I had an interesting exchange in the comments of this post with reader sh on the subject of portfolio protection. I won’t relitigate the question here since you can go read our exchange, but sh got me thinking about public markets and what they are, and aren’t, for.
I take for granted that the price level of public market equities, that is to say without dividends reinvested, will be flat over the next 5-to-10 years. Far from being valuable insight, however, this conviction is completely worthless. That’s because I have not the slightest inkling about the path of public equity prices in the next 5-to-10 years. A “flat” intermediate-term prediction can describe a market that drops 80% and then quintuples, a market that doubles and then drops 50%, or a market that just staggers along for the foreseeable future.
And of course that leaves totally aside the fact that my seemingly-precise expression “5-to-10 years” masks a difference of five whole years!
Remember what high stock prices and low interest rates are for
Almost a year ago I wrote about the Federal Reserve’s plan to save the American economy: sell everything and start a business. The plan was and is marvelously simple: by buying up trillions of dollars in government bonds, the Fed was able to drive the interest paid on safe securities to extremely low levels. That forced investors seeking returns that used to be available on risk-free assets to buy riskier assets. It forced investors seeking returns that used to be available on risky assets to buy even riskier assets. And, ultimately, it was supposed to make returns so low, funds so cheap, and equities so overpriced, that people would be enticed to borrow money, issue equity, start businesses, hire employees, and get the American economy moving again.
You got your tax cut. Now what?
The Republican party felt compelled, for aesthetic reasons, to include adjustments to individual tax rates in their recently-enacted changes to the tax code, but the overwhelming impact, in both practical and budgetary terms, was on corporate taxes. Those changes mean that in the short term, US corporations with assets owned by international subsidiaries will be able to retitle those assets in the name of the parent corporation at discounted rates, permitting the US company to use the assets to pay dividends and reduce their share count (offset by the shares issued to their executive suite, of course).
Whether you think the 2018 year-to-date rise in the stock market’s price level was “caused” by those changes to the tax code or not, it has certainly risen, and if you’re invested in public market equities, you may have noticed their increased value (even though you shouldn’t peek).
The question I have to ask is, now what? Still-low Federal Reserve interest rates have now been combined with a shot of adrenaline from Congress to push public market equities to all-time highs. But what’s the plan? Or rather, what’s your plan?
Imagine the opposite conditions
People even a little younger than me won’t remember this, but in the early 2000’s it was possible to earn 6% APY, or higher, on a totally liquid money market savings account (mine was with PayPal). People older than me may remember when US Treasuries were paying well over 10% APY in the early 1980’s. What would be the appropriate response to conditions like those?
Logically, you’d want to get the highest-paying job you could, work as many hours as your boss let you, spend as little as possible, and save every penny you could in the longest-dated securities you could. Treasury Inflation-Protected Securities weren’t issued until 1997, but if those high-interest, high-inflation conditions existed today you’d probably want to give up a few points of interest and buy 30-year TIPS. Of course, public market equities were also very depressed, so in general saving as much of your income as possible and scooping up as many securities as possible was the right move, and you would have been richly rewarded for it.
Last call for this business cycle
We’ve reached full employment and employers are having to raise wages and working conditions and lower hiring standards to attract additional workers. Inflation is starting to fitfully show signs of life. The Federal Reserve has raised interest rates off the floor and may accelerate the pace of increases this year.
Eventually, these conditions will converge, growth will collapse, and it will be time to start scooping up cheap stocks and bonds again. But we’re not there yet. If a year ago the time was right to start a business, today the time is perfect to start a business.
So, what now?
I come at this from the point of view that it’s better to take advantage of what the tax code offers, than to blindly struggle against it. Hence I max out my HSA and 401k yearly, and do a Roth rollover with what’s left.
Our legislators had to work around Congress’s reconciliation rules for budgets, and chose to sunset individual tax rates in 7 years while making cuts in corporate tax rates permanent. So most people will see increases over the rates they paid on earned income in 2017 starting in 2025, all other things being equal.
Between now and then, individuals dealing with personal income rather than business income should think about squirreling away enough money in tax advantaged investments (preferred stocks, REITs, MLPs, etc) that they can more than replace the increased taxes on personal income with business income. I say “more than replace”, because the present situation is unsustainable, and some increase in corporate tax rates has to happen. Start now so that 7 years time and some compounding can help get you where you want to be,