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New From Epsilon Theory: ‘Things That Go Bump In The Night’

"Why should we pay good money to buy put options as a hedge on our portfolio when the Fed will give us a put option for free? I think this is the most far-reaching and transformative effect of the extraordinary central bank policies of the past eight years — we are no longer afraid of things that go bump in the night."

The following is brand new by Ben Hunt, as published over at the excellent Epsilon Theory and reposted here with permission.

You can also follow Ben on Twitter here.

Penny

Same with markets. Things turn out right a ridiculous amount of the time. Pennywise only shows up once every 27 years. Should we be scared about his market equivalent?

Like many children with over-developed imaginations, I was always scared of things that go bump in the night. To this day I remember vividly the events (all fictional, of course) that frightened me so badly, like this scene from the 1979 made-for-TV movie of Stephen King’s Salem’s Lot, where little vampirized Danny tries to get his friend to open the upstairs window and let him in. You see, vampires have to be invited into your house. You have to give them permission to destroy you.

Hold that thought.

Anyway … as a child, I convinced myself that I could keep myself and my family safe from these malevolent forces and evil eyes if only I surrounded myself with the proper talismans (mostly stuffed animals, arranged just so around the bed) and said the proper words to God before going to sleep.

And it worked! This was classic magical thinking, just like that used by so many of our smartest and most powerful adults to protect us from the malevolent forces of economic recession and political decay.

I’d love to say that I’ve outgrown these fears that I know are irrational, but the truth is that I still surround myself with protective talismans and carry them with me wherever I go … a couple of lucky pennies, sure, but also a lucky dime (h/t Scrooge McDuck); one of the many chestnuts that I’ve rubbed between thumb and fingers till it’s oiled black and smooth, thinking this was my uniquely private charm until I recently found a well-worn chestnut hidden away in my grandfather’s rolltop desk; fortunes from cookies I ate 20+ years ago; my half of the turkey wishbone from this Thanksgiving, where my wife and I always not-so-secretly try to let the other win; an ancient post-it note wishing me luck, scribbled by one of my kids not for any particular reason, but just because. Powerful magics, all.

I’ll bet any amount of money that everyone reading this note has their own protective talismans. Maybe not as over-the-top as me, but you have them. This has always been my can’t-miss Turing test — the question you ask of an intelligence you can’t see to determine if it’s human or machine — what’s your talisman? What’s your charm of protection or luck? Every human being has a talisman. No machine would. It’s like asking a computer what mnemonic device it uses to remember something like the colors in the spectrum of visible light … the name Roy G. Biv has no meaning to a non-human intelligence other than as a curiosity of a less-capable species.

In investment and allocation circles, we have a name for these magical protections against spooky market forces that go bump in the night. We call them hedges. Now I’m not talking about hedge funds per se. I’m talking about the ad hoc hedges used by naturally long-only allocators like foundations and endowments and pension funds and big family offices. I’m talking about the ad hoc hedges used by naturally long-only investors like everyone with an IRA. I’m talking about how everyone reading this note has, at one time or another, gotten scared about markets and decided to hedge their professional portfolio or personal account with something that will make money if markets go down. Not as part of a considered review of risk tolerances and return projections and portfolio convexity (whatever THAT means). Not as part of an intentional portfolio that might include a long-volatility manager or a dedicated short fund. But just because we’re scared of something going bump in the night, and we need a talisman to ward off the bogeyman.

The most common of these casual hedges, the investment equivalent of a lucky penny, is the put option, and its most common expression is the put spread.

Quick review! A put is an option where you’re betting on whether the underlying thing, say the S&P 500, will go down below a certain price level before the expiration date of the option. So if I buy a put option that’s “struck” at a price level 5% below where the S&P 500 is today, and that option expires three months from today, then in three months my put option will only have value if the S&P 500 is at least 5% below its current price. The farther below that 5% strike price, the more money the option is worth.

A put spread is when I both buy AND sell a put option. Slightly different put options, of course, otherwise I’d just be buying and selling the same thing, but the difference between the two options — either in expiration time or (more commonly) the strike price — is the “spread” that I’m now betting on. So let’s say I bought a three-month put option struck at 5% down on the S&P 500 and sold a three-month put option struck at 15% down. When those options expire, I’ll make money on the put I bought if the S&P 500 is down at least 5%, and I’ll make a little money on the put I sold (limited to the price someone paid me for the option in the first place) if the S&P 500 avoids being down more than 15%.

