Smart Money in Hard Times: To Protect Your Portfolio, See the Bubbles

Cindy Spitzer and Bob Wiedemer

DID YOU LOSE MONEY IN THE FINANCIAL CRISIS OF 2008? Has your home lost value? Is the latest rollercoaster of stock market ups and downs making you a bit woozy?

While many analysts insist this is merely a lingering down cycle and that full economic recovery is on its way, nothing could be further from the truth. Rather than a down cycle that will eventually be followed by a reliable up cycle, what we have instead is something very different this time: a falling Bubble Economy.

See the bubbles now and you can begin to prepare and even profit when the bubbles fully pop. Choose to stay bubble-blind and you will likely be taken by surprise when the current Bubblequake is followed by a very dangerous Aftershock. How you and your portfolio fare may very well be decided by what you door fail to do--in the next couple of years. What is a Bubble?

A bubble is an asset value that rises primarily due to increasingly positive investor psychology rather than underlying fundamental economic conditions that are sustainable over time. At first, the rising asset value is not a bubble. It is pushed upward by real fundamental economic drivers, such as rising company earnings, in the case of rising stock prices. But after a while, as prices continue to move up, something else may take over. Investor excitement to own the rising asset can push the price beyond what would otherwise be reasonable, based entirely on the hope that the price will go even higher in the future. Everyone wants in simply because everyone wants in.

For example, during the Internet Bubble of the late 1990s, investors eagerly snapped up dot-com stocks, whether the companies were profitable or not, simply because other investors were eagerly buying them. The relatively new and growing Internet was hot, and rapidly rising Internet stocks were even hotter. In the so-called 'new economy,' many investors temporarily persuaded themselves that old fashioned things like company earnings really didn't matter as much as before. Of course, a lack of company earnings still matters a great deal . Eventually some people began to notice this was a bubble and decided to sell. As soon as enough investors began to exit their Internet stocks, a whole lot more also got out and the Internet Bubble popped.

In hindsight, the Internet Bubble seems so obvious now. That's because bubbles are much easier to see after they burst. The trick, of course, is to see a bubble before it pops so you can protect yourself and even cash in on it. On their way up, bubbles can make you a lot of money. On their way down, they can wipe you out.

Beyond what bubbles can do for individual investors, bubbles also play a key role in many of today's rising and falling economies. In our books, America's Bubble Economy (Wiley, 2006), Aftershock (Wiley, 2009), and Aftershock second edition (Wiley, 2011), we reveal how several important bubbles have been driving the growth of the U.S. economy for more than three decades, and how they will eventually fall, popping our overall bubble economy.

Here is a quick look at the six bubbles we describe in much more detail in our books:

  1. Real Estate Bubble

Generally, home prices and personal incomes tend to rise more or less together. When people earn more money, they can afford to buy more expensive homes and the demand for housing rises. Growing population also increases demand for housing. However, from 2001 to 2006, home prices rose more than 80% while inflation-adjusted incomes rose only about 2% over the same time period. Our first book in 2006 not only correctly predicted the real estate bubble, but showed how its fall would kick off the global financial crisis of late 2008. The real estate bubble is still falling and will continue to do so until after all the other bubbles pop.

  1. Stock Market Bubble

Typically, stock prices rise with company earnings, yet from 1982 to 2002, the Dow increased an astonishing 1,200 % without a similar rise in company earnings or in the U.S. Gross Domestic Product. We call that a bubble. However, in the last decade or so, the stock market has been essentially flat with some periods of sharp declines and rallies. While the stock market may climb again in response to a short term government stimulus, it is just a matter of time before this bubble fully pops.

  1. Private Debt Bubble

Private debt is usually kept at a reasonable level because lenders avoid taking on too much risk. However, prior to the global financial crisis of 2008, super low interest rates and a non-stop upbeat atmosphere created by the real estate and stock market bubbles, kept private loan money flowing to consumers and businesses as fast and loose as cheap beer at a fraternity party. Risky mortgages went to almost anyone who could sign their name, huge corporate buyout loans with very high leverage ratios were considered just fine, and banks and other lenders rarely worried about mortgage or other loan defaults. Some of the hot air has exited this bubble since the 2008 financial crisis, but it still has a long way to fall when all other bubbles fully pop.

