When the stock market collapsed in 1932, there was no bell rung that announced the start of the Great Depression.  People went to work the next day completely unaware of the black star that was hurtling in their direction about to consume the wealth and economic life of the country. What they were not aware of was the structural breakdowns in the financial system that had occurred. The resulting drama that affected the lives of everyone unfolded slowly like the metaphor of the frog in the frying pan. It was only in retrospect that many would have made different choices about how they would have prepared for the years ahead. Our capital markets have just had a modern version of a structural breakdown.  None of have any idea of the repercussions of millions of baby boomers entering retirement with only nominal savings. None of us have faced diminishing credit availability. And none of us have witnessed the battle between inflation and deflation, or our currency declining in value, or the central banks running out of ideas to fix it.  We are entering uncharted waters with formidable dangers ahead.

We’re all getting older. Our investment time horizon is getting shorter, and I believe that we’re all growing tired of the volatile market swings that are becoming more and more common.  This isn’t your father’s stock market. To make matters worse, the growth and power behind the derivative products that have come into being in the last 15 years has changed the fundamental dynamics of the markets. Unfortunately, this has occurred at a time when the economies of developed nations have risen exponentially to jaw-dropping levels and free market forces are being distorted by government and central intervention. This is a dangerous mix. While many of these instruments serve the function of risk management vehicles, they also have the ability to make life unbearable for investors who think these are the same markets of pre-2000. The time to recover from an investment mistake is not as forgiving as when we were younger. Perhaps now is the time to forget about trying to make money in the market and simply protect what you have. 

People have sought my advice for many years. Today, things are so bad that I thought I’d put my two-cents-worth in an article in hopes that some investors find some value in it in helping them figure out what the heck to do with the wealth they’ve spent their lifetimes accumulating. I don’t have all the answers; there is no perfect investment in times like these. Everything is an educated guess.  Diversification is still important as always because no asset class is ever in a permanent bull or bear market. I do not mean for my comments in this article to be taken in the absolute and they will certainly not fit all investors with different preferences, time horizons, and circumstances.

I won’t bore you with details about me other than to briefly say that I graduated from a top business schools and spent almost 35 years trading, advising and observing stock, options and commodity markets on an hourly, minute-by-minute, tick-by-tick basis. I’ve done this through seven presidents, countless bull, bear, and flat market cycles, wars and peace. The “feel” one gets from assimilating what news and world events do – or do not do – to price and volume action cannot be reduced to a quant model. Long-time traders develop an intuition that they cannot even explain. However, good intuition has to be tempered with humility and utter indifference. If you are wrong, you take your loss and move on. You have to know when you can “watch it for a while”, and you need know when to move fast. And you have to know when there is high danger.  

We’re in high danger.  The wheels are coming off and the President has his foot hard on the gas trying to get to his destination before the wreck.

So with the aforementioned caveat, I’ll share my thoughts on the different asset classes you may be considering – and one you’re probably not. For sure, the following may likely be at odds with the opinion that you’re going to hear from your favorite financial advisor, money manager, financial show, or pension consultant. Take it or leave it. I hope it is helpful.

Yes. That is, both. Right now we have what feels, looks, and quacks like deflation, but is it? Historically, (and intuitively) a case can be made that you see deflationary forces during a banking crisis.  Inflationary forces generally take hold as the next phase after a banking crisis.  In the past, this took many years before the inflation shows up from all the money printed during the banking crisis. However, unlike the banking crises of the past, we live in a world where data and information travels at the speed of light and is studied by thousands of economists around the clock. As a result, things happen faster and investors have more means at their disposal to react faster than when there was only the pony express, newspaper, and telegraph. 

Right now, if we were having true deflation, one would expect to see the longest duration points on the yield curve to rally the most and see the yield curve flattening – especially in the US Treasury 10s30s segment. Many economists watch this as deflation barometer. In fact, the UST 10s30s curve is near its highs of the last 20 years – but that may be changing. The whole curve has indeed been flattening somewhat, but it has been slow and grudgingly. Are the forces of deflation winning?  Perhaps, or maybe the market is saying that all yields are generally declining because the Fed has to hold fast to this course for the foreseeable future.  Since prices are falling the hardest in (what was) the most highly leveraged asset class – residential and commercial real estate – perhaps what we are really seeing is simply deleveraging. Anywhere else, I am just not observing major price declines in areas such as energy, food, and healthcare. Just as inflation lifts all boats, I’m not witnessing the inverse of this presently.