Why would I do this complicated little dance? I do it in order to reduce the net cost of the put option I’m buying (the one struck at 5% down in this example). I want to buy some “insurance” on my portfolio that will pay off if the market is down more than 5%, and I can reduce the cost of buying that more-than-5%-decline insurance policy by selling someone else a more-than-15%-decline insurance policy. I mean … yeah, I’m scared of a 5% bogeyman attacking the market, but a 15% bogeyman? In the next three months? C’mon, that’s crazy talk. I’m not THAT scared.

As you can imagine, there are a zillion different variations on the put spread theme, depending on how scared I am and what I’m scared about. As you can also imagine, selling these put spreads to naturally long-only investors is a lucrative business for Wall Street, the bread and butter of equity derivative desks everywhere.

Again, I want to make clear that I’m not talking about the Street’s interaction with professional investors where options trading is part and parcel of their particular strategy. If you’re a BMW salesman, do you make your money by selling to a guy who owns a limo service and knows everything about the car business? No, of course not. You make your money by selling (or better yet, leasing) a new vehicle every three years to the doctors and lawyers and financial advisors who love their beemers. They’re not dumb guys and you’re not fleecing them (or else they’ll try a Mercedes for a change), but it’s not their business. This is where you make your margins. It’s exactly the same thing with the Street and selling portfolio hedges to naturally long-only investors.

Here’s the other similarity between luxury car sales and portfolio hedge sales. When you step back for any sort of a long-term view, is there really a meaningful difference in the transportation utility between a new BMW and a used Chevy? Of course not. There’s a personal utility I get in driving a BMW. My dad bought a BMW 1600 (the cheaper cousin of the 2002) in Birmingham freakin’ Alabama back in 1972 when BMWs were economy cars. I learned to drive a stick shift with that car. That car would flat-out FLY. It connects me with my father, gone 20 years now, and my own youth to own a BMW. So you’re damn straight I’m going to keep driving one. But I don’t own a BMW because it improves the Sharpe ratio of my transportation portfolio. I own it because it’s a powerful talisman for my personal life story. It makes me feel better about myself.

This is the reason why so many naturally long-only investors have paid for billions of dollars in ad hoc portfolio hedges, mostly in the form of put spreads, over the years. Not because these hedges have improved the risk-adjusted returns of their portfolio — decidedly on the contrary, in fact — but because they make long-only investors feel better and more secure about their portfolio. Ad hoc portfolio hedges are a crucial part of the STORY we tell our investment committees — either an external committee or, more importantly still, that internal investment committee we all carry around inside our heads — about how we are ever-vigilant against the monsters lurking just beyond the castle walls.

And it works! Not in an economic sense, of course, but in the powerful psychic benefit it provides, like me as a child arranging the stuffed animals around my bed just so, or me as an adult driving a BMW.

But here’s the thing about our adult talismans — they’re not cheap. Sure I might not care about the premium I pay to drive a BMW when times are good, but I can tell you from experience that I care a lot if my annual income takes a big hit. Talismans and charms are great for the psychic benefit they provide, and god knows I’m all about psychic benefits, but if it’s that or paying the mortgage …

I think that naturally long-only investors are now abandoning their portfolio hedges, because they can no longer easily afford the psychic benefits of these expensive adult talismans.

The investment returns of so many naturally long-only investors have been so disappointing for so many years (in relative terms if not in absolute terms) that it is harder and harder to justify the very real cost of putting on ad hoc portfolio hedges. If you don’t keep up with the Joneses in the investment returns you provide your client, external or internal, you will be fired. If you’re a good story-teller, that will buy you more time with your client than if you’re a poor story-teller, but it’s only a matter of time. You. Will. Be. Fired. In times like this, psychic benefits go by the wayside, and I think this is creating a big shift in the behavioral structure of markets.

I don’t have any proof-positive charts to show you that naturally long-only investors (who control the vast majority of financial assets in the world, btw) are now changing their long-held behaviors by abandoning ad hoc portfolio hedges. I have plenty of anecdotes and stories, and a couple of suggestive charts, but like all big shifts in investor behavior this is a slow burn that won’t be obvious until it’s already happened. If I’m right, though, this is a sea change in the way that the game of markets is played, with important implications for anyone who cares about playing the players and not just playing the cards.