  1. Consumer Spending Bubble

With real estate prices rising to bubble heights, the stock market feeling so irrationally exuberant, and loan money of every type gushing fast, bubble-happy American consumers naturally went shopping. The Consumer Spending Bubble is a direct consequence of the real estate, stock, and private debt bubbles, and until lately it has been a big reason for our prosperous economy, which is roughly 70% driven by consumer spending. Of course, that also means that the falling Consumer Spending Bubble will play a big role in our falling multi-bubble economy.

  1. The Dollar Bubble

As we like to say, often the hardest bubble to see is the one you're in. The best way to see the falling dollar bubble is to think of the value of the dollar in terms of supply and demand. High demand relative to supply keeps the value of any asset high, including the value of the dollar. On the other hand, falling demand or rising supply can undermine the value of any asset. Unfortunately, in the case of the dollar, we have both.

Rising supply of dollars is a direct result of quantitative easing (explained in the next section) by the Federal Reserve in an effort to boost the stock market and economy. Massive money printing provides some stimulus in the short term, but in the longer term, this increase in supply will eventually cause rising inflation and rising interest rates that will help push our falling bubble economy down even faster. Investors don't like falling-dollar values.

Falling demand for dollars (and dollar-denominated assets) by investors here and around the world is one of the primary consequences of an overall falling bubble economy. The more our bubble economy falls, the less attractive our dollars become. Falling demand for dollars will make other currencies more attractive and the Dollar Bubble will pop.

  1. Government Debt Bubble

The biggest and most dangerous of our many economic bubbles is the huge Government Debt Bubble, now at an unthinkable $15 trillion and currently growing at the rate of $1.3 trillion per year. Beyond the sheer magnitude of these numbers, there's a scary fact. Not only do we never pay even one penny of this debt back, we also make our interest-only payments on this debt --by you guessed it--borrowing more money! It's like taking a cash advance from one credit card to make the minimum interest-only payment on another credit card. Clearly, that's not a winning long-term strategy.

What makes the Government Debt Bubble particularly dangerous is that when interest rates inevitably rise, as we will explain later, the government will have to make our interest-only payments at higher and higher interest rates. At some point, that is going to become impossibly expensive, as our bubble economy continues to fall and interest rates go higher and higher. No one will want to lend us more money under such unmanageable and risky conditions and, at that point, the only way we will be able to raise more money is to print it. When the Government Debt Bubble pops, we could go from our current AA+ rating that everyone is now fretting about to XXX faster than investors know what hit them.

America's Bubble Economy

All this adds up to a bubble economy on the way down. On the way up, each of these bubbles supported the others, creating much of the bubble wealth and prosperity we have been enjoying for many years. Now each of these falling conjoined bubbles is putting downward pressure on the others, moving us closer to an eventual multi-bubble pop. The previously virtuous upward climb of rising bubbles has now turned into a vicious downward spiral of falling bubbles. That is why we have not seen the elusive job growth and economic recovery that so many people are hoping for today. There are just too many falling bubbles.

Government Stimulus Helps in the Short Term, But Hurts in the Long Term

To cope with the effects of the falling real estate, stock, and private debt bubbles, and in reaction to the global financial crisis these popping bubbles created in late 2008, the U.S. government began deploying a financial stimulus, in various forms. While these measures help us in the short term, they will surely hurt us down the road. At first, we ran up very large budget deficits and passed big spending plans to try to rekindle the falling economy and create jobs, or at least lose less of them. This worked to a limited extent. Certainly without such big stimulus spending, unemployment and the economy would have been much worse by now.

In addition to U.S. government stimulus spending, the Federal Reserve is dishing out some short term stimulus medicine of their own, aimed at boosting stocks and the economy. Beginning in early 2009, massive money printing via the Federal program of quantitative easing (QE) allowed the Federal Reserve to buy large quantities of government and mortgage bonds with money they newly created. As shown in the chart, the Fed has pushed the U.S. monetary base up from about $800 billion in 2009 to more than $2 trillion in 2011. This is an enormous increase in our money supply.

Some of this newly created money has been flowing into stocks, driving up the previously floundering market in one of the biggest rallies in history. As long as the Fed massively printed new money with QE1 and QE2, the stock market has been supported and growing. In fact, the only time the stock market has gone up since 2008 has been while the Fed was printing money.

However, since QE2 ended on June 30 of this year, stocks have been riding a terrifying rollercoaster of unpredictable ups and downs, with investors increasingly nervous about the lack of robust economic recovery and uncertain about the lack of clear direction in Washington.

