Welcome to the 11-02-2017 update from your Pocono Summit Certified Financial Planner and retirement planner, Mike Savage. Today, Mike discusses passive investing and the nature of economic booms and busts.


There is a lot of interest these days in what many people call “passive investing”.  Hundreds of billions of dollars are flowing into ETFs that are designed to track the movements of certain markets like stocks, bonds, commodities, etc.

While the indexes that you are investing with are rising it seems to make perfect sense to let the rising tide lift all boats. I am sure that all those invested in passive funds from 2003-2007 were giddy with great returns until the 2008-2009 recession cost many 50% or more of their value at that time. I didn’t say 50% of their gains- those were wiped out all-together. It was a 50% drop that many experienced in their entire accounts if you were in the S&P or Dow. Since the Nasdaq had never fully recovered from its 75%+ drop from 2000-2002 the losses were not quite as high.

How quick we are to forget the lessons of the past. I was always taught that the same mistake would not be made in the same generation. It appears to me that we are nearing a third large pullback in the last 20 years where we have seen a boom (1995-2000), bust (2000-2002), boom (2003-2007) bust (2008-2009) and boom (2010-?).

One thing that all of these booms and busts have in common is that they all have a theme. Actually we can go back to 1929 when revered economist Irving Fisher proclaimed that the stock market was at a new permanently high plateau. After the resulting crash it would have taken 27 years to get back to having your original investment restored.

In 1995-2000 investing legends like Jeremy Grantham and Warren Buffett were ridiculed for not getting the new paradigm. It was claimed that it was a new economy where clicks and eyeballs were all that counted- earnings didn’t matter- until they did.

In 2003-2007 we were told that Real Estate would only go up. The Fed would not allow anything to rain on the market’s parade.  Of course, as it always seems to happen, the markets proved a little too nimble for the central banks to get in front of and many were badly hurt by believing the baloney being peddled on the financial game shows. As a matter of fact, when anyone tried to warn of impending danger (think Peter Schiff) they were ridiculed and laughed off the shows.

Here we are with what I believe to be the largest and most dangerous bubble that has ever existed globally. Part of the reason it is the most dangerous is that it is not confined to any one area or country but it is a global phenomenon.

The structural problems that caused the economy to seize up in 2008 have not only not been fixed but the problems are exponentially larger today than they were then. The world has record debts that are being serviced by “printing” money. If economics were taught in our schools this likely could not have happened. Anyone with Econ 101 would recognize the severity of a situation where many nations are so far in debt that if they didn’t have a “printing press” they would have likely defaulted LONG ago.

Actually the numbers that these debts represent are so large that they could never print enough money. All they actually do is click a mouse and voila- there is “money” to pay the bills. Wouldn’t it be nice if we could do that? Of course, we would wind up in jail because it is illegal for us to counterfeit!

If all we had to worry about were the underlying debts then maybe we could somehow skate through what I fear is coming. There are reports out there that there could be as much as $2 Quadrillion in derivative bets out there. (Warren Buffett calls these derivatives “financial weapons of mass destruction”). There is a reason for that. When markets are moving up you can enhance your gains. On the flipside, in downward action, your losses would also be magnified. This is the most likely reason that over $16 trillion went into bailing out global banks in 2009. (GAO) I can only imagine what it might take today.  GAO- US Government Accountability Office

For anyone who feels like a genius because you have been in on the nice run of the past few years- congratulations! I am truly happy that you have participated. Keep in mind what another investing legend- Art Cashin often says. When I enter a room (trade) I always want to know where the exit is.

Of course, as passive investing implies many don’t even think about the exit and have been rewarded well so far. Many people and computer programs are programmed to “buy the dip” and it has worked well- actually for a little too long already.

As I wrote last week when you get near a top many trades become crowded and a reversal in sentiment can lead to large pullbacks in short  periods of time.  According to Jason Goepfert of Sentimentrader Cash in mutual funds are at all-time lows, margin debt is at all-time highs and net worth of investors is also at all time highs.

