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Navigating the Next Recession Part Two

Accurate Forecasting
So, what led to this level of success? To start, I believe it was the accuracy of my historical forecasts, particularly leading up to the financial crisis. Here’s just a sample.

The housing-market correction.

I forecast the housing depression of 2007, writing in the March 2006 Navigator newsletters, “In the next five years, house values are going to return to their 1997 levels plus inflation.” In the second quarter of 2006, the S&P/Case-Shiller Home Price Index reached an all-time high of 188.93, and as I had forecast, in the second quarter of 2009, it hit a low of 111.11.

The gold rally.

I forecast the gold rally, writing in the January 2007 Navigator newsletters, “My long-shot prediction of the year is gold (the single worst asset class over the last 10 years) will rally.” In the January 2008 Navigator newsletters, I continued this thought, writing that gold would reach $1000 per ounce, and in the January 2009 Navigator newsletters that gold would reach $1,100 per ounce.” At the time of my initial forecast, gold was selling at $625 per ounce. In May 2008, it reached $1,000 per ounce, and on November 6, 2009, it reached $1,100 per ounce.

The recession of 2008 and 2009.

I forecast the recession months before anyone knew it had started, writing in the December 2007 Navigator newsletters that the “recession risk increased from 60 percent to 70 percent in 2008, and in the January 2008 Navigator newsletters that “a recession begins in the middle of the year.” In December 2007, growth of gross domestic product (GDP) was 2.1 percent. From July 2008 through June 2009, GDP growth was negative for four consecutive quarters. Looking back, we now know that the recession formally began in December of 2007, and lasted 18 months, until June of 2009.

Skyrocketing unemployment.

I forecast skyrocketing unemployment, writing in the January 2009 Navigator newsletters that unemployment would reach 10 percent nationally. The national unemployment rate began 2009 under 7 percent, and on November 6, 2009, in line with my forecast, unemployment broke 10 percent nationally.

The Flash Crash.

I forecast the quick drop in stock prices that occurred on May 6, 2010. In the January 2010 Navigator newsletters, I called for “the first 1,000-point down day in the history of the Dow Jones Industrial Average in 2010”. In the Flash Crash, the Dow plunged approximately 1000 points (around 9 percent) in one day! It was the biggest one-day point decline on an intraday basis in Dow’s history. I refer to this forecast as a “Jackpot”.

The end of the bull market for bonds.

I forecast the end of the great 29-year bond-market, rally, writing in the January 2012 Navigator newsletters, writing, “It’s as simple as this: When you have interest rates this low, eventually inflation starts to come back. And the way you tame inflation is by increasing interest rates. And when interest rates go up, bonds prices go down.” By 2013, it had happened: Bond yields entered the year near all-time lows. “Ouch,” said a June 15, 2013, Barron’s article entitled “What Goes Up Must Come Down.” “Bond investors knew they could be in for pain this year, but maybe not the body blows that have battered them from all directions over the past six weeks.”

This is just a sampling of my forecasts, but I think it’s important to provide more. After all, I’m an economist, and it’s my job to make accurate forecasts. Reviewing my past predictions is the only way to check up on how well I’m doing my job. Too many of talking heads on financial news channels are masters of predicting what just happened.

To build credibility regarding my forecast of the next recession, in the appendix, I provide excerpts from a number of articles I wrote before and after the Great Recession. As you’ll see, if you take the time to read them, I had begun to see the cracks developing in the U.S. economy as early as January 2008. I felt strongly that these cracks would widen as the year progressed, leading up to a recession starting in the middle of 2008. I conclude the appendix with my all-time favorite article, “This is Not Your 2006 Economy,” which I wrote in May of 2009, around the same time the $863 billion economic stimulus package was passed. In it, I used my love of classic muscle cars to illustrate where I thought the economy was heading—and unfortunately, for most Americans, I was correct.  

I hope you’ll read these articles because they were written in real-time, without the benefit of hindsight. They’ll show you that my forecasts about what the so-called Great Recession would look like were pretty accurate. Seeing that, I believe you’ll listen more carefully to my advice on how to best navigate the next recession.

Recession Rules to Live By
Your only choice is to navigate the recession, but that’s easier said than done. It will take some hard work as well as some sacrifice. Here are my suggestions.

Live below your means. In times of peace, it’s important to prepare for war, so start a war chest today. Avoid accruing debt by never using credit to take a vacation, go out to dinner or finance a car your more then four years.  Save a little each month—even if it’s just the change in your pocket.

Don’t try to ride it out. As I’ve noted, the S&P 500 Index returned an annualized 4.24 percent over the past 15 years ending June 30, 2013, and that included dividends. With inflation rising, 4.24 percent is barely a return at all. And, you could actually lose money, because markets don’t always come back. The Nasdaq Composite Index hit 5000 in 2000, and now, 13 years later, is only at 3500. The list of stocks that hit an all-time high then never reached that price again is almost endless. Remember Apple at $700 per share.

