Current Conditions Warrant Caution

There are a host of reasons to be cautious at present. Government spending, supported by an avalanche of debt, has propped-up the stock market and the economy, but it cannot continue. As with all borrowings, there must be a lender to provide the loan. After several trillions of dollars of new treasuries issued, one must question who is going to continue to buy new bonds the federal government tries to sell? Following this same reasoning, who is going to continue to buy the debt of the individual state governments?

If we examine the real estate market, it too is supported in large part by debt – buyers borrow from banks to secure mortgages to buy properties. We all remember what can happen to the real estate market when too much debt is accumulated (do you remember 2008?).

If we look at virtually any asset class – stocks, real estate, bonds, art, precious metals, and even cryptocurrencies – all are at or near all-time high prices. Again, we must ask – how can this be sustained?

For markets to continue to move higher from current levels, new money must enter the market. Where will that new money come from? The economy, despite the federal and state governments’ best efforts through borrowing to provide stimulus, there simply is not enough money available to support continued growth for the economy; it’s just too large. Those unemployed receiving unemployment benefits, at some point, will stop receiving those benefits. When that happens, unless they have found jobs, they will no longer be able to pay their bills, spend to support the economy, pay for their mortgages, etc. They certainly will not be purchasing stocks or real estate.

It appears that the current argument for continued growth is that, with the vaccine for the Coronavirus now being distributed widely, that the economy will recover. This is an overly optimistic viewpoint for several reasons. First, even if everyone gets vaccinated, and even if the vaccine is 100% effective against the current strains and any future strains, so that the virus is no longer a detriment to economic growth, thousands and thousands of businesses has failed. Those businesses will never reopen, regardless of any success we have with the vaccine. Second, if we follow the logical progression from the failed businesses, millions of people lost their jobs when these businesses failed (there are at least 14 million people unemployed as a result of Coronavirus right now, and that number grows every week). Without those businesses, there are no jobs available for these unemployed workers, regardless of the vaccine’s effectiveness.

The most important consideration is that there are serious, fundamental challenges to the economy that have been created by the massive borrowing of the federal and state governments. Inflation is a very real probability. Taxes, both at the state level, and at the federal level, will increase (Biden has already stated that he plans to raise taxes). Interest rates have already started creeping up in anticipation of the Fed raising rates to combat inflation. Higher taxes and higher interest rates will reduce borrowing, and will cause refinancing existing debt to be increasingly expensive. All of this – higher taxes and higher costs for debt, will pull money out of the economy, reducing GDP growth, which will likely push the U.S. economy into recession or possibly a depression, depending of the pace of the increases in taxes and interest rates.

With all of this in mind, I recommend caution. Holding significant cash balances is a prudent strategy at this point. Continuing to purchase stocks at ever increasing all-time highs is foolish, and frankly dangerous, especially for those planning to retire within the coming ten years. Keep in mind that the vast majority (almost all) money managers, mutual fund managers, hedge fund managers, and the like, have a mandate to remain 100% invested regardless of how high stock and bond prices may go. This means that the decision to raise cash falls on the investor. In other words, investors cannot depend on their financial advisor, investment or mutual fund manager, to raise cash. It is up to you!

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