At the heart of all this angst, of course, is not just “debt”, but “too much debt”. This is what it is all about. This is ground zero of the whole problem. Most investors, of course, are well aware of this, but amazingly continue to look at the asset classes as if this “too much debt” issue exists in a vacuum. “Debt” is ok when you have income to pay it off, but “too much debt” means you can’t, and it is a game changer. According to the Bank of International Settlements, through 2012, about $5 trillion in debt will come due and need to be rolled over. $2.6 billion is European debt and about $1.3 is US. It is a leap of faith to assume that investors’ appetite for debt will improve over the next two years. 

To compound this problem, short-term, politically expedient decisions are being made instead of long-term solutions. The government is cannibalizing the capital our economy needs to grow our way out of this mess with taxes. They are trying to stimulate consumption when the real problem to deal with is reducing the debt. Can you imagine telling a doctor that you broke your arm but he keeps examining your ear? In spite of the trillion dollars that has been thrown at this economy we are now seeing how little it has accomplished in terms of creating jobs and increasing commerce. We are observing this now. We are witnessing the end of democratic socialism.  Perhaps not on a current basis, but certainly on a long term basis, the math does not work anymore. 

When you can’t pay your bills you are going to default. However, if you are a government, you can print more money and keep buying your own bonds. Do not confuse 3% 10-year Treasuries as a sign that investors like these returns. We have 3% 10-year Treasuries because the government prints money and buys these bonds to keep interest rates low - plus the fact that there are few places that global money flows can go into that have liquidity. So don’t over-think bonds believing that these yields represent safety and value.   It is the mother of all bubbles. This works until it doesn’t. 

Assets that were once inflated by debt are now deflating. Deflating assets (declining prices in residential and commercial property) jeopardizes the collateral backing the debt. Most of the money being printed is being held in reserves of commercial banks as reserves for precisely these deteriorating/deflating assets.  This money is not in circulation so there is no “multiplier effect” creating inflation – right now.  Moreover, the Federal Reserve has decided to pay interest to these banks to keep that money there instead of lending it out. This is a relatively new policy change designed to keep that money in the bank vaults. The Fed loans banks short-term money to buy higher yielding long term Treasuries and the banks make the spread. What a deal! It’s virtually a riskless transaction. And everybody wrings their hands trying to figure out why the banks aren’t lending to businesses to help the economy grow? This is so crazy! You can’t make this stuff up! 

This blatant obscenity is to bail out the bondholders of the institutions that got us in this fix to begin with! Too big to fail? Not for me they’re not, and not for the American people. History will show this to be one of the biggest robberies ever committed. But I digress.

Back on topic, in 2002 Bernanke wrote a paper detailing the dangers of deflation. Briefly, he claimed it was easier to take steps to avert deflation than to try to emerge from it once it is firmly established. Of course, we all know the answer to this: print money. Call it quantitative easing or whatever, it is printing money. We’ve seen Act 1 where the Fed basically bought mortgages and a whole alphabet soup of mortgage vehicles. Act 2 is where the Fed observes, “Oh no, this isn’t working! The whole economy is getting sucked into a black hole! We’ve got to buy more assets.” It is like trying to light a fuse with wet matches; sooner or later one of those matches will ignite then look out! So the fed moves out on the curve and starts buying longer-dated US Treasuries, mortgages, and perhaps eventually corporate bonds. This makes longer-dated yields drop (and prices rise). We may be in the blow-off top of a 25-year bull market in bonds. Enjoy it while it lasts.

The US and European bond markets are not “free markets”. Bond rates are being heavily controlled by the central banks. Whenever a market is not permitted to seek its true market value, it always ends poorly. A country can control their interest rate or control their currency. It cannot do both.  To be sure, there will be a point where investors will demand a higher rate of interest to compensate them for the risk they are taking in holding those bonds of a country that is printing money like a madman. Then as those rates climb, it sharply increases the cost of the interest our government has to pay so deficits rise sharply which makes rates rise more, and so on. If the government cannot pay the interest from tax receipts, it will have to borrow more to pay the increasing interest costs. (Yes, that does sound like a Ponzi scheme, by the way.) Conditions will deteriorate until there is some triggering event money will either panic out of bonds and rates will spike (prices plunge) – or the Fed will print money so rapidly that the currency will collapse. Hyperinflation is generally caused by a currency breakdown. In my humble opinion, we could go from runaway deflation to hyperinflation in a matter of weeks. Those hoarding cash in runaway deflation could wake up to find their assets have evaporated because of some emergency action by the Federal Reserve. They have done it before as recently as the early 1970’s when they closed the gold window suddenly. For foreign holders of dollars who used to be able to exchange their paper for gold, it was clearly a defacto default.