Here are two charts that suggest a behavioral shift.

First, this chart (h/t Joe Gulotta) shows the ratio of outstanding equity put options to call options on the Chicago Board Options Exchange (CBOE), the largest options exchange in the U.S. I like looking at the ratio of puts to calls because it’s not impacted by the overall level of options usage in and of itself. Whatever the overall option activity might be, this ratio is isolating how many investors are participating in negative markets bets (puts) versus positive market bets (calls). The put/call ratio is typically used by traders as a sentiment indicator (so in this case showing a bullish market sentiment), and that’s all well and good. I’m using it for a different purpose … not to judge sentiment levels per se, but to see if we can glean behavioral patterns from the path in which those sentiment levels change over time. I’m not particularly interested in measuring sentiment or even change in sentiment. I’m interested in understanding the behaviors associated with sentiment, and how those behaviors change over time.

There have been six trading days over the last eleven where there were only half as many put options held by investors as call options. Prior to this, there were six trading days with this 1:2 ratio over the past two years. Also, you can see on this chart that there have always been spikes of put buying activity every few months, when investors get scared about this or that and decide to buy some talismans for “protection”. We haven’t had that sort of spike since last summer, and it’s not like there haven’t been any well-publicized market bogeyman since last summer. It’s the put-buying behavior that’s changed.

Second, this chart  (h/t Devin Anderson and the rest of the Deutsche Bank equity derivatives team) shows the changing value of outstanding put options on the S&P 500. In other words, I’m less interested in the ratio or total number of put options out there at any given time, than in the dollar amount of hedging that those put options represent. This is what it means to show “delta-adjusted” open interest on put options, measured here in billions of dollars. So per this chart, over the past five years the maximum amount of hedging on the S&P 500 index using put options occurred in the fall of 2015, with about $230 million worth of “insurance”. Today, however, there is only about $70 million in S&P 500 index protection outstanding, the lowest amount in five years, and it sure looks to me like it’s on a path to nothing. Which would be an amazing thing.

I’m not saying that it’s a bad thing.

In fact, as someone who has a strong professional interest in encouraging allocators and investors to focus on what truly matters for their portfolios (see, of course, Rusty Guinn’s 2017 serial opus for Epsilon Theorysummary of the chapters linked here), I think it’s a good thing to stop making these ad hoc portfolio hedges. And if it’s accompanied by a conscious review of risk, reward and REGRET in our investment strategies for a profoundly uncertain world … well, that’s a really good thing.

But it is an amazing thing, with some important implications. Here’s one:

For years now, whack-a-mole vol-selling strategies, where any slight pick-up in volatility was promptly whacked on the head with a mallet of put selling and volatility futures shorting, have been extremely successful. Why? Because when volatility spiked up it meant that there was a bogeyman narrative being projected by CNBC and the like, and the naturally long-only allocator or investor got all scared and decided to “buy protection” with a put spread or some similar ad hoc hedge. And then when the bogeyman didn’t materialize, this “insurance” expired worthless, and the premiums paid were pocketed by the volatility selling strategies. If you’ve ever bought a portfolio hedge (and god knows I have), then you’ve been the counterparty to these vol-selling strategies. Time after time after time, you’ve been on the losing side of the zero-sum game that is the options market.

Today though … if that talismanic put-buying behavior is going away — and I think it is — then systematic volatility selling strategies won’t work as well going forward as they have in the past. That’s not a bold market call. It’s just a mechanistic fact of markets: sellers don’t get as high of a price for what they’re selling if you have fewer buyers. Volumes go down and margins are squeezed for traders, too.

This isn’t just an issue for hedge funds and Big Bank equity derivative desks. Systematic vol-selling strategies are everywhere these days, including the most vanilla of accounts. Got a covered-call overlay (also called a buy-write strategy) on your RIA account? That’s a systematic vol-selling strategy. Now please, I’m not saying that these are bad strategies or anything like that. Really, I’m not. I’m saying that a change in the hedging behaviors of institutional investors isn’t just inside baseball stuff. It matters for every financial advisor, every individual investor trying to figure out what to do.

