How to Tell When Stocks are Overpriced (It’s Easier Than You May Think)

In “The Independent Musician’s Guide to Not Going Broke“, I made a strong case for what is now the conventional wisdom in finance: That putting away a good chunk of money every month into broad stock market index funds is one of the safest, surest and simplest ways to build wealth over long periods of time.

However, I also made a very important caveat: That when stocks are cheap, you’d be smart to buy more of them, and that when stocks are very expensive, you’d be smart to buy fewer of them—and purchase other things instead. I’ve been writing a lot about that lately.

Recently, I found myself in a conversation with a person who took the idea of index investing much too far: “You can’t know when stocks are expensive!” he said. “People said they were expensive when the Dow was 3,000 and at 10,000! It’s at 17,000 now. The market goes up over time. Buy now and the market could be 100,000 in 10 years!”

While this kind of statement has some grains of truth, it also reveals some tremendous flaws in thinking. It’s hard to blame this gentleman of course, as this is what the mainstream financial media tries to teach us whenever it can: “Buy, buy, buy, buy, no matter the price! No price is too high! Stocks will always go up over time!”

Naturally, the financial media of today has a vested interest in selling that kind of irrational nonsense. But the reality is that it is indeed extremely easy to tell whether stock markets are cheap or expensive, once you know what to look for. In a moment, I’ll show you clearly, and in simple detail.

First, it’s important to recognize that successful stock investing has next to nothing with the price of stocks going “up” over time. I know this sounds counter-intuitive to many, because it’s the opposite of how they were trained to think. But if you look more closely, you’ll soon realize that stocks don’t actually go “up” over time. They go pretty much sideways, in the grand scheme of things.

Let’s take a look at what I mean. First, a recent chart of S&P 500:

Sure, it looks like the stock market is going “up” over time. But it’s not, really. At least not by nearly that much.

A large part of what you’re seeing is not stocks becoming worth more but rather, dollars becoming worth less. This is a concept known as “inflation”. And once we start to adjust this chart for inflation, we start to see a very different picture:

inflation adjusted sp500

“Inflation Adjusted” S&P 500 Index from

This time, we’re zooming out even farther, going all the way back before 1880. Notice that, right now in 2016, stocks are actually still lower in price than they were way back in 1999 and 2000.

This means that the stock market has still not yet recovered in real terms from the great tech bubble. (Excluding the incredibly small amount of dividends you may or may not have earned when buying at those inflated prices.)

But even this chart isn’t quite good enough, because it doesn’t actually track “inflation” at all. What it tracks is “an increase in consumer prices, as measured by the U.S. administration.”

The administration of course, has something of a vested interest in making this figure appear as low as possible, so that that folks don’t get too ornery. And so, there’s a lot of black magic and questionable accounting that goes into creating the “official” figure.

Inflation, more rationally defined, simply means “an increase in the money supply.” So to get a look at what the stock market is really doing, it is best to compare it against something that is relatively more fixed in supply and usefulness than a dollar bill is.

If you were to instead track the stock market in terms of barrels of oil, or ounces of gold, or tonnes of wheat, you start to get a very different picture indeed. Here’s that very same index again, this time, priced in gold ounces:

The S&P 500, priced in ounces of gold.

The S&P 500, priced in ounces of gold.

Very interesting. Where has that “upward” movement gone? Is it really there at all?

But even this chart isn’t quite ideal either. I’m not certain that gold is the absolute best measuring stick for a stock price. What’s truly important to recognize is what the real value of a stock is to begin with.

When you’re buying stocks, you’re buying two things:

1) A share in the “earnings” of a real company. (How much money the company makes after expenses.)
2) A share of the “assets” it owns. (How much all of the stuff and money it owns is worth.)

That’s it. Deep down, that’s all there is to buy.

Sure, you’re also making your best guess about whether these two things are likely to increase or decrease in the foreseeable future. But ultimately, that’s about the size of it.

Simply put: The more stocks cost compared to their earnings and assets, the more “expensive” they are. And the data shows that when it comes to stock indexes, the further above the average real price that you purchase stocks at, the further below the average your real returns are likely be.

Let’s look at this in action. Here is the price of stocks once again, this time compared to their past 10 years of earnings. This is known as the “CAPE” or “Schiller” price/earnings ratio, and it is very predictive of future returns:


The price of stocks compared to an average of the price/earnings ratio over the past 10 years. The average is about 16. Just before the market started tanking this year, it had ballooned to almost 30. This can be seen as nearly 2x overpriced compared to the average.

One of the first questions to ask when you are thinking about buying stocks is “how many dollars do I have to pay for a dollar of earnings”?