Either scenario will decimate bond holders. It has to. Bonds/debt is where the bubble is. I believe this has to be the end game: Bondholders will be wiped out. What else can become of  bad loans? As Harvard professor Niall Ferguson has said, “Treasury bonds are safe until they are not.”

This is the last chart that Wall Street and the financial media want you to see. It is from the consulting firm, DALBAR’s latest study on the 20-year annualized investment returns by asset class versus investor returns from 1990 to 2009.

For their methodologies and past studies, Google search: DALBAR and investor returns and read these sobering studies.

Beat the market? Most investors cannot beat the inflation rate! Even worse, 75% of the money managers cannot beat the S&P 500. So why not invest with the other 25%? Because every year it is a different 25% who beat the market! Keep this in mind as you watch the “experts” on CNBC.

It is almost impossible to be a passive investor. The Dow was at 10,000 in 1998. It is under 10,000 now as this is written. Sure there were dividends, but at the same time don’t forget to adjust those returns for inflation. And while you’re at it, what are the risk-adjusted returns? Most of all, what kind of gut-wrenching volatility and indigestion did you have to endure to get those zilch returns?

If you take anything away from this chart, be it this: Do not think you are going to protect your wealth in (this current economic climate above all) by investing in the stock market. We see these fantastic swings in market averages and we intuitively transfer that to how much money we could make. However, it is an illusion, a mind game. Seriously now, certainly you have probably made some money on some stock or mutual fund purchases over your investment lifetime. But have you ever gone into your office, locked the door, and tried to tally all of your investment returns and figure out what your track record was.  Investment returns do NOT equal investor returns. Be careful of relying on any market returns you hear. They are usually quoting the last 50 years of returns, like these are birthrights. Statistically, they are quoting a data set whose meaning is severely overstated. The market returns for the past 50 years were based upon a unique set of world events, demographics, industrialization, technological innovations, capital flows, and social values. That was then.

This is critical to your understanding on where you want to commit your hard-earned money. I’m not saying to completely abandon stocks, but the best returns came when our country was producing something of real value like machinery/industries, or houses for baby boomers, or energy, or most recently (the 90’s) technology. I don’t see that in today’s macro picture. What’s the macro theme, emerging markets? Perhaps. But this country has no “big theme” to get behind and none in sight. What’s the engine that’s going to get people employed again? I do not know. 

Energy should be front and center, but I don’t see any revolutionary initiative in this direction. The Department of Energy was established on August 4, 1977. It went from zero employees to 16,100 employees and 100,000 contractors today and this nation still has no comprehensive energy policy. What do these people do all day? How much world growth from economies recovering from a recession/depression can you reasonably expect in the years to come if energy prices escalate as we approach peak oil?

If my guess is right about the direction of our currency then, yes, you do want to have your money in some hard assets rather than paper. At some point a house will have a value of x. I just do not know what x is, but I do know we are getting closer to it as values deflate. It will probably be when rent costs and mortgage payments become similar. I don’t think you can go too far wrong with that broad rule of thumb.

I have even less of a feel for commercial real estate. As malls, offices, and businesses close or move to the online virtual world, we are changing patterns of how we conduct commerce. (Who doesn’t see something in a store, then searches for a cheaper price online?) Those business spaces may never be occupied in the future.  We are always going to have stores and offices, but when you consider the degree of overbuilding we did in this country, there is an enormous amount of excess capacity at the same time the economy is shrinking. Investors bold enough to step into this area must have adequate capital to endure the fixed costs required to carry some of these properties for an indefinite period of time. I know there are steals of deals out there, however if breakeven is many years away, investors need to do some serious soul searching if their property will be commercially relevant at that time (will tenants return) and what their annualized returns may be when they look back and run their rate of return calculations.

