Blog | CB Investment Management

“Sea Change” – Expanding Debt Trap And Instability

Passive investing has become entrenched, but was not designed for instability.

“Best Investor” standards safeguard optimal investing.

The global banking system is more highly leveraged on balance sheet to equity measures than ever before, and bank credit is beginning to contract. All the major central banks have undeclared loses which wipe out their nominal equity, affecting their own credibility as backstops to their commercial banking systems. Systemic risks are escalating, even though market participants have yet to realize it.
Alasdair Mcleod

“Many investors today still pretend that we’re in the system that we had from 1980 to 2020. We’re not. We’re going through fundamental, lasting changes on many levels.”
Russell Napier

if you grant that the environment is and may continue to be very different from what it was over the last 13 years – and most of the last 40 years – it should follow that the investment strategies that worked best over those periods may not be the ones that outperform in the years ahead.
Howard Marks

“It is not the strongest of the species that survives, nor the most intelligent. It is the one most adaptable to change”.
Charles Darwin

In recent years the Federal Reserve has been alternating between opposite extremes in policy. An expanding debt trap comes with ever more violent cycles. How can investors manage this optimally?

Following record QE, or asset purchases, the Fed is now doing the opposite, QT, also at a record level.

Having kept interest rates at zero for a record period, while inflation exploded higher, it is now raising interest rates at the fastest pace for decades.

Having kept M2 money supply growth relatively stable since 1959, it has now broken the historical range on both sides within two years! How do you think this is all somehow helping create a stable, healthy and productive economy?

The Fed is struggling to achieve its mandates. The system has become unstable with the new Dominating Debt Dynamics. Can the Fed really manage this? Or is it just adding to instability in search of increasingly unattainable objectives?

So the Government is stepping in. Russell Napier explains….

They’re impotent. This is a shift of power that cannot be underestimated. Our whole economic system of the past 40 years was built on the assumption that the growth of credit and therefore broad money in the economy was controlled through the level of interest rates – and that central banks controlled interest rates. But now, when governments take control of private credit creation through the banking system by guaranteeing loans, central banks are pushed out of their role. There’s another way of looking at today’s loud, hawkish rhetoric by central banks: Teddy Roosevelt once said that, in terms of foreign policy, one should speak softly and carry a big stick. What does it tell you when central banks speak loudly? Perhaps that they’re not carrying a big stick anymore.

In relation to the stock market M2 money supply is currently sending a red flag.

Concensus profit margins and earnings estimates somehow remain strangely anchored on the clearly abnormally high outlying year 2021, rather than the more normal 2018/2019 levels and broadly ignore the risk of recession. There is still a big adjustment to earnings expectations yet to come.

Furthermore, it is still not clear that the economy has yet adjusted to the rapid rise in interest rates in 2022, let alone additional rate hikes to come.

Passive investors had their worst year for a century in terms of a stock and bond combined allocation.

Record bond losses, combined with one of the worst stock market returns to produce a record bad outcome for passive investors.

Most passive investors may not have deeply studied the history of passive investing, or what happens when a debt trap takes over the economy. The last 40 years have been relatively benign and worked out well, but the range of outcomes going back further, and reviewing other countries, has been very different from recent decades in the US. It is important to have realistic expectations of the outlook, grounded in broad historical experience.

The chart below suggests that in 2022, despite the terrible performance, passive investors did more of what they do. Buy more on the dip.

Clearly it will take more bad experience to change the majority practice on strategy.

A fully invested completely passive portfolio is generally the best methodology for high returns in a long uptrend and the worst in a downtrend. That makes it an increasingly high risk strategy in volatile and less benign circumstances.

Passive Investing is increasingly inappropriate for retirement investing. It’s not acceptable to have a drawdown of 20% in retirement. Just to return to a modest 4% compounding rate. That requires a 35% return or the investor will continue to stay far behind even a modest objective.

As in everything in investment assumptions and strategies, the ultimate failure in many widely used methodologies comes from misunderstanding dynamic realities. Many widely used investment methodologies contain assumption flaws which will become ever more exposed in volatile conditions.

If you are in retirement or anywhere near retirement you need to fully adopt Best Investor standards so you can verify objectively in real time, the extent to which you are on track for “Capital Preservation and Compounding”. Make sure you are in control and on top of the situation, and have a genuinely credible and durable approach.

Investors need to be able to examine a portfolio in the performance grid shown below. If you are in the top left corner and above your benchmarks, the investor is well placed. If you are not you should ask some questions depending on where you are. Demand high standards, full accountability and transparency.

If you don’t do this you are on a very different path, dealing with limited transparency, poor accountability, and weak assessment capability. The worst case is that you become a slave to just your short term returns, which is an incomplete assessment and can often trigger unhelpful emotional responses. Most investors in this situation fall into a sequence shown below.

This is already playing out in crypto, and many high beta stocks. I lost the most subscribers to this insight when I mentioned ARKK several months ago. It was clear that many investors were taking a passive approach to holding ARKK. Taking a passive approach to high risk positions can be a disaster. This it what it looks like now.

