Between Rock And A Hard Place: The Great Devaluation

May 18, 2022

Between Rock And A Hard Place

First we need a plan. Then we need to know how to execute that plan.

Welcome to today’s financial markets, where there seems to be no place to hide.

Today witnessed a bloodbath in the equity markets with major indices down 4% or more on the day, their worst day since June of 2020.

Of course, it’s not just today.

Stocks and bonds have been getting hammered this year. Real estate valuations have exploded and 30 YR mortgage rates have nearly doubled, making housing a far less attractive option.

This is all occurring while the US Dollar is devaluing against real tangible things.

Gas, food, airline tickets, you name it have all increased in price as inflation roars.

The bigger problem that few understand is that while the dollar is getting weaker due to inflation, it’s getting much stronger relative to other currencies.

One year ago, the dollar traded around 90 on the DXY. Today the DXY has the dollar trading at roughly 103. So, while the dollar is devaluing against real tangible things and because of inflation, it’s actually getting stronger against the other inflated currencies against which it is measured.

The dollar has now become a wrecking ball that is smashing the global economy. It’s tearing down stocks and bonds and there may be no relief in sight.

The Federal Reserve seems more committed now than at any time since the early 1980s to raise rates to fight off inflation. As we all know, fighting the Fed is not a great idea.

What does it all mean?

We believe it means we are in the midst of The Great Devaluation. A time when all currencies devalue, where stagflation becomes the new normal, and when investors across the world must consider a new plan.

Before jumping off a proverbial bridge because everything is getting crushed, investors would first do well to put things into perspective. The year to date declines are coming after an explosive move higher over the last eighteen months.

Let’s not forget, in November of 2020, as our country voted for President, the S&P 500 was trading around 3300 points. The feeling then from most conservative investors was that equities could fall 50% without Donald Trump in office.

What makes you think they can’t now?

The Fed continued to pump money into the system for way too long. It led to a massive bubble in paper assets. Now that the Fed and the current administration must face inflation, it seems there is only one move that the Fed can make, and that is to tighten monetary policy further.

That pivot has left most investors looking at the carnage and stuck like deer in the headlights without a plan.

So what should investors do?

We are not financial advisors, so we are not permitted to offer financial advice. We can, however, highlight what we know about the past and offer ideas on how investors may want to think about the future.

Start here.

Rather than consider what has been lost so far this year we believe it’s worth considering how far we have come, how much lower things could actually fall, and why now may be the most important time to make changes to the portfolio, especially when we consider the Federal Reserve's intent on significantly tightening monetary conditions.

The reason stocks and bonds exploded so high in the first place was because the Fed had their foot on the gas. Now that their foot is on the brake, it seems fair to expect that stocks and bonds could continue to fall significantly lower from here.

Mike Wilson, a highly respected and closely followed strategist from Morgan Stanley, believes that stocks could fall another 15% and that the S&P 500 will fall to 3400 points. Wilson is the Chief Investment Officer for US Equities at Morgan Stanley. In a note released on Sunday night he wrote, “We remain confident that lower prices are still ahead…In S&P terms we believe that number is 3400 points.”

Jeremy Grantham, perhaps even more well known than Mike Wilson, who many people believe to be among the greatest investors of our time, has targeted 2400 points on the S&P 500. He believes we are in the rarest of all super bubbles and that stocks have much further to fall.

Which is why it shouldn’t surprise anyone that Goldman Sachs has lowered their year end target for the S&P 500 times this year. In December, the optimists at Goldman predicted a 5100 point year end ‘22 target. In February, they lowered this target to 4900 points. In March, they lowered it again to 4700 points. Most recently, in May, Goldman Sachs targeted a year end of 4300 points for the S&P.

We have often highlighted this Wall Street game.

The big investment banks must continue to “re-adjust” their targets so that they don’t look like absolute idiots when we see how wrong they were at the end of the year. Never forget, investment banks are in the business of selling us why everything will go higher. Don’t be surprised when Goldman comes out and re-adjusts their year end S&P target even lower.

It is rare indeed to find honesty like Mike Wilson at Morgan Stanley.

It’s why we must ask ourselves a couple of critical questions...

What is our plan? And, perhaps even more importantly, who is selling us on this plan?

Here is the Wall Street way…

There are three simple questions most investment advisors are trained to ask. A version of the following conversation happens thousands of times a day between financial advisors and potential new prospects throughout our country. In fact, it's virtually become a script.

1. Do you want to win, (Prospect Name)?

The answer to this question for most is simple. “Yes, I absolutely want to win.”