How long will this continue? We predict there will eventually be more QE ahead (although no doubt under a different name) to once again boost the stock market. This is effective short term medicine, not just for stocks but for the overall economy. Wealthy investors spend more money when their portfolios are doing well. Many middle class Americans own stocks in their retirement plans and feel more confident when their accounts are up and studies show that even people who don't own stocks feel more buoyant spending when the stock market rises. So printing money provides a short term boost to both the stock market and overall economy.

The Short Term Medicine Will Become a Long Term Poison

It would be lovely if all we had to do to solve our economic problems was to print more money. But printing massive amounts of money--in this case, a huge 200% increase in the U.S. money supply in just 2.5 years-- comes with a very terrible future price tag: a significant rise in inflation and interest rates. Unless this money printing stimulus can create a significantly booming economy very quickly, which we know it cannot because the current bubble economy is falling, there will be no way to reverse this massive money printing in time to prevent very significant future inflation.

Not sure you believe us? Ask yourself, if there were no negative consequences to printing massive amounts of money, why hasn't the Fed been doing it all along? And if there is no future risk, why don't they just keep doing it for the next 100 years? In fact, why don't we all just print money in our basements every day so we can buy all the goodies we want, whenever we want? Even without a degree in economics, we all intuitively know that this can't work. That's because when we print money, we are increasing the supply of dollars, and increasing the supply of any asset drives down the value of that asset. In this case, massive money printing now will mean big inflation (loss of dollar value) later. It won't happen all at once, like a bomb dropping, and we will not have hyper-inflation, but in time, inflation is going to be quite high.

In fact, rising inflation has already begun to creep up, with the latest U.S. Consumer Price Index (CPI) at 3.6% for July 2011. Energy costs, which are not included in the core CPI, are rising at a whopping 19% inflation rate and food costs are up by 5.4%.

Rising inflation is not just a U.S. problem. Inflation and fear of inflation are rising around the world, as well.

High Inflation and High Interest Rates Will Pop the Bubbles

The problem with rising future inflation (caused by massive money printing by the Fed) isn't just that things will cost more and wage increases won't quite keep up with rising prices or that your investments will have to earn at a higher rate of return just to break even on the loss of value due to inflation. The even bigger problem is that rising inflation eventually causes rising interest rates, and those hurt asset values across the board (stocks, bonds, real estate) and will pop what's left of our bubbles.

For example, even a relatively small rise in interest rates will significantly impact bond values and all fixed-income investments will suffer dramatically. Higher interest rates will also make mortgages more expensive, which will discourage home buying and further depress the housing market. Higher interest rates will make it harder for businesses to borrow money to hire more workers, buy more materials, and expand. Of course, with stocks and bond prices down, home values dropping, and unemployment on the rise, it will be no surprise that consumer spending--which is more than two-thirds of our economy--will drop, too. Overall, rising inflation and rising interest rates will be the death knell for this so-called 'recovery.'

Once inflation passes 10%--most likely in the next two to four years, although it could be sooner--we believe there will be a dramatic shift in general investor psychology regarding the US bubble economy, dollar, and dollar-denominated assets. Soon after, America's multi-bubble economy will fully pop.

Investing safely and profitably in the current Bubblequake we are now experiencing is hard enough, but as all the bubbles fully fall, the coming Aftershock will be an even more dangerous investment environment than we have today.

What's a Wise Investor to Do?

First, don't get fooled again. The financial crisis of 2008 and the recent stock market drops this past summer are just small samples of what is to come when the bubbles fully pop. Smart money in hard times requires smart thinking, a good plan you can live with, and very active and savvy investment management. The buy-and-hold days of 'set it and forget it' investing are over. Now we all need active portfolio management based on the correct macroeconomic view of what is happening and what will happen next.

Our books and investor services provide much more detail about what you can do to protect yourself in the increasingly difficult economy. Here are some important highlights for the deployment of smart money in hard times:

  • Be Careful with Stocks and Bonds

In the short term, we may see stocks do relatively well as the Federal Reserve decides to launch another round of massive money printing sometime between now and the 2012 election. Enough QE could even push the Dow back to 14,000 or higher. However, up until the Fed does further money printing, stocks prices will be volatile and could drop over any news that reminds investors of their underlying anxieties. More importantly, the biggest drops in stocks are still ahead, most likely coming after inflation passes 10%, although a wildcard event could bring it on sooner.