And it goes way beyond the impact on this investment strategy or that strategy. What I think we’re seeing is the next necessary step in the transformation of markets into political utilities, where political institutions like the Fed are tasked in a more and more explicit manner with supporting the interests of the Nudging State and the Nudging Oligarchy. Does anyone doubt that if a vampire were truly to appear and knock on the market’s window, say a vampire in the form of a North Korean artillery attack, that the central banks of the world wouldn’t do “whatever it takes” to keep markets from falling? Why should we pay good money to buy put options as a hedge on our portfolio when the Fed will give us a put option for free? I think this is the most far-reaching and transformative effect of the extraordinary central bank policies of the past eight years — we are no longer afraid of things that go bump in the night.

But should we be?

Let’s agree (I hope) that buying ad hoc hedges in response to our fear of things going bump in the night is a poor implementation of our worries, that it’s an expensive psychic benefit that rarely moves the portfolio performance needle even if it works. But if we could implement a hedging strategy in a systematic way (not necessarily mathematical, although maybe, but always rigorous and repeatable in its process … something I’ve written about a lot, notably here and here), should we?

Are there monsters that the Fed can’t protect us from?

YES.

I think that there are two ways to think about the monsters that are immune to the central bankers’ Protection from Evil spell (sorry, revealing my OG D&D roots there).

First, there are monsters that the central bankers CAN’T control. Now to be honest, there aren’t too many of these bogeymen out there after eight years of forward guidance chants and $20 trillion of asset purchases, but the most obvious ones all come out of some unexpected turn of events emerging from China — a military coup, a hot war, a yuan devaluation (or float), a cold war on trade … something of that ilk. All very low probability events, but not totally crazy, either. If China and the U.S. are ever seriously at odds in a geopolitical sense, then it doesn’t matter how much jawboning we get from central bankers … the market is going to decline in a serious way. But I don’t get too worried about these monsters that the Fed can’t control.

Much more important, I think, are the monsters that the Fed WON’T control.

There’s an old saying that I remember liking so much when I first heard it: “Ask for forgiveness, not permission.” It appealed to me (and I suspect to most readers) because it speaks to our personal sense of independence and autonomy. By golly, I’m going forward with this smart plan of action that might not get approved in advance by my boss or my board or my significant other, because I truly believe it’s best for the team. And if my boss or my board or my significant other has a problem with my actions after the fact … well, then I’ll swallow hard, take full responsibility and ask for forgiveness.

This is exactly the opposite of how vampires behave.

Vampires ALWAYS ask for permission.
Vampires NEVER ask for forgiveness.

You get one chance to say no to a vampire. After that … well, you asked for it.

I’m not talking about Stephen King vampires. I’m talking about real-world vampires, intensely self-interested professions that have been institutionalized into destroyers. Real-world vampires aren’t knocking on the window asking for permission to come in. We’ve already given them permission. They’re already inside.

Like politicians who are invited into our White House and Capitol with our votes. Politicians who then enact policies to enrich and empower themselves, their families and their posses. Politicians who pursue these policies with absolute entitlement and zero shame.

Like police and surveillance organizations who are invited into our homes and cellphones with our tacit and explicit expressions of support for civil security. Police and surveillance organizations who then seize our property and our communications. Police and surveillance organizations who pursue these seizures with absolute entitlement and zero shame.

Like technology companies who are invited into our friendships and purchasing behaviors with our voluntary social media and online commerce participation. Technology companies who then monetize our most private habits, opinions and preferences. Technology companies who pursue this monetization with absolute entitlement and zero shame.

Like unfathomably large banks who are invited into every aspect of our lives with our insatiable appetite for debt and consumption. Unfathomably large banks who then claim a permanent and unbreakable lien on our income and our labor. Unfathomably large banks who pursue this claim with absolute entitlement and zero shame.

Each of these modern vampires has charisma. They don’t present themselves as ghouls floating outside the upstairs window. They present themselves as the Robert Pattinson equivalent for whatever group of citizens they need to open the front door wide. It is, per Anne Rice, the first lesson of the vampire: “to be powerful, beautiful and without regret.”

This is how you NUDGE.