In times like these and based upon everything I mentioned above regarding these perilous economic times, gold absolutely makes a lot of sense. It is a place holder. It has been a store of wealth throughout history and that has been a heck of a track record. The central banks are always talking down gold, but that does not explain why they own about third of all the gold that has been mined since the pharos. 

The traditional arguments against gold are that you cannot eat it, it will be difficult to use it at your grocery store, and it pays no dividends. Then you have to figure out where to store it. You could use a depository, but the government could demand to look into your safe deposit box. You could keep it in a safe at home, but that won’t do much good if a bad guy holds a gun to your head or your child’s head.

The biggest fear that I have heard voiced is that the government could confiscate gold like they did in the 1930’s. However, they don’t have to. They could accomplish the same thing by suddenly passing a 60% tax when you go to sell it.  Think about this; even threatening to impose a tax like that against the “evil gold hoarders” would drop the price 25% overnight. There’s already the reporting framework in place: it was slipped into the voluminous Health Bill (of all places) that our politicians recently passed! Checkmate! They gotcha!

Before I answer this, let’s take a step back.   The early 1990’s ushered in the advent of the FIRE economy – Finance, Insurance, and Real Estate. For the past 20 years this country has excelled in creating imaginary wealth through financial engineering and growing our services industry. Consider how fundamentally absurd this is. No wonder our economy is in the tank! It is a miracle it didn’t happen sooner! 

True wealth is created from taking raw materials and creating something of value that people need or discovering new technology that increases productivity. This is how our country became the greatest nation on earth. This is why China and other emerging countries are growing so strongly – they are producing things. 

Common sense tells us that the safest place to invest our money is to trade these foolish paper representations of wealth (today’s US dollar) for something that people will need. Just to name two, we’ll need energy and we’ll need food. Today’s iPhone or the hottest app will be tomorrow’s dinosaur. There was a time when it looked like General Motors, or Microsoft would own the world. They had transitory products. Competitors overtook them. By the time you figure out that the party is over, the insiders will already be long gone.

Regarding energy, you can buy energy stocks, but keep in mind that, like any stocks, they are prone to dilution, poor management, having their reserve’s depleted, or – God forbid – an environmental disaster. Remember, there is no perfect investment. 

Farmland investing is not a get rich quick scheme. It is a quiet asset class with cap rates running about 3%-6% annually, plus (historically) the land has appreciated at about the rate of inflation. That’s not bad. In fact, it has been one of the best investments of the last 40 years. It has had lower volatility than bonds and higher returns than stocks. 

Everyone remembers the plight of the farmers during the Great Depression and the Farm Aid concerts in the 1980’s. What did they have in common – high debt levels, leverage. Today, there is very little debt in US farmland, so it is in strong hands. That’s why land prices have been so stable and investment grade properties are so difficult to find. Read: easy to live with as an investment.

I don’t know if this can be repeated in the future, but indeed the fundamentals for the foreseeable future are promising. The quantity of arable land is decreasing every year from erosion and development. The millions of people in the emerging market countries who are entering the middle class are demanding better diets which imply more meat which translates into higher feed usage. It has been written that if everyone in China ate two eggs per week, it would take all the grain produced in Canada just to feed the chickens! That’s how perilous our food supply is on this planet. When you add in the increased variability in weather patterns, the delicate supply/demand balance could be easily tipped.

Farmland in the United States is the best on the planet. We have been blessed with lots of arable land, good growing seasons at our moderate latitudes, good soils, rainfall, ocean ports on three sides, road, rail, and river transportation as well as ample storage facilities. 

Many people are befuddled or intimidated at the mention of farmland investing. Don’t be. Owning farmland as an investment is easy to understand if you are working with a knowledgeable individual who specializes in this niche and can give you guidance; it is surprisingly easy to understand. Institutional and high net worth investors have quietly been in this space since the early 1980’s. They use property managers who specialize in farmland management. For a relatively nominal fee, they can handle all the supervision, marketing, and reporting for you. Like any real estate, farmland cannot be sold overnight. However, investment quality farmland offered at a fair price sells very fast. 

The minimum practical investment size will begin in the $1 million range and this is clearly not in everyone’s budget. However, in today’s economic climate - and compared to the other asset classes - it is a good investment, a comfortable oasis, with a bright future for as far as the eye can see. US farmland is a fine place to store a portion of your wealth. 

Conclusion