A long term risk that should not be overlooked

First of all, let me  just repeat again about the direction of a stock or the market when I talk. Any such trending should be understood in the right context. The market is very fluid and dynamic and the day to day changes are extremely volatile and difficult to predict. Oftentimes, the short term direction for a stock or the market can be totally contradictory to its longer term direction, which is very common and normal.

So today’s topic is about the long term trend as the subject already indicated. While I have been cautiously bullish for the market for the next few months or each a year or so, my long term view on the market has become quite bearish actually. As I said many times here, the current booming economy in the US and around the world is based on debt driven fundamentals. All the countries and most of the companies are borrowing money as if there will be no tomorrow. The historically low interest rates in the past 10 years have made such a crazy debt creation a non-issue till now. Indeed, who cares how much money is borrowed when there is close to zero interest they need to pay? But can we really think we can continue the free lunch forever? Don’t be too stupid to believe that. A reckoning day will come for certainty and this day is approaching closer and closer each day. When interest rates start to increase, which is already happening now, it will start to add cost to all the businesses borrowing money and to the governments as well. Initially it will just be a little bit but manageable pain to handle but when the interest rate reaches to certainly point, e.g. 4% or higher, it can bring down all the debt-burdened businesses to cause enormous chaos and we will see a financial crisis that will make the 2008 crisis like a beach walking. In my mind, this is not if but just when. I have talked about the potential long lasting bear markets in the future (see here).  Interestingly I saw something similar but in a different perspective. The paper is in Chinese: “前两次美国失业率跌破4% 都出现了经济衰退(details here)”, which means economic recession occurred two times before following the unemployment rate dropped below 4%, one in 1966 (that triggered a 15 years long bear market)and the other one in 2008 that triggered a 50% market crash.And then here is what  Jamie Dimon (JP CEO) just said: Economy is ‘strong’ but odds for another recession are ‘100 percent". Another dire prediction is coming from the famed legendary investor, Jeremy Grantham. He is not someone you should easily ignore. Per the Wikipedia, Grantham is regarded as a highly knowledgeable investor in various stock, bond, and commodity markets, and is particularly noted for his prediction of various bubbles. He has been a vocal critic of various governmental responses to the Global Financial Crisis. Grantham started one of the world's first index funds in the early 1970s. What Geantham thinks about the future? Not so pretty as well: Grantham Forecasts Rough Seven Years for Equities, Bonds as reported by Bloomberg. Actually he is predicting negative returns for the next 7 years.     

Since I’m so bearish for the long term stock market future, you may ask what I’m doing with my money to hedge against the potential enormous risks. Two principles I strictly follow for my own asset management:

• For my long term investment, I don’t look for high growth stocks at all as they are typically high debt companies in order to fund their fast growing businesses. Many of them will face deadly blow when the interest rates jump too high. Don’t forget, just back to early 90s, the long term interest rates had reached as high as 18%. It will just be a killing to all the companies borrowed heavily for their businesses. I’d rather hold a bunch of quality stocks that are very strong financially and have a decades long track record to pay increasing dividends. As I have just demonstrated recently (see here), you don’t need the stock to go up for making a killing amount of money over time. All you need is your patience to let the stock do its magic by reinvesting the dividend. And actually lower stock prices will even help you make more money over time. These are exactly the stocks I want to hold during long lasting bear market, if it indeed hits us. I’m convinced it will come sooner or later and I’m building up such a long term portfolio starting 10 year ago. If you care about your financial future, start to do this now. When you start to feel the pain by waiting for the headlines telling you a bear market is coming, it will be way too late. Just remember, compounding wealth growth is not about high growth rate but long-term slow growth for many years and eventually it will trigger an explosive up run. The magic moment typically happens around 15-20 years after you hold and reinvest the dividend of a stock. If you think this is too long and cannot wait for that long, just think about the fact that Buffett has made the vast majority of his wealth only after he was 50s (see here). He is worth $70 billion now but he only reached his first $1 billion when he was 56. Folks, don’t believe you can make millions if you are already in 50s or even 60s? With the right strategy and patience, most of you can easily make the dream realized during your lifetime! Don’t be fooled by someone telling you that you can only make money by chasing high flying stocks. Actually it is the opposite for most of people that this strategy will only make you poorer not richer over a long run.
• The second important principle I follow is to avoid a stock-market-based long term strategy that is out of my own control. The most relevant one to me is the life insurance policy. I have talked quite a lot that I’m a big fan of a specially structured Whole Life based life insurance that is guaranteed in return but with a substantially reduced cost to set up. Just a quick note here that I’m not talking about the traditional WL which is indeed very expensive to set up. So don’t need to come back to advise me how expensive WL is. I have set up my WL costing me more than 50% less with all the features I’m looking for: guaranteed tax-deferred return with potential of even much higher dividend returns during high inflation era (which is coming in the next 10-20 years). And all the cash values built up can be used tax free for my retirement and legally protected that can be passed on to my loved ones tax free at death.   
  I often got questions from some friends asking while I was not interested in the fancier and highly promoted life insurance like Indexed Universal Life (IUL). I hope you can better understand why I don’t want to have IUL at all. I’m pretty sure IUL has been doing great in the past 10 years or so but I think it is probably the worst time to buy IUL now given my long-term bearish view on the stock market. The problem with IUL is its uncertainty. People often got confused about the downside protection highly talked about for the IUL and thought IUL will never go down as its worst return will be capped at 0% if the market is going negative. It is half true when you are talking about the investment portion of the policy. But don’t forgot about the nature of IUL: it is an annually renewable term life. As such, the cost for term life will only increase year after year for the policy and will increase substantially higher when one gets older. This cost part is not market based feature and will guarantee to increase regardless. The worst case scenario will be the market is not doing well for prolonged period of time, which is what I expect to come with a high probability, and you get no return at all from the investment portion but the cost for the policy is keeping going up. Eventually this may cause the policy elapse or kaput. If you don’t believe this, just ask your agent to show you the fine print and see if there is such a statement to the effect that there is no guarantee for the policy return with the risk of elapse. You may pay big money upfront to guarantee the policy will never elapse but it will negate the whole purpose of low premium and high return/protection. Just be clear, I’m not against IUL at all, just like I’m not against trading with stocks at all. If the market is doing well, IUL could be a good policy for you indeed. The problem is its long term uncertainty embedded in the design. I don’t want to be told that my money is no longer available after 15-20 years of paying premium, especially when I’m already in 70s or older. I’m not saying every IUL holder will run into this problem but the risk is certainly there for everyone. So, sorry, I’m not putting my serious money into IUL at all. If you want to rely on the stock market to generate income, you will be doing much better with the dividend reinvestment strategy. For long term it is actually extremely safe as long as you are careful about the getting into the quality dividend stocks you hold. I know I may be offending some IUL agents by talking about its risks here but I think it is the right thing to do for me to spell out the potential risks when I see for anything, especially I have been constantly asked about WL vs IUL.  I was burned more than 10 years ago by a universal life policy and ended up losing most of my money after 10 years of paying premium. I just wish I could have been told about the potential risks associated with UL back then. I know IUL has improved a lot compared with the traditional UL but still it has its uncertainty that can never be avoided due to the nature of any UL policy. If you don’t care of the market risk, then no problem to go with IUL. This is similarly a choice of going with the floating mortgage for long term if you don’t care how the loan interest rate will change. But if you want to be sure about the long term outcome, then IUL will not be a good choice, at least based on my understanding of it. Since I’m very bearish for the long term future of the stock market, I won’t touch IUL at all for my money.