you want to buy? Here!”
It’s like that guy who was a salesman. Goes on … those of you that remember Johnny Carson, late night, Johnny Carson.
This guy goes on. He says, “I’m the greatest salesman ever.”
“Oh yeah?”
And these are the days when people smoke cigarettes on TV. And Johnny Carson has his big ashtray.
And he says, “Okay, well, sell me something.”
And the guy goes, “Well, what do you want to buy?”
And Johnny goes, “How about this astray?”
And he goes, “Well, what do you like about it?”
“Well, it fits the decor in here. It’s got a good … it’s a good weight, it’s good color,” blah, blah, blah.
And he said, “How much you willing to pay for it?”
And he said, “$5.”
He goes, “Sold.” That was it.
Whatever you’ll buy, I’ll sell you. And it is kind of the way the mutual fund companies work.
So it says … Wall Street Journal. Back to that.
It says, “TIPS aren’t a complete solution because they can incur significant losses if interest rates rise, reducing or even negating the benefit of the inflation protection.”
So pretty much what I’m saying. You can lose money in these things, especially true if they have elevated prices.
And if you look at what’s going on … and the way a TIP works is you put a thousand dollars in it, and it’s a 10-year TIP, and it’s got a 2% coupon which means that it’s going to pay you $20 a year. That’s the coupon: it’s going to pay you $20.
And if you have inflation of 3%, let’s say, then what’ll happen, the face value is going to go from $1000 to $1,030, and now the 2% will be applied to $1,030. So instead of $20 you get $20.60.
And then what happens is that is supposedly the benefit of these things.
Now the issue, though, is that these things lost 8% in 2013. They’re not without risk.
And the other thing is this. Here’s the thing about these inflation-protected bonds that I want to point out.
The CPI is widely used as the core indicator for inflation, right? That is how this is calculated: the Consumer Price Index.
And the problem is there’s a lot of criticism around the CPI. You got an example when energy prices rose 50%, then you had these grocery items that increased by 30%.
CPI just only went up a little bit, and it’s because it will exclude a lot of things that you may buy on a regular basis. And it’s not going to be part of the purchasing.
Now here’s the thing: if you think about it, the CPI’s based on purchasing habits of urban consumers.
You may live in a suburban area or rural area, and your purchasing powers are totally different from somebody that’s a city dweller. And you don’t purchase the same thing at all.
So what happens is that you have these TIPS. They started in 1997, and I really hold some reservations about them.
They’ve been around since 1997. They weren’t even around when we had the big inflation in the 1980s.
And you think about this: who is borrowing money with Treasury inflation-protected securities (TIPS)? The Treasury.
Which is the what? The government.
So think about it this way. Let’s say you’re the government, and you’re the one borrowing money.
And you have something that you actually control, which is in the inflation rate. Or you determine what is in the basket that determines what is inflation.
And you, of course, want to keep the budget in line. You don’t want to be spending too much money, especially on interest payments.
You don’t want to be spending too much money to borrow money. And you’re the one … you have the power over determining what is in the basket that determines what inflation is.
What would you want to do? Keep it as low as possible.
Why? Because the lower the inflation rate, the less your borrowing costs.
So I’ve always had that reservation.
Do I have any TIPS in my personal portfolio? Yeah, but very, very little.
I mean, it’s probably less than 1%. It’s just not a whole lot just simply because of the fact that it is an issue.
Bonds are there for safety. I’ve always held that as my viewpoint regarding bonds in an investment portfolio.
And I just don’t necessarily think that this is something that investors ought to be going and doing, going and throwing a whole bunch of money at TIPS because they’re worried about inflation.
Equity markets: best protector on inflation, long run, because it’s totally separate from that because prices going up are being increased by who? By companies.
And I own the entities that are raising prices, as I would say. So, hence—and it’s not determined by the companies themselves.
So, in essence, we don’t have that same conflict, so to speak, with this. So I hope that makes sense.
Inflation, yeah. Is it an issue? Can it be an issue? Sure it can.
And if it is an issue, I’m going to want to make sure that I own equities. I don’t want to put a whole lot of stock in fixed-income investments.
As I’ve said many, many times, people get worried about markets. They get worried about the government, and they go, “I’m going to pull all my money out of stocks! I’m scared of the government.”
And I go, “Well, yeah. Good luck with that.”
‘Cause what are you going to put your money in? Bonds and CDs and fixed-income investments, which basically, are backed by what? The dollar.
Which is issued by who? The government, which is who you don’t trust.
That doesn’t make a lot of sense.
Anyway, Paul Winkler. You are listening to “The Investor Coaching Show” on SuperTalk 99.7 WTN. I’ll be back right after this.
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