My good friend, Rob Robbins at Franklin Templeton Investments, sent me the Real Return Forecast below from GMO.  At first blush it is pretty negative!

What is obvious is that investors are going to have to accept higher volatility in such asset classes as international or emerging markets if they expect to get any kind of positive return over the next 7 years if GMO is correct.

This forecast however has two glaring weaknesses in our opinion.  Those weaknesses are that it assumes: 1) that returns are stable over that 7 year period, and 2) that you are a "buy and hold" investor.

So let me address each weakness separately.

Stable Returns

First, when investors think about forecasts like this they tend to assume that the return stream will be stable, i.e., the same every year.  However, the truth is that markets are volatile and returns are likewise volatile.

We can see that returns are volatile, below, in this chart of annual S&P 500 performance courtesy of Macrotrends.net.  

If we take it one step further and overlay GMO's expected returns for U.S. Large (dotted red line) over this chart, you can see that there will likely be up and down years throughout the forecast period.

Pick a period of time, like the one I highlighted in the blue box, and you can see there are years you will make money and likely years you will give back returns.

This Forecast Is For Buy and Hold Investors

The second point I would like to make is the GMO returns assume that you are buying and holding your investments during this forecast period.  However, if you are a client of ours that is not what you will be doing.

So lets assume for a moment that we have a replay of the 2008 - 2014 period.  

What would that possibly look like for a client with an actively managed account assuming a 5% loss in 2008 while getting out of the markets post a bear market signal, a 12% return in 2009 due to a late signal to get back in the market and only 80% the returns of the S&P 500 in the balance of the years due to excess Central Bank intervention? Sound familiar?

Here is what that looks like:

A phenomena called "Recency Bias" has most investors up in arms about actively managed strategies, but if we include 2008 in this hypothetical analysis, you can see that if we can avoid the big down period (which if you are honest with yourselves you know is coming), that even with earning less return in 2009 - 2014 years you still come out ahead in terms of an annual return (10.75% vs. 5.74%).

Now let take a SWAG (scientific wild a_s guess) at what market returns may look like in the next seven years under GMO's forecast.  Bear in mind this is just a hypothetical guess and it is possible that big down years are replaced by a series of smaller loss years or the big loss year is pushed farther out by even more Central Bank intervention.
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What we see here in this SWAG is that while the buy and hold investor did realize a negative seven year return in the S&P 500, the actively managed account did much better because he/she avoided the hypothetical big draw downs in 2017 and 2018.  The actively managed account was slow to respond to a rally in 2019 and made only 80% of what the buy and hold investor did in 2020 - 2023 period but still came out substantially ahead.

The Moral Of This Story

The moral of this story is that even if you are one of the many persons out there looking feverishly for positive returns and are turned off by forecasts like GMO's showing the next 5-10 years will be low return years, there is hope!

The solution is not what has been working so well since the 2009 bottom (buying and holding and indexes), but what has not been working half as well and that is an actively managed approach.  Investing is cyclical and every type investment strategy has its day in the sun.  You have to figure that the buying and holding of index is probably in the 8th or 9th inning if it were a baseball game.

In the years to come, the key will be to avoid the big down periods and just do "ok" in the up markets.  The result will be positive returns.  Maybe not what we have seen in the past but "ok" positive returns.

If we then get smart and add exposure in the areas of the market highlighted by GMO as potential outperforming asset classes maybe that return profile improves further.

This is NOT the time to go chase some other investment options such as direct lending or commercial bridge loans or even the next tulip mania, this is the time to change how you approach the markets because the cycle has to be near an end.

I certainly don't want to disparage diversifying, but right now in this market everything is in bubble territory and the more you stretch for return, the more likely are you to get your head handed to you on a platter when this market finally hits the skids.

So let us know if we can help you position for what is likely coming.  We offer a Free Second Opinion - click here to sign up.

For clients and interested parties, this video highlights some of the recent changes to the way we see and invest in the markets and highlights ancillary services we have added.

Sometimes is seems the Federal Reserve and other Central Banks are running counterintelligence agencies and not reserve banks.  A perfect example of this is Federal Reserve Chairperson Janet Yellen's comments on Friday that “in light of the continued solid performance of the labor market and our outlook for economic activity and inflation,” the case for raising interest rates again has gotten pretty strong of late.

The truth is that the economy is weak and there is no way they are raising interest rates. This was evidenced by the market's fast intraday reversal of more than 100 Dow points. 

It seems the Fed's best tool at present is to talk the market into believing they are leaning towards interest rate normalization (i.e. tightening) and then find reasons not to follow through.  At least the other Central Bankers are not so nefarious with their actions.  They are out there buying equities and pumping up markets with ever increasing monetary stimulus.

So where will all this lead?

I spent a good part of the weekend trying to figure out just that.

The truth finally hit me when I watched a simple economic video that defined deflation, hyperinflation and stagflation.

According to Crash Course, hyperinflation is where inflation rises by 50% or more per month.  So with hyperinflation the velocity of money increases as people spend money as quickly as possible to avoid a decline in the value of their money.  This increased velocity of money changing hands increases inflation exponentially.

Deflation is a contraction in the supply of circulated money within an economy, and therefore the opposite of inflation results from declining or stagnate wages and falling prices.  The velocity of money falls as people wait to buy what they perceive will be less expensive in the future.  This decreased velocity of money changing hands increases deflation.

Finally stagflation is when output stagnates at the same time that inflation rises.  The end result of stagflation is price inflation, rising unemployment or stagnant wages and a disastrous economy. With stagflation the velocity of money may increase but output does not allow for significant increases as there is not the wage growth to support people spending money as quickly as it is earned.

So the key to understanding where we are headed is to examine the velocity of money which luckily for us the St. Louis Fed provides to anyone who cares to look.

​Here is the current velocity of money:

M2 is a measure of the money supply that includes all elements of M1 as well as "near money." M1 includes cash and checking deposits, while near money refers to savings deposits, money market securities, mutual funds and other time deposits, according to Investopedia.com.

Notice how the velocity of money continues to fall off a cliff or move downward on the right edge of the chart.

Assuming this data is accurate from the St. Louis Fed, this means that we continue to battle deflation.

So as investors, what does this mean?

First, you should delay buying things where prices have generally declined over time.  The longer we wait, the lower the price (unless it is textbooks, college tuition, or healthcare).

Second, the government will not stop printing money until there is no more deflation and the velocity of money starts to rise.

This means that they will continue to try to find ways to make you feel wealthier, such as supporting equity markets.  The Fed is not doing this directly, but Japan and Switzerland sure are buying U.S. equities and rumor has it that the U.S. has a facilities line with the Swiss that they are using to buying U.S. equities on behalf of the Fed because it cannot by mandate (at least openly).

Mike Maloney of GoldSilver.com believes that first there will be deflation in the U.S. followed by all out monetary and fiscal assaults to overcome deflation and then that will be followed by hyperinflation.

If he is right, we still appear to be in the deflationary stage and more stimulus is like to be the result.  At the moment global growth is weak or in recession.  The monetary policy is barely working because of wage stagnation, weak output and recessionary pains around the globe.  All the more reason for those in power to double down!

At some point, growth will increase and inflation will take off.

So my final recommendation is use this time is to look for opportunities to buy at value today things that go up when inflation hits. These items include stocks, gold, real estate and other hard assets.   I cannot tell you the timing of when things shift, but I believe it will happen.  For all I know it may be happening now as gold has broken to new highs.  I personally am looking to use the pullback currently underway to add to my position as a hedge against inflation and further debasement of global currencies.