Each of these modern vampires of the Nudging State and the Nudging Oligarchy shares a certain DNA. Not to get all Marxist here, but these vampires share the DNA of Capital, in opposition to the DNA of Labor, and this is why you will never see the Fed or any other central bank lift a finger against them. Because the Fed is also a creature of Capital  not a vampiric destroyer as these modern manifestations of Capital have become — but a creature of Capital nonetheless.

Meaning what, Ben? Meaning that all of the Fed’s policies — and particularly the monetary policies that are most impactful on our investment portfolios — are in the service of Capital. Sometimes, as we’ve experienced over the past eight years, that means incredibly accommodative monetary policy to support asset collateral prices. Sometimes, as we’ve seen in the past and I think we’re about to see again, that means punitive monetary policy to crush labor and wage inflation.

I don’t know how this change in monetary policy regime plays out. I don’t know how quickly punitive monetary policy happens or how far it runs. I can’t predict it. But I know that the Fed won’t prevent it, because the Fed isn’t your protector, and that’s what you should hedge against in an intentional, systematic way.

In real life it’s never the monster that goes bump in the night that gets you.

It’s always the monster in plain sight.

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18 comments on “New From Epsilon Theory: ‘Things That Go Bump In The Night’

  1. So, I read this, and it confirms much of what I know from just observation.

    The thing is, as a “non-professional” investor, here’s what I take from it:

    1) professionals are not necessarily — and in fact, seldom — good sources for advice given the current financial environment.

    2) no one is going to watch out for me other than me (I’ve known that for many, many years).

    3) be prepared for stuff to go sideways, through the barricade, and down the cliff.

    4) take steps to minimizee damage to your portfolio from that near-certain event.

    So, here’s my question . . . I can’t trust experts, I can’t trust institutions, and I can read literally dozen of opinions telling me how to prepare. Precious metals and crypto-currencies aren’t somethign I’ve ever considered nor would I consider them now.

    Other than being mostly into cash and sitting in the corner waiting for the effluent to hit the rapidly spinning blades, what is the “regular investor” supposed to do?

    I mean, cash is great, but when inflation hits (as apparently everyone thinks it will) it will gnaw at that cash horde.

    I could try real estate except that I can see the same borrowing patterns now as I did in the mid 2000s. I could go down the list, but I’m repeatedly told we’re in a new era and something we’ve never seen before and hence the usual approaches to minimize risk won’t work.

    Understand, I’m not asking for detailed advice, but the above piece ends with:

    “But I know that the Fed won’t prevent it, because the Fed isn’t your protector, and that’s what you should hedge against in an intentional, systematic way.”

    . . . right after it dismantles all the “standard” hedging. When I read we need a new theory or approach to handle the changing and erratic financial environment that’s resulted from heavy manipulation, it tells me we don’t have one yet, and that one is not forthcoming anytime soon.

    Is the underlying message that we’re basically screwed and no one knows what to do?

    • Richard Haider

      Trader Kid

      • Richard Haider

        Yes! We took over 50 years to screw ourselves. we are not going to come out of this without paying the price. Diversify in every aspect of our lives.

        • Diversify is good advice . . . but Epsilon Theory has a number of articles dealing with arguments as to why that’s not going to help (unless you hit a mythical sweet spot they admit is difficult to do).

          My approach (for my age) is capital preservation, so right now I have very little exposure to risk (and missing out on all the exhuberance).

          The concern, frankly, is not the market, stocks, bonds, etc.

          The concern is what does this country look like in ten years? I’m asking both with respect to finacial and political considerations, especially since the two are inexorably tied at the hip.

          I hear people speak about the shit hitting the fan and “we’re going to pay the price” but there’s no details forthcoming as to what that even means. Are we talking riots on the streets? Or just that for a few years we won’t be able to count on making money in the market? Or both?

          I know there’s no crystal ball, but it’s a tad annoying continuously reading about this “price” we’re going to pay and no one explains what that is, exactly. The spectrum of possibilities seems to range from a stock downturn (most people don’t own stocks) to a failure of the political and social system (that would affect a lot of people).

          • Richard Haider

            Disperser,

            I wish I could write as well and as fluently as you do. Nevertheless, here it goes.

