Thursday , 25 July 2024

Be Careful! Former Investment "Rules" Nolonger Work – Here’s Why

Investment “rules” that were relevant for a century are obsolete. They were based on a world where economies grew, people’s standard of living increased and outcomes tomorrow were always better than today. Arguably each of these conditions will not hold in the future but if they don’t, neither do the rules of thumb that guided investing last century.  These guiding principles developed and worked in a world that no longer exists but applying them in the future will result in devastating financial outcomes. [Let me explain.] Words: 1261

So says Monty Pelerin ( in edited excerpts from his article* entitled Investing Guidelines Are No Longer Relevant

Lorimer Wilson, editor of (A site for sore eyes and inquisitive minds) and (Your Key to Making Money!), has edited the article below for length and clarity. This paragraph must be included in any article re-posting to avoid copyright infringement.

Pelerin goes on to say, in part:

Two rules of thumb considered sacrosanct and worth commenting on are the following:

  1. Buy and hold
  2. Diversify

1. Buy and hold, to be effective, depends on the following conditions:

  • That the future will be similar to the past.
  • That economies and incomes will be larger next year than this.
  • That savings and investment will drive growth.

Arguably these assumptions no longer hold.

2. Diversify assumes non-correlation between financial assets in different industries and countries. So long as that was true, portfolio risk could be reduced via diversification.

Today’s economy is powered by liquidity rather than economic production. In this world correlation coefficients between what are distinctly different assets tend to approach unity. Panic and liquidity lead to two states of the world – risk off and risk on.

Buying and selling of financial assets tends to be more mob-like than reasoned. Everyone wants to buy or sell at the same time. The correlation between all assets has risen, reducing the effectiveness of diversification.

The rules of thumb that worked for most of last century no longer do. “Normal” circumstances, to the extent they ever prevailed, surely do not now. Without normality, guidelines developed based on it, are of questionable value.

What Changed?

Lots, although two factors are most important:

  1. Markets
  2. Governments

1. Markets

Markets are increasingly controlled by governments. Socialism and Communism are improper descriptions. Fascism, which retains private ownership but with decisions increasingly made by government, is a better description.

The decision-making sphere of owners has been reduced. So has the freedom of individuals.  Hardly any part of everyday life or economic activity does not involve government rules and regulations. Freedom and efficiency have been reduced. So, too have incentives.

A major factor in government involvement was the adoption of the false paradigm presented by Keynesian economics.  Government assumed responsibility (although not accountability) for economic outcomes. Keynesian interventions resulted in rather constant meddling in fiscal (taxing, spending) and monetary (interest rates, money supply) affairs.

The inroads made by Keynesianism coupled with the impositions on economic actors transformed the US economy into something approaching central planning. Markets exist, but are not as free and functional as they were.

2. Governments

Governments around the world are near sovereign bankrupty. Think Greece, but think also Japan, the U.S. and other major democratic countries. All head toward the same fate.

The common and causal factor producing this march to ruin is the exploding welfare state. In democratic societies, people vote themselves increasing benefits. Politicians, focused on the next election, compete with each other playing Santa Claus in exchange for votes. Governing philosophy becomes secondary.

Entitlements increase the demand for more entitlements. More people accept entitlement income and leisure in exchange for the disutility of work. The workforce shrinks  as beneficiaries grow. The productive sector of society also shrinks. Economies necessarily with fewer people working grow sluggish. At some extended point, economies become dysfunctional.

Governments try to extend the charade of living at someone else’s expense by spending more than they collect. Eventually governments are unable to borrow to pay the bills and resort to money creation.

All modern social welfare states have reached this point. Each is burdened by crushing debt and attempting to hide this fact. The demand for more benefits continues to grow. Politicians continue to spend at destructive levels via money creation. Social promises and debt are beyond the points where they can be honored.  No economic policies can rewrite the rules of arithmetic, which now control the fate of governments and nations.

Citizens who properly lived lives in accordance with government promises are likely to be impoverished as a result of the changes ahead. The plight of every welfare state is that politically they cannot stop the promises but meeting these promises is impossible.

How Will This End?

It will end in an apocalyptic event.  The event will likely exceed the pain and problems of The Great Depression of the 1930s. The route to this end is uncertain for there are two very different paths:

  1. An Economic Collapse
  2. Hyperinflation Followed By An Economic Collapse

1. Economic Collapse

An economic collapse will eventually occur and be triggered by a cascade of debt defaults. The likely economic impact of this ending will be similar to that of the Great Depression.

  • The Dow Jones Industrial Average could fall below 3,000.
  • The bluest of the Blue Chip stocks could see price-earnings multiples in the 5 range, at least those that are fortunate enough to have earnings.
  • Real estate will plummet in value and the dollar will gain, rather than lose, purchasing power.

2. Hyperinflation

Hyperinflation, on the other hand, might produce a Dow of 40,000 but this number would be fictional in terms of value. $40,000 under this scenario would probably buy less than $3,000 under the collapse scenario because the purchasing power of the dollar will have plunged — think Weimar Germany.

Markets would eventually turn to barter as no one would want dollars. The unwillingness to hold dollars ratchets the velocity of money up toward infinity. The Fed controls the supply of money but not the demand. When demand drops, the Fed is powerless.

  • The economy turns to barter and trade shrinks dramatically.
  • The hyperinflation effectively collapse the economy into a Depression.
  • For a while it might be a hyperinflation Depression.
  • Eventually the Fed will stop printing and it will become a deflationary Depression.
  • All of the negatives of a normal Depression will then occur, although likely at much higher prices.

What Can One Do To Protect Oneself?

Just as there are ways to protect yourself against tornadoes and hurricanes, there are things you can do to prepare for what is coming. In both cases, however, there are no certain safe havens. Preparing for the coming nuclear winter is made more difficult by the two paths to Depression. Each path requires a different strategy.

  1. If the path is directly into Depression (i.e., without hyperinflation), then stocks are not a place to be; nor is real estate. Cash will do well. Bonds, so long as they don’t default, will also do well.
  2. If a hyperinflation precedes the proper strategy is just the opposite. Stocks are better than bonds or cash and real estate is likely to perform well.

The dilemma facing investors is less where we are end up than how and when we get there. The uncertainty regarding the timing and path to the next Great Depression provides the challenge for protecting your wealth.

Stock picking under normal conditions is usually a fruitless effort. Under the uncertainty ahead, it should be forgotten. Some of the keys to success in the upcoming maelstrom are the following:

  • Portfolio allocation
  • Flexibility and the ability to adjust quickly
  • Downside protection more than upside profits
  • Real Wealth focus as opposed to nominal wealth

The old strategies of buy and hold and diversification will not work in terms of what is coming. Investors are going to have to shorten their time frames and behave more like traders.”


Editor’s Note: The above post may have been edited ([ ]), abridged (…), and reformatted (including the title, some sub-titles and bold/italics emphases) for the sake of clarity and brevity to ensure a fast and easy read. The article’s views and conclusions are unaltered and no personal comments have been included to maintain the integrity of the original article.

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