Will the market crash? From the perspective of a 19 year old.
There is a lot of debate on the stock market, and what to do right now. Depending on your age, this question is different, well is it? I mean…it should be, right. I mean most brokers will always say just ride it out, it will come back, which is true of the markets, but not necessarily that specific account. Let me give you a little back round of me before I present my findings, because it is important to have credibility.
I have been in the life insurance, and financial industry since December of 2017 and I have seen a lot of clients. In 2018 I saw approximately 300 different families and their specific situations financially. I have been taught almost all of what I know regarding how the markets work and the different markets by my direct superior. This man, has been around the world, and run companies in Germany, the US, and Paraguay. He has successfully created the second largest timber investment plantation in Paraguay, owned newspapers, a precious medals firm, been a realtor, been an insurance man, traded his own money, obtained his series 65 license and many other accomplishments. So I have a good mentor, who has taught me all he knows about these various markets, how it all works technically and theoretically. He has also taught me a lot about taxes, and to this day he has not been wrong about any tax advice he gave me, (I have checked his work), he has taught me about business, about the history of money, and many other things. For now that’s all that needs to be said, for that is all that is relevant. Now you know that I am not just a bum from the street trying to put my random opinion on the markets out for all the world to see.
Over the past year, after having viewed about 300 different situations, I have noticed a few things. One, they all have a different situation, Two, that almost every single one of them, with only 2 or 3 exceptions, have a broker managing most of their life savings, and Three, they all have the same outlook on things.
If you simply want to see my reasoning and evidence for the reason I believe the stock market is going to crash, scroll down to “will it crash?”
So let’s break this down a little. First, they all have a different situation. No two people that I have met have been in the “same boat”. Each family has a different set of goals, each family has a different family situation, each family has a slightly different outlook on life, and obviously they all have the numbers specific to them, their life insurance, their IRA’s, their house, etc. What is important is the fact that they are all somewhere on the road of retirement, some already are, some haven’t even thought about it and some are about to retire. So their strategy should be different based on this fact alone. Obviously after close consideration, a person will know that there are certain circumstances that can majorly affect this place on the road. Okay, next they all have a broker, (with a few rare exceptions). The thing that gets me about this one, is that, even though I have encountered many different brokers for different families, all of their brokers say the same thing to them. It goes something like this, “THE MARKETS ALWAYS TREND UPWARDS, SO JUST BUY AND HOLD, AND OVER TIME WE WILL MOVE YOU TO A MORE CONSERVATIVE ALLOCATION”. WTF, is my first thought. As a young person, I do not see how all of these brokers can believe what they are telling these people. I say this because I know a lot of them do indeed believe this. So it leads me to ask, why and how can they? I will get to my conclusion in a bit. First we need to keep going into this. All of these people have a different situation and they think that this one size fits all perspective is actually a valid perspective. First of all what does conservative mean? Second of all, what are they even putting them in? This brings me to my last commonality. They all have the same outlook on things, to clarify this, I mean that all these families believe relatively the same thing in regards to the stock market, and that is about like follows. “We should be okay, we are in a conservative place, and the markets always come back if they fall”. Or “We won’t lose much if it falls because we are in a safe place. Okay, now lets move on.
I don’t believe that the families I have seen believe this on their own accord. I believe that they have been pushed this narrative for their whole lives, through advertisement, and from their brokers. I don’t blame them for this because it is shoved down their throat. But let me try to break this down so it makes sense. I will take it one point at a time.
What do brokers do? Well, for those of you who don’t know, if they are only licensed as a broker, they can sell two things. Stocks and bonds, or a form of them. When it is broken down this much it helps a person to realize that, they honestly do not have a lot of options. So when they are choosing what to put a person’s money into, they have those two options. Okay, this might not be all that bad assuming those two options can accomplish what is needed. Stocks, mutual funds, and ETF’s are the main three things that these brokers use when allocating the client’s funds. Mostly (from what I have personally observed) mutual funds. Why is this, I think because of the false feeling of security. The brokers can say to their clients that they are diversified, and then because of the propaganda that has filled our lives, they believe that if a fall comes, they won’t be hit so hard, because they are diversified. This is completely false. The only part of it that can be considered true, is the fact that they are not going to loose everything if one of those stocks within the mutual funds goes to zero due to unexpected circumstances. Other than that, it is false. I will reiterate that I am writing this with the concern of a market crash in my mind. If the market crashes, they will indeed lose because they entire market comes down, and with it all of the stocks, including the stocks in their mutual funds. It is just like owning a whole bunch of individual stocks and then looking at your overall returns instead of focusing on one stock, so it really doesn’t mean anything different. How many companies didn’t lose any value during the last three crashes? I don’t know of any. The reason is because things go in fads. When the stock market is hot, all stocks even weak companies are hot, and therefore overrated and further, overvalued. So when the fad wears off, it wears off across the board leaving those companies who had a hike in stock prices disappointed. This is a super short explanation of why mutual funds are not really safe, and not diversified, I simply don’t have the time to dive deep into that subject, as is the case with each of these paragraphs. There is simply too much for this article.
