Last week’s post about the record high “Quit Rate” of American workers generated a fair amount of feedback. Some said “it’s about time” that workers finally gained some leverage over greedy employers, but the majority questioned the wisdom of workers flexing their bargaining muscles at this stage of the economic cycle. They said it was irrational exuberance at best, foolhardy at worst, particularly for younger workers who haven’t been through a full economic cycle before.

Speaking of irrational exuberance, several of our clients have been interviewed in the national media about whether our economy and financial markets are heading into bubble territory.

Dr. Guy Baker, CFP, Ph.D founder of Wealth Teams Alliance (Irvine, CA) said a bubble occurs whenever one sector of the economy is doing much better than would be expected if it were not for a few specific factors in play. “The dot-com boom became hyperextended because more and more dollars were flowing into companies that had no viable economic record,” added Baker a member of the Forbes 250 Top Financial Security Professionals List and author of The Great Wealth Erosion, Manage Markets, Not Stocks and Investment Alchemy. “The gold rush mentality drove the urgency to not lose out. As a result, the value of Internet companies soared and became a bubble,” observed Baker. “When the bubble popped, only the strong survived. When we look at bubble thinking today, the only real bubble driven by economics is cryptocurrency,” he added.

Regulatory bubble

While some readers also pointed to meme stocks like GameStop, non-fungible tokens and the boom in SPACs, Baker said he is more worried about another type of bubble that most folks aren’t paying attention to – the government regulation bubble. “We saw this in 2009-2010 when the government caused disfunction in the mortgage market,” explained Baker. “Homebuyers were able to qualify for mortgages based on nothing more than their signature and a statement of ‘fact.’ The free money came home to roost when the economy slipped, and these homeowners walked away from the houses leaving the lenders with an empty house and an inflated value,” he added.

Baker maintains that economic bubbles are part of the capitalistic system, and usually isolated to the companies affected, but regulatory bubbles are not. “They are dangerous and can cause huge damage to institutions and businesses,” he added.

So, how can investors protect themselves from speculative investments related to economic bubbles?

The best way to protect yourself is through wide diversification, advised Baker, adding that in a “well-balanced, smart portfolio” most of the companies that would be “disasters when a bubble burst” will not be included in the mix. He prefers ETFs and mutual funds that are well diversified. “It’s important not to buy funds that do the same thing,” said Baker. “Also, stay away from funds that say one thing and do another. Low turnover is a key metric to watch. Low turnover means the portfolio managers are making good choices and sticking with them. High turnover suggests the fund is chasing yield.”

Five stages of an economic bubble

In his landmark book Stabilizing an Unstable Economy (1986), economist Hyman Minsky identified five stages in a typical credit cycle which follow the typical stages of an economic bubble:

1. Displacement. Investors get enamored by a new paradigm, such as an innovative new technology or interest rates that are historically low.

2. Boom. The asset in question attracts widespread media coverage. Fear of missing out (FOMO) on what could be a once-in-a-lifetime opportunity spurs more speculation, drawing an increasing number of investors and traders into the fold.

3. Euphoria. Caution is thrown to the wind, as asset prices skyrocket. Valuations reach extreme levels during this phase as new valuation measures and metrics are touted to justify the relentless rise. The “greater fool” theory plays out—the idea that no matter how prices go, there will always be a market of buyers willing to pay more.

4. Profit-Taking. Believing the bubble is about to burst, the smart money starts selling positions and taking profits. But estimating the exact time when a bubble is due to collapse can be a difficult exercise.

5. Panic. It only takes a relatively minor event to prick a bubble, but once it is pricked, the bubble cannot be reinflated. In the panic stage, asset prices reverse course and descend as rapidly as they had ascended. Investors and speculators, faced with margin calls and plunging values of their holdings, now want to liquidate at any price. As supply overwhelms demand, asset prices slide sharply. Think the early days of COVID or the 2008-09 global financial crisis.

Most think we’re somewhere between Euphoria and Profit-Taking. But, as economist John Maynard Keynes famously said: “the markets can stay irrational longer than you can stay solvent.”

What’s your take? I’d like to hear from you.

Conclusion

As billionaire value investor, Seth Klarman likes to say: “At the root of all financial bubbles is a good idea carried to excess.” Or as Warren Buffett always says: “Be fearful when people are greedy and be greedy when people are fearful.” I’m not sure whether we’re in a bubble or not, but like most things in life, the truth usually lies somewhere between the extremes.