            Governments will lose credibility and governments will change and will be replaced. However, I don’t believe, there will be confiscation of personal assets, unlike other society, that does not seem to be in American DNA. Here people generally want to be the next self made millionaire, instead of taking from the guy who has already made it.

            Our future generations may not have it as easy as we had because our standard of living was based on unearned borrowed money and money created from thin air. Our kids may have to earn it and compete for their standard of living with the rest of the world. However, we will still be the best nation on the planet to deal with the coming storm.

          • Perhaps it’s because English is also my second language, but I don’t see anything wrong with the fluency and quality of your writing.

            I like the optimism that you have and — truth be told — I have a fair amount of optimism as well but it’s for the long run.

            The US (as a country) in its history has faced all sorts of things that could have derailed it and in a few instances, it nearly did. So, yes, there is some backbone to the American people and the professed ideals enshrined in its psyche . . . but even that is under attack.

            While I still hold hope, tribalism, identity politics, class warfare, all seem to be aplified by the advent of the Internet and the 24-hours news/opinion channels.

            Meaning, while I think we have a good chance to weather all this and what’s coming next (whatever that is) it still means that a lot of people will go through some short-term very unpleasant hardships. And yes, many generations of people have experienced the same or possibly worse in the past 200+ years.

            So, yes, we (the people who follow us) will likely survive and perhaps even prosper, but in the interim it’s not going to be much fun for a whole lot of people.

            Anyway, thanks for the conversation.

      • Trader Kid?

        See, this is where I profess my ignorance; I don’t even know what that means.

        • Richard Haider

          Hi Disperser,
          It was just an error, I could not figure out how to correct. My apologies.

          Getting back to our discussion, Given the proliferation and debasement of our financial systems, easy money, deficit spending, and political expediency, we have had in the past, I believe, there is a certain inevitability for a lot of pain. I am a newcomer to this beloved adopted country. At the end I still believe we have lot of good decent hardworking and honest people in this society with great civic values. We do have the best legal framework, national institutions and generally high moral value in our society. We will recover and rebuild. Once the dust settles, we will still be in a better position than the rest of the world.

          Personally, I have no debt, some rental income, a very diversified portfolio in large national international companies and 50% in cash and short term t-bills, still do some short term trading in Mo Mo stocks. Just my two cents.

        • I can agree on some of that when speaking about individuals. Less so for larger groups.

          Personally, I’m very conservatively positioned (or what I think is very conservately positioned) with 1/3 equities (“stable” companies with deep pockets and dividends), and 2/3 a combination of cash and overlapping CD ladders. I’ve not had any debt since the middle 1990s and even right now I’m in between houses as we’re looking for a place to go and live (in no rush, at least for now, as we’re in Hawaii).

          What I mention about larger groups is what worries me both on the personal level and politically. As an example, I watched large unions get exclusions and waivers from certain ACA rules that apply to others.

          During the financial crisis I watched governments bail out pension plans and companies while the individual investors took the hit. My own losses were never actuated as they were paper losses but that was also because at the time I was working.

          I’m now retired and I’m called overly conservative for keeping enough liquidity to allow me to live for six+ years without touching investments.

          Per my (conservative and overly pessimistic) calculations, I only need a 3% net return (post inflation) for our savings to last into our 90s (uunlikely we’ll live that long, but that’s the plan).

          So, looking at all that, I’m not personally worried . . . and yet, if enough people get hurt, they can pressure the government to do certain things that will affect me ond others with savinsg. Things other countries who are hurting are either considering doing or actually doing. Things like penalizing people who did save and were prudent in their affairs.

          Although I don’t see it in the current environment, some people happily speak of the government taking over private retirements accounts. In view of so many states being in the deep crimson with their pension liabilities, it’s not outside the realm of possibility that at some point the majority of voters might be in favor of something like that, especially since the majority of voters have little to no savings for their own retirement.

          It sounds paranoid but this isn’t me reading some conspiracy theory. Some people are outright hostile to the idea that a few have savings and politicians are going to feel increased pressure to “help out” all these poor people who spent money they didn’t have and all these poor states who promised money they didn’t have based on projected returns that were pipe dreams.

          So, when I ask about thei “price” we’re going to pay, I’m asking because if the price is that a lot of people lose a lot of money in the market because they took unreasonable risks based on unreasonable expectations, well, crap, I don’t really give a rat’s ass. Sure, it won’t be pretty, but we’ve gon through that before.

