Money Matters ...

Is financial catastrophe around the corner?

By Robert Smith
The Daily Record Newswire

Last year, Jeffrey Gundlach, co-founder and head of DoubleLine Capital, gave a speech to investors at Los Angeles’ City Club. His message was simple: “financial catastrophe (was) on the horizon.”

Gundlach is worth listening to. He is one of the top bond guys around and he was one of the few money managers who correctly called the housing market implosion and profited handsomely thereby.

He argues that our ongoing economic crisis has evolved over the last 30-40 years and is doing so in three phases. The first phase began in the 1970s as individuals, businesses and governments began to move away from debt-based financing as a temporary expedient used judiciously and sparingly, to a lifestyle that enabled ever greater consumption —
leveraged buyouts, multiple credit lines, second mortgages, etc.

This massive accumulation of debt to buy more stuff resulted in an economic boom that finally ended in 2008 with the credit bubble implosion. This was the end of phase one. It was marked by multiple bank failures and the most severe global recession since the Great Depression.

Phase two began shortly thereafter. Central banks around the world rushed into the breach, dropping interest rates to near zero and thereby flooding markets with liquidity to keep the private sector afloat.

Obviously, we are still in this second phase. The Fed and other central banks have kept the pedal to the cash creation metal in order to reduce unemployment. What is less obvious is how long this phase will last.

However, it must end … if for no other reason than the fact that real deleveraging of the global economy simply hasn’t occurred. What has occurred is massive debt transference from the private sector into the public sector. By little more than sleight of hand, Ben Bernanke and Co. have simply moved trillions of dollars in debt from one side of the page to the other.

We can extrapolate from this and say the third phase will likely be catalyzed by the insolvency of one or more of these governments. This will likely occur in Europe simply because EU governments do not have available the same political and economic mechanisms to forestall such a crisis that the U.S. has. Then, a real global run on the bank will begin that insolvent governments such as our own will be hard-pressed to put right.

In light of this scenario, here are some strategy points for investors to ponder:

• Preserve capital. The times they are still a changin’; therefore, investors should focus on preserving their capital rather than growing it. This means that stock market investments should necessarily be of short duration and these companies should pay big dividends to offset possible loss of principal.

• Avoid bonds. We are at the tail end of a 30-year lower interest rates/higher bond prices cycle. According to bond king Bill Gross, when interest rates or inflation do rise, bonds will be burned to a crisp. Simply put, the upside for bonds is pretty small now and the downside is huge.

• Own gold and other precious metals. They are a surrogate currency now that cannot be debased by profligate governments. Our volatile and uncertain times mandate increasing this allocation (I have been saying this since gold was $600/ounce).

• Own real stuff. I have long been a proponent of hard assets. They can be a unique store of value. Furthermore, the cost of ownership in a zero interest rate environment is negligible. I continue to emphasize securitized commercial real estate in my own portfolios because they are hard-asset based (a good principal hedge) and they often provide attractive, tax-advantaged, increasing cash flows. Think of it as that missing part of a fixed income portfolio.

• Look outside the U.S. I know it’s hard to imagine, but there are other countries whose economies are managed more prudently. Canada is the closest example at hand. It never bought into the political correctness thing like the U.S. did in regard to lending money. To buy property in Canada, one actually needs a down payment and good credit. Imagine that! I guess having a prime minister who actually understands economics makes a difference.

• Be quick on your feet. Like most others, I don’t know when phase 3 will begin. However, when it does, there probably won’t be much advance notice. Get the ducks in a row now. The longer that one waits, the more they will cost.

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Robert Smith is president of Peregrine Private Capital Corp. Contact him by calling 503-241-4949 or visiting www.peregrineprivatecapital.com.