Market Outlook

If you want to be successful as an investor you can’t afford to miss the swings in the commodity to equity ratio shown below. Most likely the low is in on this ratio as the Fed struggles with its management of the financial system. Although inflation is currently considered the main economic problem, Russell Napier explains why inflation is likely also the longer term solution. This will be supportive of real assets relative to financial assets.

Certainly, the yield curve indicator combined with the recent outperformance of gold relative to the S&P 500 suggests there is room to run for gold which may lead commodities.

Investors Need To Think Differently About Bonds

There is now too much instability and uncertainty to be a long term investor in long maturity bonds. While they remain a great trading instruments the range of future outcomes has become too wide and uncertain to place long term commitments. The shorter maturities look much more attractive than they have for several years, and provide income and cycle trading opportunities grounded by short term interest rates.

Summary

Markets remain stuck in the vice of the most challenging conditions for investing. When growth is declining and interest rates are rising equities, bonds and most alternatives perform badly. While most of the interest rate rises are likely behind us, they are not finished according to most western central banks.

The record collapse of markets in 2022 was severe, and it most likely signals a new policy and investing environment. The collapse of underlying growth combined with exploding debt levels can no longer be managed effectively by the post 2008 experimental policy “tools”. Government policy will play a bigger role as the shortcomings of central bank policy becomes increasingly apparent.

The imbalances from the post 2008 policy environment have barely started to unwind and will need new direction. Capital is likely to move towards short maturity bonds for the lower risk and higher yields. With a lag, global restructuring at some stage should lead to a capex boom in the US, the health sector may replace the technology sector as the focal point for growth, real assets may outperform over time, and China is highly likely to have at least a cyclical upturn.

“Best Investor” Standards Safeguard Optimal Investing

In order to optimize opportunities safely, investors need to be set up with the most productive framework possible. Why not adopt the methodology of the most successful investors of all time? They all ended up embracing their own version of “Capital Preservation and Compounding”. You can find out why here.

The great additional advantage of “Capital Preservation and Compounding” is it’s clear definition. Just 5 metrics which can be illustrated in the Risk/Return Performance grid tell you in seconds how well you are doing.

Raise your accountability, transparency, understanding and control of your investing in real time by having access to this information.

Transform Your Investment Experience

The room for policy manoeuvre, and the stability of the current system should not be taken for granted. Volatility has increased and is likely to continue to stay high. The outlook has rarely been this uncertain. Investment management needs Best Investor metrics and techniques as never before.

Market and economic events are moving fast at this stage. If you need a quick review of the issues that you may need to know about for your own circumstances, schedule a FREE consultation today.

Please note these important disclaimers: Educational use Only. The market update published by CB Investment Management, LLC (“CB Investment”) is intended to be educational in nature and is not intended to be a recommendation for any specific investment product, strategy, plan feature or other purposes. Accordingly, it should not be construed by any consumer and/or prospective client as solicitation to effect, or attempt to effect transactions in securities, or the rendering of personalized investment advice for compensation.Advertising and Marketing. Communications such as this are not impartial and are provided in connection with advertising and marketing. This material is not suggesting a specific course of action or any action at all. Prior to making any investment or financial decisions, an investor should seek individualized advice from a personal financial, insurance, legal or tax professional that takes into account all of the particular facts and circumstances of an investor’s own situation. No person associated with CB Investment is a licensed attorney or tax professional and the information contained herein should not be considered tax or legal advice. Links to Third Party Content. This Market Update contains links to articles or other information maintained by unrelated third parties. You acknowledge and agree to the following: All such information is provided solely for convenience purposes only because we believe that it may provide useful content and all users thereof should be guided accordingly. We disclaim any responsibility for the link’s performance or interaction with your computer, its security and privacy policies and practices, and any consequences that may result from visiting it. We do not control the content published by the third-party; we do not guarantee any claims made on it, nor do we endorse its sponsor or any of the content, policies, activities, products or services offered by any advertiser on the site. CB Investment assumes no liability for any inaccuracies, errors or omissions in or from any data or other information provided by the third party and inclusion or reference by CB Investment to any third party link should not be construed by any consumer and/or prospective client as a solicitation to effect, or attempt to effect transactions in securities, or the rendering of personalized investment advice for compensation, over the Internet.
Important Information regarding Registration Investment advice is offered through CB Investment Management, LLC (“CB Investment”), 8231 Crestwood Heights Drive, Mclean VA 22102 an investment adviser registered with the states of Virginia and Maryland. Registration with the states of Virginia and Maryland should not be construed to imply that the SEC has approved or endorsed qualifications or the services offered, or that its personnel possess a particular level of skill, expertise or training. Important information and disclosures related to CB Investment are available at https://old-site.chris-belchamber.com.

Best Practice is a matter of your Best Interest.


Education and a Commitment to Informed Consent is an Obligation.

Chris Belchamber is an IRMAA Certified Planner

Medicare’s IRMAA impacts every retirement plan. Learning how to mitigate it is available via IRMAA Certified Planners designation.

Sign up to receive the best practice community insights directly into your inbox

Leave a Comment

Your email address will not be published. Required fields are marked *

Related Posts

Sign up to receive the best practice community insights directly into your inbox