Welcome to the 12-20-2017 update from your Pocono Summit Certified Financial Planner and retirement planner, Mike Savage. Today, Mike preaches about what it means to have an investment option that’s truly “safe.”
There have been numerous stories put out by many respected investors that they believe that the liquidity that is supposedly provided by ETF products may be an illusion. While it appears that an ETF can typically be sold at any time we have to remember that there has to be someone to buy on the other side.
I got a real awakening yesterday as a good friend and client came in and asked me about a muni ETF that was paying an unusually high yield. Immediately I knew that there had to be some risk involved- mainly because I can’t find any highly-rated bonds paying that type of yield.
What I saw when I did a little research stunned me.
Keep in mind that, in a mutual fund, the manager keeps some cash available to handle redemptions so that if the underlying assets of the fund start to fall and redemptions come in there is cash available so that sales don’t have to be made into a falling market. Also keep in mind that most ETFs do not keep this cash cushion as they are fully invested into their underlying assets that they try to track.
Getting back to that unusually high yield- there may or may not be a risk of default (based upon the area it is highly likely in the future) but the real kicker is that there was an unusually high percentage of leverage in this supposedly “safe” fund.
Can you imagine if the fund suffers losses and redemptions start to come in? Not only is there no cash cushion but the fund will have to sell extra assets to make those redemptions because of the leverage that they have employed. This could lead not only to a run on the fund but also a rout in the price that could be stunning to anyone concerned. Selling may beget far more selling and drive the prices of the underlying bonds falling- possibly uncontrollably if the selling is fierce enough. If there is a panic I believe you could count on it.
This reminds me of an asset class that we held prior to 2009 and had a stellar track record of positive returns in many market cycles and I remember saying to myself that no matter what- this asset class should hold up. I had 30 years of history to back up that idea. Along comes October of 2008 and this supposedly “safe” asset class-which many people are touting again today- lost 35% in a WEEK! Things can unwind fast- particularly when leverage is involved.
I don’t believe it would take much to start a chain reaction that could lead to many of these levered funds to have large valuation problems. In the muni area a default in the wrong place could cause a lot of confidence to be lost and redemptions to begin. In other words, when greed turns to fear I believe these levered funds- particularly of the ETF class could suffer major declines. In this case you could be giving back years or a decade of that “yield” that you are so fond of getting at this time.
Don’t get me wrong. People are making decisions based upon- as I have said before- nothing really being “safe” anyway. Many go out on the yield curve or into more risky assets than they normally would because they have to to get a perceived decent return. Worse yet, many have done this simply to survive. I expect that many have no idea of the risk that they are taking.
The longer this goes on (intervention into all markets) the more complacent people become. Instead of a healthy fear of a correction that may lead to at least a little caution most are more fearful of missing out and getting left behind. At this stage of the game I believe that caution and patience just may produce the best dividends going forward.
Always remember that the idea is to buy low and sell high. Many are jumping in now because they believe the “market” will just keep going up. I agree that it will keep going up- until it doesn’t and the extra $100 trillion or so in debt that has been added to the global balance sheet just may usher in a new era of deflation because of the bursting of the debt bubble. Many who thought assets purchased were “safe” may be in for a rude awakening. Remember Mortgage backed AAA securities that turned out to be junk?
Isn’t it amazing that the central banks were buying in 2009 (adding to their balance sheets) and now are looking to sell (unwind the balance sheet)? I’ll bet they know the “buy low-sell high” story all too well.
For those who believe the Fed has your back- where were they in 2000-2002? Where were they in 2007-2008? Oh I remember- telling you all that everything was wonderful and the economy was great – until it crashed. I can’t believe so many have forgotten the booms and busts that have been extremely recent in time. This time it just may be different- it may be worse because instead of letting capitalism take its course they just compounded on the errors that got us into trouble the last time. This time the imbalances and mal-investments remain but are far larger in size and scale.
I believe those “in the know” like central banks, major banks and their cronies are loading up on gold and silver for a reason. I believe they see the writing on the wall and in order to survive they want real assets and not an illusion of value- they want real value that has stood the test of time.
If anyone reads ancient history- does it ever mention a dollar or a euro? Does it mention a Yuan or Yen? No- all through time gold and silver are money. They have historically held their value. Even as coins lost value they lost value because less metals were actually in the coins. I believe this is extremely important to understand and to have at least an allocation to these assets in your overall portfolios. If nothing else, it generally is not correlated to stocks and could provide a hedge against a pullback. In a more dire scenario it just may be the asset that allows you to start over.
As always, Be Prepared!
Mike Savage, Financial Advisor
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