Learn to say NO to your kids.  I have three children (two adult) of my own so I can speak as a parent. Never tap your retirement account for your children’s needs, other than medical of course. You need to retire more then they need a new phone, a vacation, a car, new sneakers etc. Yes, this includes education.  I know this is a hard one but NEVER touch your retirement to even educate your kids.  I am not saying that you shouldn’t help to pay for education.  But if you need to withdraw money from your retirement plan, pension and/or 401(k) to do it you can’t afford it.

Save after-tax money outside of your retirement accounts. During the recession, you’ll need money you can access without penalties.

Keep some money in cash. Even with today’s very low interest rates cash must be a part of everyone’s portfolio.

Invest the rest in a no-load mutual fund. Many have monthly minimum investments as low as $100, so open an account today and set up an automatic monthly investment account (as long as it’s not a target-date fund, as I explained in Chapter X). Good, all-weather no-load mutual funds with very low monthly minimums include Oakmark Equity Income Fund (OAKBX), PIMCO Total Return Fund (PTTDX), American Century Equity Income Fund (TWEIX), Vanguard Wellington Fund (VWELX), and Schwab 1000 Index Fund (SNXFX).

If you’re already retired, protect yourself even more. Move two to three years of distributions to a high-yielding money market fund to ensure you have enough cash to cover expenses in the event of a market downturn.

Do not retire until your debt is.  Retiring with debt is like filling a swimming pool that has a leak in it.  You don’t really know how much water you are going to need.  I find I am doing more and more retirement plans for a individuals and couples that plan on carrying debt into retirement.  When someone asks me “when can I retire?” I always say the soonest is the day after you are debt free.

Ensure that you keep your portfolio risk low. As I’ve shown you, two similar investments with different levels of risk can produce dramatically different returns. If you don’t know your portfolio risk, you have the wrong financial advisor. And don’t assume you can set it and leave it; do regular portfolio checkups to ensure you’re portfolio risk remains low.

Don’t be afraid to take profits. Remember, an investment’s gain isn’t yours until you sell the investment. Taking a profit is the only way to make money in the stock market. Trim the winners that are the most risky.

Get a financial advisor. I know brokers and financial advisors are ranked only barely above politicians when it comes to public trust, but you can’t let that stop you from getting help when it comes to investing. You simply can’t go up against the professional Wall Street sharks on your own. My advice is to ask a trusted friend or colleague who they use (but under no circumstances should you hire a friend; money does strange things to people and even stranger things to friendships). When you have some candidates, consult any one of many good web sites that list the questions you should ask an advisor.

Navigate Carefully
There you have it. I’ve showed you that I saw the Great Recession coming, and I gave you a road map for surviving and possibly even thriving during the next one—and it all comes down to economics.

I know, the nine steps I provided don’t seem economic in nature. But, every major decision you’ve ever made involves economics. Whether you realize it or not, we’re all a tiny part economists. The economist in you subconsciously helped you select the college you attended or didn’t attend, the last car you bought, the last vacation you took, even your life partner.

That economist helped you by telling you how to evaluate what you were getting and what you were giving up with each choice. So, if you remember one thing from this book, it’s this: Take that tiny part of you that’s an economist and apply it to your investments. Ask yourself, before you choose an investment, “What am I getting and what am I giving up to get it?”

For example, if you’re thinking about investing in a government bond, what you’re getting is a fixed interest rate and a promise to pay back your principle, and what you’re giving up is an opportunity to grow your investment at a much higher rate. Or, if you’re thinking about investing in an aggressive-growth mutual fund, what you’re getting is access to a part of the market that will appreciate the most in up markets, and what you’re giving up is not putting your principle at substantial risk. 

So, I challenge you to put the economist in you to work, because I believe most of us have the ability to see what we’re getting and what we’re giving up on a daily basis, even when it comes to investing. Practice it a few times, and it will be old hat in no time. If you can answer the question and are comfortable with your answer, then I think you’ve made a good investment choice. But if you (or your financial advisor) can’t answer what you’re getting and what you’re giving up to get it, just say no.

My Fiscal Solution

A fiscal mess, in part, is lead us to the 2008 recession, but I have a way out of it. Politicians may not listen, but you will, and remember, you vote in elections.

1. Cut corporate income taxes to 25 percent. It will unlock the billions of dollars sitting in foreign banks and encourage more businesses to invest their capital.

2. Cut capital gains taxes to 10 percent. We MUST encourage all of us to grow our capital. Remember when capital is created so are news taxes and jobs.

3. Move towards a cashless society, thereby eliminating the tens of billions of dollars of business transacted each month that goes untaxed.

4. Create a progressive national sales tax that will tax the wealthy more than the middle class, and will capture off-the-books earnings when money is spent. (Basic necessities such as food and clothing should be exempt.)

5. Ratchet up Federal Insurance Contributions Act (FICA) tax contributions to the poverty level (because no one should pay a penny in payroll taxes until they reach that level), and raise the corresponding amount above the cap to make up the difference.

6. Provide Social Security benefits only to those who need them, because Warren Buffet, Derek Jeter, Brad Pitt, Sofia Vergara, Matt Lauer and Oprah Winfrey don’t really need a benefit that was designed to keep retirees out of poverty.

7. Install a millionaire tax on all income above $1 million.

8. Create a national lottery with proceeds that go directly to pay our ever-growing national debt.