The long-run average is somewhere in the neighborhood of $15 or $16 in price for $1 of earnings. Right before the market started tanking in January of 2016, that ratio had ballooned to nearly $30 for every $1 of earnings. That’s almost double the long term average. And it’s very close to where we were right before the Great Recession.

By this metric, you can confidently say that either the price of stocks (or the value of the dollar) would have to drop by about 40% to return to a more “average” valuation. Though it’s worth noting of course, that markets almost always tend to overshoot the mark.

For some context, a “price to earnings ratio” of 15 means that it will take you 15 years to earn back your initial purchase price. Roughly speaking, this translates to an effective implied interest rate of around 6% or 7% per year. This is an “average” long-term return for stocks.

A PE ratio of 10 means that it will take you 10 years to earn back your investment. This is an implied interest rate of roughly 10%, and is a bit better than average for stocks.

A PE ratio of 30 however, implies that it will take you 30 years to earn back your original investment. This implies an interest rate of just a bit over 3%. For all the downside risk there is in stocks, it is hard to see this as anything but a terrible deal.

We can see the same kind of thing happen when we look at price compared to “earnings yield“, which essentially means “how much cash the company earns for you every year, just for you owning the stock”:

S&P 500 Earnings Yield. This is the past year of earnings divided by index price.

S&P 500 Earnings Yield. This is the past year of earnings divided by index price.

As you may notice, this is very close to the lowest levels we tend to see.

The average here is close to 7.5%, and we’re currently around 4.5% today, which once again means that stocks would have to drop by 40% to return to average territory.

If history is any guide however, stocks don’t tend to drop back to average. They tend to drop right through it, and often straight through the floor—passing only briefly through the average—and then proceeding to find a dejected rock bottom, going into severe undervaluation for some time, before slowly climbing back up to average, and eventually beyond, over the course of many years.

This means that as likely as it is that stocks will drop by 40%, it is even more likely still that they will drop by more than 40%. How much? I don’t know—possibly 45% or 50% or 60% or 80%. It’s anybody’s guess, really. But it’s also worth recognizing that this drop could be hidden somewhat, due to another important factor: Money printing.

Naturally, people tend to get pretty upset upon realizing that their retirement accounts and home values are built on a house of cards. (I can hear some people grinding their teeth right now and trying to rationalize these numbers away.) And so, governments do what they can to try and ameliorate this effect. If the past 45 years of history serves as any guide, they will tend to do this by effectively “printing money”.

In practice, although there is a significant pressure for stock prices to drop by 40% or more and return to fairer valuations, this “drop” could just as easily be accomplished by devaluing the dollar, thereby masking the drop in real prices.

Through this method, you could easily have stock prices drop by only 20% or so and the dollar devalue by 20% or so, and that way, the people don’t get quite as angry in the short term. Or, you could even have the dollar get devalued by 40% or so over a number of years, while the price of stocks remain in place—at least nominally. This is more or less what happened during the long “silent crash” of the heavily inflationary 1970s.

While this “solution” of printing more money in order to inflate asset prices does lead people to be a bit less acutely angry in the short run, it tends to make them stew with anger in the longer run. This approach brews inequality and loss of opportunity, masked by an illusory “wealth effect”, felt almost exclusively by those at the “top” of society.

This kind of thing leads to phenomenon like “Donald Trump” and “Bernie Sanders”. In hindsight, a bit of short term pain in the form of falling asset prices may very well be preferable to the alternative of a lot of long-term pain under the rule of a divisive and authoritarian strongman of any stripe.

So in short, of course you can know when stocks are expensive. You can look at their price compared to their earnings. You can look at their price compared to their assets, also known as their “book value”.  You can look at their price compared to their dividend yield, which is how much you get paid simply for owning a stock.

It’s really not that complicated, especially when we’re talking straight index fund investing: All other things being equal, if you pay more for earnings and retained assets, then you tend get lower yields than if you pay less for them.

You can—quite easily—look at historic averages for these figures to help see where we are in the business cycle for stocks. Look at their price compared to earnings, to book value, or the price to “dividend yield”. Compare the price of stocks to other hard assets like commodities and real estate. Compare the likely return on a stock purchase to the likely return on an education. (And I mean a real education. Not the kind you tend to get in most schools.)

In the world of investing, this should be considered very basic stuff. The idea that a person can’t tell when stocks are overvalued is simply absurd. If you really believe that, it only means that you don’t yet understand how stocks are meant to be valued, and would probably be wise to learn the basics before you consider going and putting all of your money into them.