Next let’s take a look at bonds. The brokers can sell bonds. This used to be a pretty common thing. I personally have a few bonds that my Grandma gave me that are supposed to give me $100 when I am 30. LOL. However, this is not as common of a practice anymore. What is very common is a bond fund. So for anyone not entirely sure what a bond is, the simplest way for me to explain it is, you give the Gov. some money, and in return they promise to pay you a certain percent of that money every year until it matures then they will return your principal. It used to be that you had coupons, and you cut it off and took it to the bank and they actually cashed it in for you. So the basic principal is this, imagine today the interest rate is 3% for a 10 year bond (A moderate length bond), and I buy a bond for $1,000, that means I am going to get $30 every year for the duration of the 10 years and at the end I get the principal back. So I would make $300 after ten years. Now imagine I have this bond, and the next day the interest rate is set to 4% for the same bond, and you my friend buys the same one. He has a 4% return, I have 3%. Then the next day, we both want to sell our bonds, and you want to buy a bond. If you were looking at our bonds, who’s bond would you want to buy? Obviously my friends because you will make more than I will. So what am I supposed to do? If I want to make my bond more attractive to you, I will have to sell it to you for $900. $900 because my bond will return $100 less over the course of that period. This is exactly what happens every day with bond funds. When I first heard about bond funds, I didn’t understand how a bond fund could lose money if all it did was make interest at different rates, but when it was explained to me like this it made sense. So in short, when interest rates are rising, the managers of the bond fund, start doing exactly what I just described, they start trading their cheap bonds for better higher returning bonds, and as a result the fund loses money. So in principal a bond, or a bond fund can be good assuming that the interest rates are headed down. The nice thing about this is that normally interest rates move a lot slower than stocks. Hence the appearance of safety.
So this situation gives brokers enough to come up with lots of angles to sell the client on either situation. The market is going up a lot and they are in those mutual funds. When the market gets bad and the clients get worried they move some money to the bond funds, so they feel a little more safe.
Another thing I don’t understand is that these people trust their “financial advisor” so much, that I don’t get it. One thing that almost no one realizes is the fiduciary responsibility that all financial personnel have. Most and I mean most, (about 97%) of financial “experts” or “advisors” have a fiduciary responsibility to their company. All of them have a fiduciary responsibility, however the small 3% of them have a different license and only have a fiduciary responsibility to their client. What this means is that the majority of financial people are legally bound to do what is in the best interest of their company, meaning that even before they do what’s best for the client they have to do all in their power to make sure that the clients money is most optimally placed so the company can make money off of it. There are minimum requirements for them to follow in order that they don’t completely screw over the client but it is not a lot. The reason that most people don’t have this other license is twofold. One it is a lot harder to get, because you have to have an even deeper understanding of trading, and also many other markets, such as futures, real-estate, insurance, and a lot of other things. Second when you have this license you are held to much higher accountability, and can much more easily be sued, and if you are your own guy, you most likely won’t have the funds to deal with a big lawsuit. So there are not many people who do this, and the ones that do, work for big companies, or hedge funds typically and don’t want to deal with accounts worth less than $10 mil. So your average broker is not as smart as those guys, but also they are not legally bound to do what’s in your best interest, and they have that same pressure from the guys on top. So how in the world can you expect to have your money managed in your best interest with that situation. I would say the only time is when they are not allowed to take any fees or commissions if you lose money. This is not much of an incentive, but it is a small factor.
Another thing is when they ask you questions about your portfolio and ask your goals, do they really even care? I assume that most of them do, but what I mean is, do they even need to ask those questions aside from having documentation of what you said in the event of a lawsuit. I personally don’t think so because, all they do is put you into one or two buckets that have been created by their company. Typically these are labeled Conservative, Moderate, and, Aggressive. So after a few questions they know which boring bucket to put you into so you are not disappointed with the result. This is so impersonal that it almost makes me sick. They are just treating you like another fish in the pond and don’t even have the ability to create a custom plan (at least most don’t).
