ON THE MONEY: Planning for what happens when the financial party ends

By John Grace

Contributing Columnist

For years, America has been throwing one heck of a financial party. Stocks. Real estate. Crypto. Gold. Silver. Private assets. Almost everything went up.

Trillions of dollars of stimulus, near-zero interest rates, and easy money helped turn investing into what I call, thanks to former President Herbert Hoover’s 1952 memoir, the “Orgy of Everything.”

But here’s the uncomfortable question: What happens when the music stops and the bill arrives? Economist Harry Dent has spent years warning that simultaneous bubbles in stocks, real estate and other assets could eventually produce an unusually painful reckoning.

His forecasts have often been controversial, and his timing has not always been right. But investors would be foolish to dismiss the larger issue simply because they disagree with his targets. Bubbles don’t send invitations announcing when they’re going to burst. As Dent said, “The bigger the bubble, the bigger the burst.”

Now add another ingredient: soaring treasury yields. Higher long-term interest rates change the mathematics of almost everything. Mortgages become more expensive. Companies pay more to borrow. Refinancing gets tougher.

The federal government’s interest expense climbs. And investors suddenly have alternatives to stocks that don’t require accepting stock-market risk.

Warren Buffett has described interest rates as financial gravity. The higher they go, the harder gravity can pull on asset prices. Which brings us to another Buffett warning sign: the Buffett Indicator, which compares the value of the U.S. stock market with the size of the U.S. economy.

Buffett once called the ratio “probably the best single measure” of where valuations stand at any given moment. In 2001, he warned that when the ratio approached 200%, investors were “playing with fire.”

Today, depending on exactly how market capitalization and gross domestic product are measured, versions of the Buffett Indicator remain at historically elevated levels. That doesn’t mean the market crashes tomorrow. It means investors should stop confusing “it hasn’t happened yet” with “it can’t happen.”

And for retirees, the stakes are considerably higher. Suppose you retire with $5 million and withdraw 4%, or $200,000 annually. If your portfolio falls 50%, you’re down to $2.5 million. To maintain the same $200,000 income, you’re suddenly withdrawing 8%.

Now you’re selling more shares when prices are down. You don’t have the luxury of simply waiting for the market to come back. That’s sequence-of-returns risk, and it can turn a market decline into permanent financial damage while trying to reach 100.

The financial industry loves to say, “Hang in there. The market always comes back.” Maybe so.

During the infamous 89% Wall Street Crash of 1929, the market took nearly three years to find its absolute bottom. After the Dow bottomed out on July 8, 1932, it took 25 years, around November 1954, for the market to fully recover to its pre-crash heights.

Note: that assumes zero withdrawals. Life expectancy climbed from 57 in 1929 to about 63 in 1933. Regret is the only thing that keeps on giving.

But will you have enough money left if and when it does? The objective isn’t to predict Harry Dent’s crash, or anyone else’s. Since preparation trumps prediction, it’s to prepare for the possibility that the party eventually ends, the music stops, and it’s time to leave. As Buffett put it: “Predicting rain doesn’t count. Building arks does.”

If you’re retired and taking withdrawals, build the ark before you need it. Because after the storm begins, with prices surging, it’s a lousy time to start shopping for lumber.

John Grace is a registered representative with LPL Financial. His On the Money column runs monthly in The Wave. The opinions expressed here are for general information only and are not intended to provide specific advice or recommendations for any individual. Grace can be reached at https://www.westlakefinancialadvisors.com.

LIFTOUT

Economist Harry Dent has spent years warning that simultaneous bubbles in stocks, real estate and other assets could eventually produce an unusually painful reckoning.