#economicbubble, #irrationalexuberance, #investing, #diversification, #GuyBaker

After a year like 2020, many were hoping for some normalcy in 2021. It didn’t last long. This first week of the new year saw a record number of Covid deaths, an armed insurrection of the U.S Capitol, a surprisingly weak jobs report, new calls for Presidential impeachment, Democrats gaining a Senate majority for the first time in a decade, and a jet liner disappearing shortly after takeoff with 62 passengers on board. Whew!

Sounded like a bad Hollywood movie script, but sadly it wasn’t.

Despite the market’s resilience (for now), it was enough to test the resolve of even the most optimistic among us. I’m sure you received calls from nervous clients asking if it was time to take a more defensive position. See what’s keeping your peers and their clients up at night.

In these extraordinarily volatile times, several advisors who participate in our PR Light program shared common sense wisdom about maintaining one’s financial cool during unsettling times. We hope you find their insights comforting and enlightening:

1. GUY BAKER, PH.D. (Wealth Teams Alliance, Irvine, CA) told Forbes that not all assets are created equal, especially when calculating your net worth. He also counseled Yahoo Finance readers to prioritize their credit card debt during their post-Holiday hangover and told Moneywise readers to brace for “higher tax rates, higher interest rates and slower economic growth during the early years of the Biden administration as the Fed acts to offset rising inflation.”*** Contact us here if you’d like to learn more about our PR Light program. Give us one hour per week of your time, and you can 10X your profile.

Prepping for a new Administration

At a time when commercial real estate seems at the abyss, BLAKE CHRISTIAN, senior tax partner of HCVT, LLP (Long, Beach, CA) believes the Opportunity Zone (OZ) program may have a unique role in leading the comeback of businesses in disadvantaged communities. It may also reinvigorate commercial real estate overall. Christian told National Real Estate Investor that both President-elect Biden and Vice President-elect Kamala Harris have praised the Opportunity Zone program as an economic development tool and that they’ll give it even more support as greater transparency and accountability is being built into the program.

“I’ve been doing this for 40 years and, and OZ is the most flexible and impactful economic development program that I’ve seen in my career,” observed Christian. “It works really well for real estate, it’s way more flexible than a 1031 exchange and it’s fantastic for operating businesses.”

Part of the power of Opportunity Zones is that they’re not restricted to real estate. “A third of my opportunity zone business is on operating businesses,” Christian told The New York Times recently. “They’re accelerating quicker than real estate projects at this point.” Practicing what he preaches, Christian is creating an OZ fund to finance the expansion of a manufacturing business, of which he is a co-owner, that converts shipping containers into housing for homeless and low-income earners.

In these uncertain economic times, KAREN KOCH, a partner of Bedford Cost Segregation, (Louisville, KY) told The Tax Adviser that research and development (R&D) tax credits can be highly effective way for all kinds of businesses to replenish valuable dollars spent on new and innovative products or processes. Koch said many companies leave thousands of potential R&D credits on the table because they think they must create breakthrough innovations from scratch. In reality, Koch said they can earn valuable R&D credits simply by properly documenting improvement they’ve made in their products or internal processes.

Speaking of processes, KYLE WALTERS (L&H CPAs, Dallas, TX) shared great tips for cutting through “analysis paralysis” and “expanding the power of your network” in separate recent columns for Accounting Today.

Finally, RANDY FOX, founder of the advanced planning firm, Two Hawks Consulting, (Skokie, IL) told WealthManagement.com why he was committed to raising $10 billion for charity. Hint: It’s about better educating advisors; not about finding big money donors.

Conclusion

My dad always told me things are never as bad as they seem when the chips are down, just as things are never as good as they seem when you’re on a roll. There are plenty of ways to prosper in good times and bad. As financier George Soros said: “Markets are constantly in a state of uncertainty and flux. Money is made by discounting the obvious and betting on the unexpected.”

There will be plenty of time for that in 2021. While you’re at it, give your folks a call. They’d love to hear from you and chances are they’re right.

What’s keeping your clients (and peers) up at night? See our 2021 CPA/Wealth Advisor Confidence Survey.

#practicemanagement, #thought leadership, #wisdom, #blakechristian, #GuyBaker, #thepersonalcfo, @BedfordCostSeg, Randyfox, #wealthadvisorconfidence