What is true diversification? Now that we have discussed a few different aspects of investing, lets look at what true diversification really is. To most people being diversified means having a mutual fund. Or having a 60% stock and 40% bond portfolio. This is really not a lot of diversification. What is necessary for a successful investment strategy is having different asset classes, thus being diversified across asset classes. Some common asset classes are, stocks, bonds, futures, resources, cash, insurance, real-estate, companies/businesses (some would consider this real-estate, I don’t), and there are others, but these are the main asset classes. Since starting this job I have seen that most people have only bonds and stocks for their liquefiable assets. This is not diversification. The other thing that is obvious is that within each class we need to diversify, according to many professional money managers, within each class you want between 5 and 10 positions. For example with your stock part of your portfolio you would have about 7 different stocks that you buy into. Not hundreds like the people who have mutual funds, and are over diversified. Anther thing that is typically observable, is that the richest people in the world have about 80% of their assets in something other than Stocks and Bonds. Most middleclass families have 80% in Stocks and Bonds, and about 20% in the other category. So we really have a completely upside down look at how to build a well diversified portfolio.
Why do we do this? My opinion is that people have been fed a certain way of thinking for so long, it is really hard to expect them to think any differently. Just think about how many of those financial institutions you see everywhere. Edward Jones, Ameriprise, and all of the small mom and pop shops on every corner in downtown. They are everywhere and they are everywhere because it’s so easy to get started. All they have to do is pass a test and boom they are a broker. They don’t have to have any amount of experience, most of them don’t even have a deep understanding of how the markets work. They just think, “how hard can it be”, “the markets always trend upwards”. Ha…that’s what they think. I have heard countless stories of brokers being super depressed after the 2008 crash, who were so dumbfounded. They say, “I just don’t know what happened”. The fact that they say this means they don’t have a good understanding of the economics surrounding the markets, and also do not have a good understanding of money in general.
So why listen to me?
I don’t say you have to listen to me, I just want you to read my evidence and make your own choice.
Will It Crash
Here is my evidence.
First of all, we have all time highs. This is a very basic and kind of assumptive reason to believe that the stock market will crash however it only makes sense to have it fall after it is at the very top. Higher than it has ever been, well, you know what they say, “What goes up comes down”. I don’t mean to be a naysayer, but it is true of humans, that we develop a certain hype about things and as a result assign a much higher value to that thing than is actually true. An example of extreme hype for something is the chart below. The Value of the Gouda Tulip Bulb was absolutely spectacular, until almost overnight it was realized as worthless. One bulb at it’s high point could purchase an entire farm and machinery, so some simply minded people, spent their entire life savings to obtain some of these bulbs, thinking that the value would continue to increase as was the generally accepted idea. Then this happend.
So is the stock market all hype at the moment? In my opinion it is, because we have a large population of young people who are used to seeing the market go up since 2008, or at least that’s what all the ad’s are telling them. “Make 7% every year and retire at 50”. The average annual market return on the S&P 500 from 2009 to 2018 was 11.26%. These are unrealistic numbers for a few reasons. One average return is not the same as actual. If you have $100,000 and make 100% one year you now have $200,000, then if you lose 50% the next year you now have $100,000 not including any commissions or fees in those losses. Your average return for those two years is 25% but your actual is 0% (or negative if you take into account any trading fees, and commissions). So from this you can see that average return means diddly squat. Actual return is the only thing that matters. This is why I personally believe in constant growth products, but that is a discussion for another time.
