Investors regularly quote the adage, ”A rising tide lifts all boats.”
In 1953, GM President Charles Wilson said during hearings to become Secretary of Defense, “What’s good for the country is good for GM and vice versa.” A half century later, the tax payers bailed out GM in an apparent effort to benefit the economy. There is no doubt GM was not only rescued but within a year was flourishing. This was a rare example of government policy being executed flawlessly and with precision. Yet, was it in the best interests of everyone?
The Federal Reserve, Congress and the Executive Office all seem to be promoting policies to improve the general economy on the theory that these policies will benefit all participants in the economy. Thus, economic policy that is good for the economy is good for all. Yet, most people will say that they think the economic recovery is very uneven.
Examples of losers in our economic recovery are the retired investors who require their savings to live on. They were the first victims when interest rates were lowered to effectively zero, which made it necessary for many retired investors to increase their risk taking to achieve their income objective. Now, the credit quality of government debt is dropping, interest rates are poised to rise and the value of the dollar the investor receives when their debt investments mature continues to drop.
An allocation that I have counseled my retired clients to adopt was one third in investments that preserve principal, one third in investments for income and one third in equities for growth. Thus, the retired investor would get a blend that achieves what they need: capital preservation, income and growth. The problem today is that this allocation is riskier than ever before. Effectively, two thirds of the portfolio is in credit and income securities that are at risk of losing value, as well as the one third in equities that was always at risk of losing value.
We are being told by economists and by the government that inflation is not happening and is not going to happen. In fact, we are being told that we should be worried about deflation, which is a sign of a depression. The two biggest components of inflation are wages and housing. I agree that there appears to be more risk that both wages and housing will continue to decline than the risk that they will rise. However, retired people don’t generally hire employees and they don’t generally contribute more money to the housing market, in fact they generally downsize. Thus, the lowering of wages and housing prices does not benefit them. A better gauge of inflation for retired investors is to join my wife on one of her frequent trips to Costco. There she will point out how prices have gone up tremendously. Of course prices are going to increase for anything that is exported or imported. The dollar has dropped; so on the world stage, prices marked in dollars must go up proportionally. The fact is we cannot export housing and so far, we have been ineffective at raising wages with our unemployment running so high. Retired investors still need to spend their deflating income consuming products and services, which are inflating.
Now to turn to the stock market – one of the winners in our economic recovery. By far, the largest expense of many companies is wages. Traditionally, productivity improvements and outsourcing have been how companies improved their earnings despite rising labor costs. Now, low wages and a grateful workforce are helping U.S. companies make more profit. Companies benefit from inflating prices because they can sell their goods and services for more money on the world stage. As a result, stocks are benefiting from low wages and high prices resulting in higher earnings. The rising tide of the economy also benefits stocks as demand for products and services increase, despite entrenched unemployment, which continues to put a cap on wages.
Whether or not your boat is lifted, now is the time to seek professional advice to be sure portfolios are invested appropriately. A lot of retired investors inform me that they are in good shape because they have all their money invested safely, which I presume means they are invested in government debt. In this environment, assets with intrinsic value such as real assets and stocks might be a reasonable hedge to the risks of government debt, and corporate debt might be a good way of spreading out credit risk.
Warren Buffett famously proffered “It’s not until the tide goes out that you realize who’s swimming naked.” He might also have said: “A rising tide lifts all boats, except the little ones that get flooded and sink.”
The fact is that our economic recovery has been very uneven. For every action we take, the law of physics seems to apply instead of the law of GM and the law of lifting all boats, because there appears to be an equal and opposite reaction. We should remember that a rising tide on one side of the planet creates a lowering tide on the other side. The best advice I can give investors in these or any challenging times, whether they be retired and living off their portfolios or saving for retirement, is to apply what has worked best for investors in high tides and in low tides, and that is to be diversified.