According to the VIX it also appears that complacency is also at an all time high.

Personally, I am expecting the unexpected. There are too many warnings out there to just dismiss. The IMF (International Monetary Fund) has released a paper describing how the economy could implode again. The BIS (Bank for International Settlements) has been warning for some time now about the excessive amount of debt that is being carried globally.

Many states and companies that can’t “print” their own money or get a bailout are showing signs of extreme stress in their finances. It doesn’t appear it will take a whole lot to upset the apple cart once the ball gets rolling.

Of course, as many stock and bond etfs continue to be added to there are some unloved assets out there that could see a large turnaround in the other direction.

When sentiment shifts from greed to fear it is likely that cash, gold and silver may play a large role in filling the void for where to invest. Since the gold and silver markets are so small (All silver mining companies combined don’t have the market cap of just APPLE) it won’t take a large percentage of assets entering that space to create large upside moves. Of course, one can’t know WHEN. That is the question. I would propose, however, that being early will be better than getting in late.

While most people are busy riding this latest boom wave I believe the smart money is preparing for what will likely prove to be trying times ahead. This is mainly because of the lengths that the authorities have gone to, to inflate this latest bubble to its current state which is literally historically off the charts.

Expect the unexpected.  Diversification out of assets that have risen dramatically, particularly in an unusually violent manner (think FAANG stocks) may make a lot of sense at this time. Remember you only have a profit on paper until you sell and collect that gain!

Many people may be collecting dividends and need to keep receiving them. In a large downturn remember that dividends are not guaranteed and must be declared by the company’s board. I would expect some companies to stop paying dividends and others to reduce the amount being paid out. You may want to see if you are holding any companies that have been raising debt capital to fund dividends and share buybacks as they will likely be the first and most severely impacted. Many household names fit that bill.

Be Prepared!

Mike Savage, Financial Advisor

2642 Route 940 Pocono Summit, Pa 18346

(570) 730-4880

Securities are offered through Raymond James Financial Services, Inc. Member FINRA/SIPC. Investment Advisory Services are offered through Raymond James Financial Services Advisors, Inc.

Any opinions are those of Mike Savage and not necessarily those of RJFS or Raymond James. Expressions of opinion are as of this date and are subject to change without notice. The information contained in this report does not purport to be a complete description of securities, markets or developments referred to in this material. The information has been obtained from sources considered to be reliable but we do not guarantee that the foregoing material is accurate or complete. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation.

Commodities are generally considered speculative because of the significant potential for investment loss. Commodities are volatile investments and should only form a small part of a diversified portfolio. There may be sharp price fluctuation even during periods when prices are overall rising. Precious metals, including gold are subject to special risks, including but not limited to: price may be subject to wide fluctuation, the market is relatively limited, the sources are concentrated in countries that have the potential for instability, and the market is unregulated.

Diversification does not ensure gains nor protect against losses.

Investing involves risk and investors may incur a profit or loss. Past performance may not be indicative the future results.  Prior to making an investment decision, please consult with your financial advisor about your individual situation.  Inclusion of these indexes is for illustrative purposes only.  Keep in mind that individuals cannot invest directly in any index, and index performance does not include transaction costs or other fees, which will affect actual investment performance.  Individual investor’s results will vary.  Pas performance does not guarantee future results.

The S&P is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market.

The Dow Jones Industrial Average (DJIA) , commonly known as “The Dow” is an index representing 30 stocks of companies maintained and reviewed by the editors of the Wall Street Journal.

NASDAQ composite is an unmanaged index of securities traded on the NASDAQ system.

VIX is the Chicago Board Options Exchange (CBOE) Volatility Index, which shows the market’s expectation of 30-day volatility. It is constructed using the implied volatilities of wide range of S&P 500 index options.  It is a widely used measure of market risk.