So unless you are very agile and knowledgeable, our best advice for the average investor is to be very careful with stocks and to consider exiting the market to the degree that you think our analysis is right. For example, if you believe our macro view and predictions about 50%, you could begin gradually dollar-cost averaging out of about 50% of your stocks.

Typically, bonds do better when worried investors sell stocks in favor of what they perceive as less risky, but lower earning, investments. So in the short term, when the stock market goes down, bonds prices may rise. However, in the longer term, any rise in interest rates will harm bond prices. With the recent Fed announcement to keep interest rates low for the next two years, bond prices may seem protected. But once inflation begins to significantly rise, interest rates will eventually rise, as well, and bonds will take a beating.

We recommend only short and medium term bonds (up to five years) and TIPS, but proceed with caution, keep your finger on the trigger, and be ready to exit on short notice. Longer term bonds do have better yields than the shorter term bonds, but they are especially vulnerable to even small rises in interest rates.

  • Consider Gold and Foreign Currencies

We are not gold bugs, but smart money in tough times is smart enough to ride a bubble on the way up. Gold is considered by most of the world to be a universal store of value in difficult times, and investors around the globe turn to gold when inflation and investor anxiety are rising. Whether you find this behavior rational or not, gold is on the rise and its major growth spurt is still ahead. Gold is up more than 500% in the last 10 years and will likely do even better in the next 10 years. No other investment will perform as gold will in the Aftershock. Silver will certainly do well also, but the world tends to think of gold as number one and silver as number two (think of the Olympic medals).

Many foreign currencies will also do well relative to the falling dollar leading up to and in the Aftershock, including the Swiss franc, Canadian dollar, and the Norwegian krone. Other currencies, such as the euro and the Australian dollar, may also outperform the U.S. dollar when our Dollar Bubble fully pops.

  • Deal with Debt

If you can, pay off or refinance all adjustable-rate debt and credit card debt, as your income and financial situation will allow. As inflation and interest rates rise, adjustable rate debt will become increasing difficult to pay down. On the other hand, do not make more than the minimum payments required on fixed-rate debt because as inflation rises, you will be paying fixed-rate debt back with cheaper and cheaper dollars.

  • Get Real about Real Estate

If you are waiting for home prices to come back soon, we are sorry to tell you it isn't going to happen. Unless you want to stay in your current home for the next 10 years or longer, now is the time to sell and find a suitable rental. At least that way you will be able to leave the area when you want to. If you need to cut the price to sell, you are better off doing that before your neighbors do.

If you don't currently own a home, don't rush out to buy one, thinking that current prices are bargains. Many more bargains are to come for those who can pay cash. However, if you need to buy a home and you can only do so with a mortgage, buying now while mortgage rates are low is a better idea than buying later when mortgage rates will be higher. Get only a fixed-rate mortgage with as low a down payment as you can and don't make any extra or accelerated payments on any fixed-rate debt or mortgages.

Do not buy vacation or rental homes because these properties will be worth less in the future, and finding paying renters will become increasingly difficult as unemployment rises.

  • Stay Calm

There is no need to panic or act impulsively. Think through your overall investment strategy based on wise macroeconomic analysis of current and future trends. Make a plan you can live with and take action in manageable steps. As long as you have your eyes open and can see the bubbles falling, you will have a better chance than most to protect your assets and perhaps realize profits when most others will be blindsided.

When it hits, the Aftershock ahead may seem like the end of the world as we know it, but it won't be the end of the world. The economy will be difficult for a while, but just like in the past, our challenges will eventually lead to real economic growth in the future. In the meantime, denying reality can be dangerous. Now is the time to prepare for the Aftershock ahead. To learn more, please see the second edition of Aftershock or contact us for more information, individual support, or investment management.


David Wiedemer, Robert Wiedemer, and Cindy Spitzer are coauthors of the New York Times bestseller Aftershock second edition (Wiley, 2011).

Robert Wiedemer is also a Managing Director of Absolute Investment Management, a macro-focused money management firm that is in alignment with the perspective and investment strategies in Aftershock. Mr. Wiedemer can be reach at 703-787-0139 or

Cindy Spitzer is president of Aftershock Consultants, providing one-time and ongoing consulting, risk assessment, and support to individuals, families, and businesses, based on the macroeconomic ideas in Aftershock. Ms. Spitzer can be reached at 443-980-7367 or