The USS Economy is Sinking by Robert B. Gordon 09/14/2003

FSO Editorials

The USS Economy is Sinking
Man The Lifeboats
by Robert B. Gordon, Sc. D.
September 14, 2003

HUGE PROBLEMS AHEAD

As I start another attempt to help my readers, I ask myself what can I write that will help bring both young and old family members to a common understanding of the great perils, known and unknown, that will be faced in the next ten, twenty or thirty years. We cannot do much about the many unknown bad surprises ahead, so lets work on the long list of known problems for the U.S. and much of the developed world.

Certainly for the U.S., the huge amount of private, corporate and government debt at all levels is at the top of the list. Private and corporate bankruptcies are at record levels and rising. Most experts I read conclude that these debts will never be paid back except in highly inflated future dollars. With longer interest rates now rising, there is sure to be an alarming number of foreclosures on homes. This depression will be the first in our history with more than 100 trillion dollars of risky derivatives capable of destroying large financial institutions. According to experts, this is a time bomb waiting to go off.

Another very real and tragic problem is that our nation’s leaders in Washington, Wall Street and Academia do not know that the Elliott Wave theory exists and are repeating all the tragic errors of the 1930’s. So they, along with nearly all of our citizens, believe that our recession has ended and that better times are just ahead. We can be sure that this lack of true understanding of our real problems will continue to be held by the great mass of Americans. The truth about our problems is being told by experts in banking and financial services on selected internet web pages. This dire message cannot reach or change the minds of our leaders or the huge masses of Americans. Our leaders in Washington are foolishly following the same wrong policies that caused the 1929 Crash and Depression. This of course gives our readers, the fleeting opportunity to help their families prepare for a very difficult future. But to seize this opportunity, immediate action is required.

CARPE DIEM

The time for action is right now, not next week or next month. The year long bear market rally appears to be topping. No one really knows how much stocks will fall in the next big bear leg down. And it could be very dangerous to hold losing stocks and funds while waiting to find out. If your extended family still hold different degrees of awareness of the need for action, now is the time to reach a. unified position. Young and old generations must reach a meeting of minds on what lies ahead. Remember that September and October are notorious for their huge stock market drops. In the severe bear market ahead, there will be no room for family differences. Unity will be a must. Anything else will be tragic.

The very first step needed right now is to sell stocks and mutual funds with large losses or any with recent huge gains whose P/E ratios are in the stratosphere. History teaches that, before this bear ends, all stocks will be selling at very low earnings multiples. Do not let your losses run. Optimism is not a virtue in a serious bear market.

Stop buying more mutual funds each month for your retirement plan. The probability for almost any ordinary equity or bond fund to produce gains over the next decade is very low in my opinion. At some point in the bear market, we expect to see massive redemptions from most popular mutual funds. This will mandate forced selling by the funds to raise cash, causing a huge fall in net asset values. If there is a large difference of opinion between age groups in any family, please make every effort to resolve it now, not next year. Remember, the chance of regaining losses in the future is very unlikely. Cashing out now and placing it in safe asset classes is the best course of action.

ONLY A TINY MINORITY WILL AVOID LOSSES

My best guess is that no more than 1% of our people have the information and will power to grow their assets in the difficult years ahead. It will certainly not be done by using the same asset classes that worked in the long bull market. More than 3 years into this major bear market, polls of analysts and investors currently show levels of bullishness as high as they were at the early 2000 bull market top. These Super Bulls are blind to the lessons of all previous stock manias which show very clearly that every past mania has not ended until stock prices have dropped below the starting level of their bull market. That means the DOW will eventually drop below 1000! That is not a misprint, I said below one thousand!

I have no data on how many Americans have the ability to manage their own money but it must be a small minority. But regardless of their number, there is a very limited supply of the available favored bear market asset classes. So, the sad answer is that there will be many more losers than winners in coming years.

To make things even worse, only a small percentage of brokers or CFPs have a good understanding of the magnitude of this bear market and the few asset classes that will prove profitable. There are very few of them reading my essays to help investors survive a vicious and very long bear market.

OUR ECONOMISTS ARE WITHOUT A CLUE

It is sad but very true that our economists in government and business have learned no lessons from the 1929 Crash and Depression and are repeating the same old mistakes. For an up-to-date account of this ongoing tragedy, please read two very recent FSU essays by Jim Willie with the titles: A Statistician’s Indictment of Economists and A Week with Richebächer in Cannes.

These are not easy reading but can be scanned to realize the extreme pessimism about our future from the veteran Richebächer and the younger Willie. The current tragedy is that the blindness of our leaders is occurring during the first few years of the largest stock mania and bear market in World history. The Elliott Wave picture is very clear. Our stock market is on its way to unbelievable lows and the resultant world-wide Depression will be severe and very long. Due to their current higher Elliott Wave level, both the bear market and depression will be much deeper and longer than those occurring after 1929 in the U.S. and in the 14 year old and still continuing bear market in Japan. It will probably be known ultimately as the Great 21st Century Depression.

PREFERRED BEAR MARKET ASSET CLASSES

We will give here our current best picks for asset classes to withstand a long bear market. To help give it the best chance for long term success we have further diversified the asset classes from our most recent example.

Short-Term U. S. Treasury Bonds	26%
Short-Term Foreign Gov't Bond	26%
Reverse Index S&P 500 Short Fund	6%
Reverse Index Nasdaq Short Fund	6%
RYJUX 30-Yr Bond Short Fund	6%
ASA Closed End Gold Fund	6%
CEF Closed End Bullion Fund	6%
Selected Open End Gold Fund	6%
Diversified Coal, Gas, Oil Fund	6%
PCL Lumber REIT (S&P 500)	6%
Total	100%

To achieve its long term objective, this portfolio with its ten very different asset classes requires a complete rebalancing every year plus a day for investors who want to take long term capital gains. It will almost certainly do better in a tax free account if it is rebalanced twice a year or irregularly on the dates of price peaks and valleys. This was demonstrated in our recent tutorial essay which should be read and reread by everyone.