2. OK, great. By how much do you want to win?

The answer to this question is less obvious. “Uhhh… A lot I guess.”

3. Great. When do you want to win by?

The answer to this question is even less obvious. Most people will say, “I don’t know. I hadn’t really thought about that.”

This is the point where Wall Street investment advisors trot out the “we need a plan” part of their presentation.

It’s true. Everyone needs a plan, and the plan should be tailored to our goals, and it should be tailored towards the environment.

Most folks are long-term investors, and most financial advisors have been taught the Wall Street method that the right way to invest long term is to own stocks and bonds.

The most common next step is to highlight what everyone thinks they already know. It is here when the 40-year-old recommendation of owning stocks and bonds gets promoted. This recommendation is typically done by asking a fourth question.

4. “You are aware, (Prospect Name), that stocks and bonds always go higher over time, right?”

To which most people then say…“Well that’s what I have heard, yeah.”

This is when the financial advisor recognizes he likely has a new client. From here, and in order to really close the deal, the advisor will offer slight modifications depending on a prospects age and perhaps tailored to which is more important to the client, income or growth.

In the end, most investors will receive a cookie cutter version of the 60/40 stock and bond portfolio model as the “plan” that has been deemed the best and “most diversified” and with the most proven track record of success.

None of this is in any way particularly wrong.

In fact, this is the strategy that almost everyone today is following. Unfortunately, the plan is backward looking rather than forward looking. The entire program relies on interest rates that remain muted and stay low over time. As we have continued to teach our subscribers, stocks and bonds have historically been awful places to invest when inflation remains elevated for an extended period of time.

It’s why, at this moment in the presentation, today’s astute investor might want to insert a question of their own:

“I do have one question, (Advisor Name), how will this plan work for me if we continue to see high inflation?”

Most financial advisors are completely unprepared to answer this particular question.

We have not had a period of elevated inflation for forty years. Most advisors have never personally experienced high inflation in their careers. Questions regarding inflation are not even questions most advisors have even been taught to consider.

Almost nobody, before recently, believed inflation was of any real concern. Few have been thinking about aggressive runaway inflation that is currently becoming embedded in the economy today.

We at Brentwood Research have. We wrote a national bestselling book on the topic before any of today's inflation was evident at all. It's called The Great Devaluation.

It’s why we are so committed to sharing what we believe to be the truth with our readers.

Wall Street can’t tell you the truth. Most on Wall Street don’t even know it themselves. Those that do are not in any way incentivized to share it. So, if you are expecting good advice regarding inflation and how to position for it, looking to Wall Street for answers is not likely a great place to start.

Here is what you should know.

The last highly inflationary period in this country was in the 1970s.

While nobody can predict the future, we can all be more aware of the past. Investors would do well to understand what happened to stocks and bonds in the stagflationary 1970s.

Let’s start with bonds in the 1970s.

In December of 1970, the 10 YR Treasury offered a yield of 6.5%. Eleven years later, in September of 1981, yields on the 10 YR Treasury had risen to all-time highs of 15.8%.

This means that Treasuries had lost more than 50% of their value during this eleven-year span.

Ok. Well, how did stocks do in the stagflationary 1970s?

Here things look a bit brighter. In December of 1970, the Dow Jones traded at 838 points. Twelve years later, in February of 1982, the Dow Jones traded at 838 points.

Most people look at this and conclude that stocks held up pretty well during this time frame. I recently spoke with an investor who told me his advisor told him that stocks were the very best way to offset inflation.

History does not agree.

It is true that on a nominal basis stocks were flat in the 1970s. An investor who had $100,000 in the Dow Jones in 1970 would have roughly the same $100,000 eleven years later in 1981.

The problem is not with the number of $100,000. The problem is with the value of that $100,000.

A postage stamp cost 6 cents in 1970.

In 1981, the same postage stamp cost 18 cents.

So, while investors who kept their money in the Dow Jones had a nominal breakeven during the highly inflationary 1970s, the reality was that the dollar lost 66% of its purchasing power during this eleven-year period.

It’s why, if you are of the opinion that inflation is embedded and here to stay, as we at Brentwood Research believe, you would do well to think about a different plan than the 60/40 stock and bond model moving forward.

There is evidence that the 60/40 model is dying.

Here’s what has happened in the short term.

Year to date, stocks have been getting hit hard and are witnessing extreme volatility. The NASDAQ is in a bear market, having fallen more than 27% so far this year. The S&P 500 is teetering at bear market territory, down more than 18% on the year. The Dow is down over 14% on the year.

Unfortunately for investors, it’s not just stocks that are getting creamed.