          But, if the price is that the government will look at a large pool of money (pensions and IRA accounts) as a way to help out the majority because things really went to shit, well then, that’s a different story.

          Realistically, I probably can’t do anything about those extreme cases, but I still wonder what articles like the above and many articles on this blog speak of there being hell to pay.

          And even then, when I read possibilities for $30T debt and runaway inflation what does that mean in terms of how that will change financials systems and policies both here and abroad?

          Anyway, I read these kinds of posts and blogs to try and glean some measure of understanding for the dynamics of institutions that are well beyond my current understanding in both scope and dynamics.

          Unfortunately, often, all I get is more confused.

  2. I keep coming up with the same question about a lot of articles I read here. “Here’s the problem; it’s new and different and nobody knows what to do about it, maybe. ” People have always invested their money in different things, but all of the usual avenues seem to be throttled. If stocks, bonds, savings accounts and cd’s aren’t workable, what do you do?

  3. It has always been “different this time”, which is why we “don’t know what to do”. One thing that isn’t different this time, is that all of us are simply emotional monkeys who will eventually react to our fear and greed like we always have….buying everything, selling everything…then repeat.

    • Yes and no . . . $15T (some say $22T) has made a mockery of the whole thing.

      I mean, even as I invested and did OK (not great, but OK) I always knew it’s a made-up quasi-ponzi-scheme game we play that is real because everyone pretends it’s real.

      Now, we’re not even pretending anymore. I think (from a non-expert point of view) one of the reasons we are at this point is that most people realize it’s a game but also believe the people who control it can’t afford to have it crash and burn. Literally.

      I’ve noticed that people with money react pretty much consistently . . . as they make and have more and more money, they become more and more protective of it (why the trickle down notion if a bunch of crap). And yes, I hear the arguments that no one can control the market, but because it is a game, it’s sensitive to bluffs and faints, and even a few well-chosen words can send it either way up or way down.

      You may be right that it’s always been like this, but the game was played by rules one could somewhat understand. Even someone like me, without direct ties to the financial and political systems, could gauge risks and rewards and discern a strategy based on my own personal goals.

      Now, some idiot (literally) will make a comment and the indices will swing a few hundred points in either direction, sometimes within a few hours. How the heck does one plan for that? My thinking is not to play the game, but that too has long-term consequences.

      . . . perhaps we are screwed . . . I would say “fucked” but I don’t like to swear.

      Not that long ago all I’d hoped for is for it not to go completely off the rails and sort of limp along for 20 years or so. Now I can’t even imagine a couple of years without things getting absolutely absurd.

      From that standpoint, all I really would like to know is what to expect. And by that, I don’t mean with the markets . . . I mean on the streets and at the stores and in towns and cities.

      For instance, one part of me can’t believe that fully half the states will have to declare bankrupcy within the next (X) numbers of years and that half the people (literally) might have to declare bankrupcy because they won’t be able to pay their loans and that the government itself might “run out of money” (whatever that means since they can print more).

      But, if I look at the numbers, that’s what I’m forced to conclude. It’s not a pretty sight and it speaks to . . . well, I don’t know. We’ve not been here before.

  4. Tom Swift Jr.

    A warehouse full of plywood, located in a town on the path of a hurricane, is always a good investment.
    In other words, protection is in the eye of the beholder. Asking for specifics from another person just won’t apply to your needs.
    I’m thinking about ammunition, OTC drugs, first aid kits, salt and a few paired sheep. But then I have the room for that stuff. And I’ll only lose money in upkeep on the sheep.
    See, specifics.

    • Not asking for specifics about what to do . . . asking what people are thinking might happen at the street level. Even a hint would help.

      • Two years ago, would this question even come up? Today, I think about it daily. Not so much for me, but for my children and grandchildren. Here we are, probably on the doorstep of another presidential impeachment, the third in my lifetime. And all the while, the “leader of the free world” is probably raising black swans on the White House lawn. When the conflict comes, guess which faction will have the guns? Disperser, your concern is my concern, this will not end well.

        • ” raising black swans on the White House lawn”

          What a great line. Hope you don’t mind if I use that sometime.