As in previous examples, we preserve capital by having over 50% of assets in short term government bonds divided equally into U.S. Treasury and foreign government bonds. The purpose of this is to protect against any further loss of the dollar against other currencies. In our prior examples over the bear market to date, the bond holding has been a major stabilizing force to protect capital against any temporary losses in the other classes. Shifting capital to other classes is the "secret" that provides a slow accumulation of capital gains when the profits are preserved in the rebalancing process.

The 18% in short positions is split equally into two short index funds and one short bond fund. To our knowledge, RYJUX is the only inverse bond short fund. Our experience is that this is the right amount to be held permanently during the expected market ups and downs. This short position will provide its share of profits in the overall portfolio rebalancing process.

The 18% allocation to precious metals will do very well in making profits and transferring them safely to the bonds when gold and silver enter periodic down markets. This will be in great contrast to those who follow gold to a price peak and then ride it back down again. Believe me, this method of periodically taking profits and preserving them in bonds is better for your nerves and may well be more profitable in the end. This asset class will be volatile with sharp price peals and valleys. We continue to use CEF , a closed end gold and silver bullion fund, traded on the AMEX, to provide a unique asset class distinct from the other two.

We have added a small open-end gold fund as a distinctly different asset class in an attempt to maximize profits from this category. We do not recommend that conservative investors should invest directly in small gold and silver mining companies due to their huge volatility. But owning small stocks thru a small, less than $50 million dollar asset fund, will make a great addition to the portfolio. It will only be possible to find a small fund with a good record before the real "gold rush" starts. We recommend ASA because it is an excellent closed-end fund that trades on the NYSE. It has a modest, fixed number of shares and trades at prices both below and above its net asset value which means that it can have larger price swings than open end precious metals funds. When the public rushes to buy gold, most funds will hold too much money for small mining stocks to have a meaningful effect.

Our final asset category is basic raw materials like coal, oil and gas in the ground and timberland, growing trees 24 hours a day. This is a long term bet on scarce oil and gas with diminishing supplies in this country. There are over 50 no-load and loaded energy mutual funds to select but there is only one large profitable, dividend-paying REIT, PiIgrim Creek Lumber, PCL, recently added to the S&P500. These assets may be slow in producing capital gains today, but they will be here 50 years from now - a long term bet on the future. I am sorry that I will not be here to take the profits. They should do just great for anyone with a long time horizon and might provide a great surprise in the near term as well.

BUY LOW AND SELL HIGH

There is no mystery as to why a long term portfolio designed for rebalancing does well for patient investors. Periodically, it requires transferring profits from the strongest performers to the weakest. We have carefully chosen ten attractive asset classes, each "marching to a different drummer". This portfolio is designed for this big bear market but the concept can work in any market environment so long as different assets are carefully selected and rebalanced regularly.

In a tax free account, this portfolio will probably require something over $20,000 but it could surely be built to that level over time, starting with the bond funds and adding the others gradually. In my experience, the portfolio management, almost totally in planned rebalancing, can probably best be done in a single discount brokerage account featuring low purchase amounts and fees on no-load funds. After the first time, the rebalancing will probably take an hour of your time and will almost surely be very pleasurable as you see your portfolio’s steady progress.

As of this date of writing, all of the ten asset classes are believed to be in up trends. If and when the major bear market ends, one would want to eliminate the short funds. But do not be too hasty in eliminating any asset class because small rebalancing profits can continue to be taken from an asset class with declining prices. How can this be? Profits come from buying low and selling higher regardless of the overall price trend. So give your portfolio a chance to perform as it is intended to do.

I have written quite a few essays on portfolio rebalancing that should be read for additional information. A year ago I published an essay on selecting foreign government bond funds that can be read at www,freebuck.com. Go to the Commentary link and then click on my name to reach the archive.

In a recent FSO essay I gave performance data on a group of no-load precious metals funds that should be helpful. There are several companies offering reverse index short funds for the S&P500 and NASDAQ. Their symbols and prices are listed daily on www.bearmarketcentral.com. More fund data is available at www.bloomberg.com with performance rankings for various fund categories. More detailed information on any fund is available at www.morningstar.com, if you have the symbol.

DO’S AND DON’TS

Please do not use a broker or buy funds with front or rear end loads as the cost of commissions each time you rebalance will hurt your returns. Irrespective of the frequency or method used in rebalancing, take a monthly total of portfolio assets. This will give you another simple timing method for rebalancing using the high and low points during a year to do the rebalancing. In a tax-free account, this will almost surely provide the best time to rebalance. As your portfolio is nearing a high or low you may wish to get the total value on a weekly basis. Rebalancing near each yearly high and low will give extremely good results.

For new readers, please do not write and ask for my fund choices for asset classes where I did not suggest a symbol. Every investor needs to be able to go to the available data and choose the funds for his or her portfolio. In a long investment program, it is likely that some changes will be needed so you might as well learn how to do it now.

Do not look only at recent performance. Look at the fund company’s total history and go for companies who will have the best chance of being in business 10 or 20 years from now. You need to choose a company with a high chance of surviving a severe depression. We expect many fund companies to disappear, which is another advantage in using closed end funds and blue chip stocks. We wish many years of successful investing for our loyal readers.

Robert B. Gordon, Sc. D.
Sun City West, Arizona
September 14, 2003
Email