Figure 1 below is a chart from Bloomberg Finance published last week. It indicates that April ‘22 was only the fourth month in the last 50 years where the S&P 500 fell more than 5% and Treasuries simultaneously fell more than 2%.

According to the Wall Street Journal, this year has witnessed the worst bond market since 1842.

In an article titled, It’s The Worst Bond Market Since 1842, the journal wrote the following; “Long-term Treasury bonds lost more than 18% this year through April 30. That surpasses the previous record, a loss of 17% in the 12 months ending in March 1980..The broad bond market has performed worse so far in 2022 than in any complete year since 1792 except one. That was all the way back in 1842, when a deep depression approached rock-bottom.” [1]

Wait! Are we in a deep depression like we were in 1842?

It sure doesn't seem so to most people.

The stock market cap is roughly 200% of GDP. The unemployment rate of 3.5% is near the lowest in the history of the country. The dollar is stronger than it’s been in 20 years. According to these numbers, it may appear like we are in the best shape we have ever been in.

It’s why we must always seek to measure truthfully.

We posed this question in The Great Devaluation. We believe it’s a critical question every investor must answer. We think it should be added to all financial advisor's "scripts".

5. How will you know if you are winning?

You see, it’s only when we ask that question do we realize that the Wall Street way has far more holes in it than history may suggest. Factor in the following before assuming that stocks and bonds are the best way to invest for the long term.

In January of 2000, the S&P 500 traded at 1455 points. Today it closed at 3923. That’s pretty good, right?

This means that from 2000 to today, the S&P 500 is up a total of 169%. Were we to have reinvested all of our dividends throughout this period, the S&P 500 would be up roughly 350%. That seems like a very good return.

Wall Street’s advice has been good on bonds too. Bonds have also done well over the last 20 years. The ETF TLT was created by Barclays on July 22nd, 2002 and measures the performance of long-dated US Treasuries.

Since its inception, TLT is up 36%.

Let’s now do some math…

Let’s say we invested $100,000 in the 60/40 model over the last two decades. Our 60% in stocks after dividends would be worth roughly $270,000 today ($60,000 x 350% = $210,000 + our $60,000 initial investment = $270,000)

Our 40% invested in bonds as measured by the ETF TLT would be worth $54,400 ($40,000 X 36% + the original investment of $40,000).

This means that the 60/40 model recommended by Wall Street has yielded a total return of about $225,000 in profits over the past two decades. Investors following this basic formula would have an overall account value of roughly $325,000 today.

Well, this doesn’t sound too bad. Stocks and bonds have definitely gone higher over this time.

But, does this make it the best way for longer term investors to invest?

We believe not. Keep in mind that our first book was called, Gold Is A Better Way, and identified the secret that Wall Street didn’t want us to know.

What is that secret?

Well, twenty years ago, in January of 2002, the spot price for gold was $278. Today, the spot price for gold is $1818. That’s an increase of 550%. Based on this spot increase, a $100,000 investment in gold made twenty years ago is worth roughly $650,000 today.

What?!

Are you saying that the strategy of just buying and holding $100,000 worth of gold for the last two decades would have been better than putting the same $100,000 into stocks and bonds according to the Wall Street 60/40 plan?

Yes, and it’s not even close.

Ask yourself, would you rather have $325,000 or $650,000?

That’s how dominant gold has been relative to the paper markets over the last twenty or so years.

But here is where it gets all the more interesting. We must look at the world from where we stand today and where we are headed.

On the year, stocks are down roughly 20%. Bonds are down roughly 20%. Gold prices are the same. Gold opened the year at $1820 per ounce. It closed today at $1817 per ounce.

We like to focus our attention on the long term. If you are a long-term investor, that horizon we believe should be ten years.

The question you may want to ask yourself now is, how did gold perform during the last elevated inflationary timeframe we have been discussing – the 1970s?

Gold prices rose roughly 20X in the 1970s, from $42 in 1970 to $800 in 1980.

Here is the point.

During historically extended periods of higher inflation over the last 50 years, gold prices have dramatically outperformed paper assets. If the next decade is like the 1970s, and markets were to perform similarly, rather than witness losses of the purchasing power in stocks and bonds of roughly 50%, investors who chose to transfer out of paper and into physical gold could see gains of 20X.

This is why we believe long term investors would do well to consider a new long-term plan.

Our subscribers know well that we believe owning physical precious metals within the portfolio is something every long term and serious investor should consider.

The above math explains why we feel so strongly.

But investors also need to know how.

Remember, once we know where we are headed, we need to know how to get there.

Best regards,

Adam Baratta