My second piece of evidence for a stock market crash is, the RMD (required minimum distribution) factor. In the United States, we have a huge generation of people, known as the baby boomers. During their lifetime most companies stopped offering pension plans, and started using the new 401k option. This was due to the fact that they wouldn’t have the risk on their hands. With the account being held by the employee, it was their responsibility, thus eliminating company liability, and the need for a pension manager. Personally I believe that the 401k was also created with the intention of getting more people involved in “playing the markets”. Because a huge factor of any investment strategy is, liquidity, or the amount of people in the market for that investment. Look at it this way, if there are only 100 people willing to buy your stock, when you think it is about to fall, you have way less chance of doing so, however if you have 1,000,000 people to sell to, then you have a very good chance of dumping your stock on some sucker who doesn’t realize that it is about to plummet. By introducing the 401k it changed the mindset of thousands and thousands of people, and we now have a culture of people who almost all have a brokerage account, thus providing more liquidity for the real big players. I am getting a little off topic. Let’s get back to RMD’s. The 401k requires that at age 70.5 a person with a qualified retirement plan must start taking out of that account (Roth IRA’s are not subject to this). So the point is, in 2017 the first part of those baby-boomers started to withdraw their RMD’s, and consequently every year more boomers will be taking out their RMD’s, which by the way go up every year. The reason for those of you wondering why they have to take out RMD’s, it is because the taxes have not been paid on that money yet, and the Government want’s their money now. So this means that an increasing amount of money is going to be coming out of the stock market for the coming years (about 10–15 years) and not as much is going back in. Let’s put it this way, because there are not as many people “buying” the stock market right now, when the boomers have to sell their positions, someone has to buy them, who is going to? It is going to be a lot harder to find people to buy it for that price, so what they will have to do is sell it for less (the laws of supply and demand). Because markets are at all time highs, most people buying are skeptical at least a little, and do not want to buy from them at full price unless they have to, so naturally they will try to negotiate the prices down, once that starts, it is going to be a land slide, because all the people who don’t need to sell their positions will get worried, and then will start to panic as the markets correct. The faster people bail the faster it will fall. Some people will say that the boomers will reinvest their money into the market, but I strongly disagree, because think about it, if you worked your entire life, you are now almost 71, your health is slowly deteriorating, what are you going to do? I would enjoy what I have, and go on trips and have fun in my golden years.
Third major piece of evidence for the correction. Price-Book values. To explain this one, it is easiest to imagine, a chart, ascending on the vertical axis, are three boxes (or zones) representing price. On the horizontal axis are the years, obviously representing time. Many dots fill this chart, each marking high points of different companies in the 1920’s. If the dot is in the 1 box it is stating that the actual value of the company represented (total assets, good will, and any other measurable assets). Meaning if you added up all of the value of all the real estate, machinery, brand, and inventory etc, of that company and the value was $1,000,000 that would be box 1. Now if you add up the total outstanding shares of that company in the stock exchange and they are worth more than $1,000,000 then they start to go into box 2 or 3 depending on how overvalued they are, and likewise if the total value of the shares, was below 1 mil, it would be in the 0 box, meaning that it was undervalued. Okay, with that being said, in 1929, prior to the crash, most companies had their numbers up into the end of 2 or three times the actual value of their company, after the crash, almost all companies without fail, were in the 0 box, meaning they were then undervalued. The point I am making is that if a company’s price book value is high, it is not a good buy. In today’s market, almost every company is at unseen highs in their price book value (if I were to guess without doing the actual numbers, probably around 6 or 7 times the actual value). This is so high that I only pray that when reality ultimately strikes, that many of the people holding these stocks, and people running these companies do not jump out of their building windows. The devastation that I believe will come in the near future, is going to be something never before seen. It will be comparable to the 1929 crash, and most likely worse, because our society as a whole has less hands on skills now.
My fourth reason is that the total outstanding credit is also on an exponential curve again.
If you look at the chart above you will see a small dip in 2008, then followed by a bounce back even better than before. More people are borrowing money, total debt owed is growing every day. What happened in 2008 that made it fall. The crooked banks, were lumping together bad mortgages, and selling loans to families who couldn’t truly afford them, real estate prices were sky high, and when the consumers started to default on their loans, the banks were in trouble because they were not keeping enough reserves, when those banks declared bankruptcy, it started a downward spiral, that would have been much worse, had the Federal Reserve not printed a lot more money and lowered interest rates even more. They did whatever they could to get more money back into the system. Also I have heard from multiple people, but have not confirmed this on my own, that other countries sent a lot of revenue our way because they had such a vested interest in the US economy. The point is, the things the banks were doing in 2008 are being done again under a different name. If you want an entertaining and informative understanding of this 2008 housing crash, watch “The Big Short”, with Ryan Gosling, Steve Carrel and Christian Bale, but beware it is not a children's movie. My point is that at some point the game is over again, and whether it completely resets, or has a correction similar to 2008 does not matter, I do know that at some point the M3 (total money supply) supply will shrink and it will cause unrest and panic in the markets.
There are a few other things that I believe will contribute to a crash, but these four are the main ones.
I hope this information was helpful for you. I will be writing another article on ways to avoid the crash soon. So please follow me to see that in the next week or so. Let me know what your thoughts are in the responses, and please feel free to point out any flaws in my reasoning. I also apologize for the messiness of this story, as it was written in three different sittings so it is not entirely congruent.
*Credit for many of these images is due to the book, “Conquer the Crash” by Robert Precher Jr.
