The time-honored advice brokers have always given their investment clients is to "diversify, diversify, diversify!” It’s the basic law of investment – Investment 101 you might say – never put all your eggs in one basket. Which is why it is so odd to see the CEO of one of the largest investment funds in the world –BlackRock – insist that his customers ignore this basic rule and invest everything they have in equities.
CEO Laurence D. Fink says that we are living in a “New World” where it is impossible to earn a decent return on traditional bonds or other conservative investments. He’s right about that; Fed Chairman Ben Bernanke has made it clear he intends to keep interest rates at zero percent through at least the end of 2014. Maybe this New World is a welcome relief for borrowers, many of whom are desperate to reduce their debts, or at least the interest cost on their debts if they can refinance at lower rates.
This is a dreadful world for savers, however. Many people who live off the interest on their savings, like retirees, have watched their income collapse to zero, and are being forced to liquidate their nest egg in order to afford food and medicine, the prices of which (along with energy) have been increasing at annual rates near 10%.
Retired people aren’t going to survive too long if their cost of staples are increasing at a rate of 10% per annum, while their investment portfolio earns 0% per annum. It is only a question for each individual how long their capital holds out. Nor is this a conundrum for retired individuals. Pension plans, endowments, insurance companies, even the banks – they are all complaining about the squeeze they are experiencing between their fixed liabilities and their vanishing interest income.
This is such a growing problem that Ben Bernanke heard an earful of complaints in Congress this week about his zero interest rate policy, especially from Congressman Ron Paul, who also charged that it was deceitful for the Fed to pretend to the public that inflation is only running at 2%. The Fed Chairman muttered something about the Fed not being responsible for calculating the Producer Price Index or the Consumer Price Index; he could have added that even government statistics show food and energy up from 6.5% to 10% this past year, and that medical and education costs have been increasing at an annual rate of 9% for decades now. But maybe he wanted to avoid an unpleasant discussion about why the Fed insists on ignoring food and energy costs so that it can concentrate on some mythical “core inflation” that no one experiences.
Maybe Mr. Fink is so sympathetic to the plight of his elderly customers that he really wants to help them. He did after all insist that his advice applied even to retirees – or maybe especially to retirees. “Most investors need a more diversified portfolio, but virtually every investor has to find ways to achieve a better return than they’ll get in cash or government bonds for the foreseeable future,” according to Mr. Fink. On the other hand, this could be among the most self-serving advice ever offered by a investment professional. Mr. Fink has already acknowledged that “Whether it comes from an individual, a corporation or a pension fund, my answer is the same: you need to get off the sidelines and get your money working again.” Both the investment management community and Wall Street would dearly love to get trillions of dollars sitting in safe investments recycled into the stock market. Not that the stock market needs the money to get a rally going – it is already up over 20% since October when the European Central Bank began its own version of Quantitative Easing (with the money supplied by the Federal Reserve through back-door central bank swaps).
The rally has already been going strong for five months, but as a professional Mr. Fink knows it's been riding on thin air. Volume has been shrinking month by month and is now at pitiably low levels that were more the norm 10 or 15 years ago. Over three-quarters of the volume consists of high frequency robots trading among themselves on a micro-second basis. The individual investor is scared of the stock market, with its tendency to flash crash 10% or more in minutes. Fewer and fewer stocks are participating in this rally; in fact much of it comes from one stock, Apple. The $500 billion market capitalization of Apple now exceeds the total market cap of all semiconductor stocks, and as well of all retail stocks. Apple is worth more than the GDP of countries the size of Poland or Malaysia. Professionals know how risky this situation is – if Apple fails to continue to perform to perfection, the whole market could collapse.
The market needs new money to take over owning Apple stock from the micro-second robots, or the itchy-fingered hedge funds that worry incessantly about poor quarterly performance. That’s why pension plans, university endowments, not-for-profit foundations, and retired people need to get off the sidelines. They are desperately needed to buy over-priced stocks from the professionals who have been ramping this market up.
Laurence Fink knows very well that the bulk of individual money is sitting with Baby Boomers who have saved for retirement. Retired people need steady, predictable income, which is about the last thing the stock market provides. Even dividend-paying stocks are subject to typical market volatility, so that investors could lose their capital in amounts that dwarf whatever dividends they might have earned over the years. Even then, today’s dividend payout is around 2%, versus the long-term average of 6%, so buying these stocks doesn’t yield much more than a long term Treasury bond.
In other words, Laurence Fink’s advice to retired people is ridiculous, and he knows it. The only way his advice would work is if retired people kept their capital in the market perpetually, but what’s the point of that? How would they live, unless Mr. Fink could suspend the laws of finance and guarantee these investors a steady appreciation in the value of their stocks over the next twenty years.
But wait a minute. Maybe that is not as absurd as it sounds. We learned today that the central bank of Israel is to begin investing some of its country’s reserves in the US stock market. Oh happy news! Israel has over $77 billion in reserves, so even a percent or two would be noticed on the NYSE. Israel has announced that BlackRock will be one of the two investment advisers chosen to sell equities to the central bank. What a happy coincidence for BlackRock (or maybe it’s not a coincidence at all). Most amazingly, Israel says it intends to join the feeding frenzy for Apple stock! And who would be surprised if the Federal Reserve didn’t twist the arms of the Bundesbank, Banque de France, and other recipients of US swap line largesse to join the Bank of Israel in “diversifying”.
Private investors need to diversify; central banks do not. Central banks are the defenders of their national currency. Their balance sheet has to be impeccable, composed of only the safest of safe instruments with the lowest possible risk of default or market value change. The only exception to this has been gold, for historical reasons. Central banks have never really liked holding on to the “barbarous relic.” For some reason, though, they have begun taking a liking to something just as risky – equities.
We have to assume that the Federal Reserve would invest in the US stock market if it could. Maybe it is already, through proxies. It would certainly have no qualms about the risks involved. The Fed crossed the high-risk Rubicon in 2008 when it took on over a trillion dollars of suspect mortgage securities from the big banks it was attempting to rescue.
If you get the feeling the world is going crazy, you are right. Our global financial overlords have lost all sense of prudence, temperance, or conservatism – qualities that in the past were the hallmarks of the guardians of the financial Temple. It would take an in-depth cultural study to figure out how such institutions – especially the Federal Reserve – came to abandoning their fundamental ethos. Maybe it comes from years and years of slowly debasing the currency through inflation, combined with a sense of infallibility unfettered by any political constraints, that allows them to think that destroying the nation’s remaining savings is an answer to an acute savings deficit (and its counterparty, an acute debt overhang).
What we see now, out in the open, is that our central banks and major financial institutions want us all to become speculators. And when we’ve put all of our money in the stock market, and the central banks have invested all their national reserves in equities – when we all become like the mutual fund and hedge fund industries which are overloaded in equities and sitting on a record low cash cushion of just 2% of their assets – when we all have skin in the stock market game, who is going to save us? What happens when just one retired person wants to take their cash out of the stock market, and no buyers are to be found?
That’s the point when a massive crash occurs. That is what happens when the last bastions of safety and prudence fall victim to the speculative urge, having dragged everybody else with them in a mad, futile scramble to create one last bubble – the grandest and biggest of them all.