          We are in the process of transitioning into being a ‘global tribe’, especially the Northern Hemisphere, mainly thanks to communication and data processing technologies. Yet, we have the clown in chief running around trying to build walls of all kinds when it comes to trading with our friends (but not Putin. When it comes to the Russians, the Donald seems to spread his own ass-cheeks in anticipation). America first, will end up being America alone. Look at what he has done to the TPP, the climate agreement, and NAFTA.

          All revolutions have had economic origins. When the inequality in a society reaches a critical level and enough people have nothing to lose, then you get revolution; the American, the French, the Russian. When? Like always, timing is everything, but I can’t help you with that.

  5. WOW! Well, for starters, what a great article … and I think I understood most of it.
    Then, what a great set of comments … or scary set of comments .. depending on?
    So – having exactly ONE option (a call on F promoted by the Najarian bros. – total disaster) under my belt, I cannot claim to have the experience to answer the question posed here about hedges. I will try to follow you all and glean some sort of plan (plan for change, then change the plan) from your sage advice.

    However, having some years of experience to draw from, I would offer the following:
    Until the masses (94% of whom are armed with some sort of lethal weapon) rise up in revolt (and then we will need the paired sheep, ammunition and, perhaps, a moat), I project that those with enough money (like myself) will require continuing healthcare regardless of the ‘health insurance’ available at the time. I am invested in hREITs which have two characteristics: They are not dependent on Federal or State healthcare insurance, and; They have as much rental space in variable-rate contracts as possible. VTR is my best example. These equities are losing value like crazy in this environment – but, if you believe in the premise that folks with money will take care of themselves in this way, then they present a continuing opportunity to buy, buy, buy at better yields every day … and will pay you to wait while collecting dividends. Opinions?

    I’m also convinced that China is serious about allowing the folks in Beijing to breath easier, and so am moving some of my portfolio towards MLPs which move, ship, and sell LNG. US produces much of NG and this seems to be a reasonable way to play the China ‘clean up’?

    Other than that, I’m trying to ‘clean up’ my own portfolio and moving towards a strong cash position. I wouldn’t have any idea how to ‘short’ volatility – but the concept of “put spreads” seems to make some sense to me. I am not certain that I would understand how to implement them.

    If you’ve followed me so far, then thank you. I will continue to follow y’all in the hopes of learning something of value .. and perhaps implementing it. I’m not ready to retire to the bomb shelter quite yet … but I would like to learn how to prepare for the ‘expected worst-case’ if I can. r.

  6. Boy is my head swimming. I have limited knowledge and even more limited advice but I will tell you all this much — whatever I have I got from real estate and the secret I learned is solid smart people management for that real estate – starting when everything was going up condominiums which typically were fairly short term residences for your college kids and within a few years they were moving out, the family sold them (good buys!) so you pick up a few – some you keep and rent and some you fix and flip. Market was always pretty good for that resale – always someone headed to college, good rental management required.

    Then you stumble into managing a large condo owner/resident property and then they eventually want out and soon more than 75% is rental units so you take over additional rental management of those units and another few years drift by and the rest of of all owners would like to sell – not that many now – and put the entire property on the market, great high dollar area, all solid plus and sell as is and that buyer wants to continue the proven rental track record right there. So you roll along for a short time — during all these phases you steady made good cash, picked up a couple of good buys for yourself, good percentages on sales and monthly rental income/management fees (license is required). You made a decent dollar and worth the effort. The fun was free!

    Now you have some bucks in the bank, relax a couple years. Feels good. Ok, times up and need to get busy again. You can see how many years you have left in the bank account, some small income from little things, elderly parents leave a little nest egg you didn’t even know they had! Collect social security, cut medical cost due to Medicare benefits, pretty healthy life has paid off…until the day it didn’t. They can’t fix it but they can treat it; not sure how long, but hey, it’s already been 3 pretty easy years and doing really well. Got plenty to get to the end and still have a big old house to sell — or pass it on to the kids. Couple of CD’s, a whole life policy that pays dividends, some little stuff. The up side is I can stop worrying again! See, it all works out just fine in the end! 🙂

    You really don’t know what will come next so, don’t stress and do anything you are not 100% comfortable doing! Don’t take the risk if you would regret the loss. You really are not in charge. 🙂

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