As always, I cannot give you investment advice, but I can tell you what I am doing: I do own some US stocks that were bought back when they were more fairly valued. I have sold some and kept others. I also also own some undervalued commodities, as well as some foreign stocks that still have more attractive valuations.

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What is the Point of Gold?

I have to admit that I never really understood gold. I never even cared much for the look of it—though I’m well aware that many billions of people have for many thousands of years. It just never seemed particularly beautiful—or useful—to my eye. But I’m not everybody.

For most of my life, I tended to associate the stuff with unapologetically ostentatious rap stars, far right-wing extremist nutjobs, Saudi princes and James Bond villains. It was something for “silly” people—for living, breathing cartoon characters. I never thought I’d be “the kind of person” who would be interested in owning any gold, perhaps not even in my wedding ring.

This of course, leaves me with a lot of explaining to do: I have to explain why I own a small amount of gold, and why it has been the single best performing asset in my portfolio in 2016.

I have to explain why my modest holding is up more than 20% year to date, and why the gold mining stocks I purchased near their very bottom are up more than 33% in just this past month or so.

What’s not to love?

Warren Buffet has famously made a great case against gold by asserting that fairly-priced, interest-bearing assets are likely to outperform it dramatically in the long run.

Buffet argues—and quite correctly—that if you were to take the money you might use to buy gold, and instead buy a reasonably-priced stock or bond or piece of real estate or farmland, any of those assets would outperform gold many times over the course of a hundred years.

A great company or a good farm bought at a fair price can provide an increasing amount of real value (and ongoing interest payments) for many years to come. Gold on the other hand, just sits there glistening, but otherwise, doing nothing at all.

He is at once entirely right and completely wrong.

Buffet is right that gold does not pay interest. But what Buffet fails to acknowledge is that it’s not supposed to. In fact, gold is not meant to be considered an “investment” at all.

Rather, much like the U.S. dollar—and all other currencies for that matter—gold is simply a form of cash savings that you can take on when interest-bearing assets are priced far too high to be considered a decent buy.

What Buffet leaves out of his analysis is that if you had the choice between buying gold or buying interest-bearing assets near the top of a bubble in interest-bearing assets, when they are overpriced by any reasonable metric, gold would far outperform. Then, at a later date in the future, you can trade in your gold to buy interest-bearing investments when they are priced more reasonably again.

Gold is just like any other form of cash in that regard. And Warren Buffet himself is currently holding a whole lot of cash. He’s just holding it in dollars instead of in gold. (Though to be fair to him, as one of the richest men in the world, it would look terrible for him to hold that much in gold at this point. Talk about giving the market jitters!)

Cash may be “king”, but what kind of cash?

The only material difference between gold and the kind cash that Buffet holds is that the US dollar has lost about 97% of its value over the past 100 years, while gold has gained about 150% in its purchasing power, depending on the exact dates you pick.

This means that when you compare gold, not against stocks and bonds and farmland, but instead against other forms of money, as one would be wise to do, you find that gold has outperformed dollars—and everything else in the same category—and dramatically so over the past 100 years.

If, for instance, you took $20 out of the bank and put it under your mattress 100 or so years ago, it would be worth about $0.40 or so today, thanks to inflation.

But, if you took the same $20 in gold and put it under your mattress 100 years ago, it would be worth about $1300 at this moment, give or take. That’s a far better prospect than any bank’s savings account available today.

And so I, a longtime gold skeptic, have come to see the value in the metal, not as an “investment“, but as an alternative form of cash savings. It’s essentially a highly liquid “store of value”—a form of money. And it works far better in that regard than does any government’s currency over long periods of time.

Of course, gold is not great for spending day-to-day (unless you sign up for a service like GoldMoney, which is definitely worth checking out) but it is a great way to defer from investing until the valuations of interest-bearing assets are more reasonable again in the future.

And that’s the point of gold: It’s not an investment at all. It’s just a form of cash savings that does not suffer from monetary inflation.

It’s for preserving a portion of your wealth until you see an attractive bargain. It is just like any currency in that regard, though arguably, a whole lot better at it than all the rest.

PS: As always, I cannot give you financial advice, but I can tell you what I am doing, which is to hold a small amount of gold, along with some cash, fairly-priced stock indexes (many of them outside the US), and some historically undervalued commodities as well.

How much in gold makes sense? That’s for each person to decide, but billionaire macro investor Ray Dalio recommends that 5%-10% would be “prudent” for the average investor. That’s his advice. As always, study widely, and decide for yourself. And as always, never expect any investment or holding to pay off overnight.

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Good Profit: In Life, Business and Art, Are You Investing, Trading or Speculating?

The word “investment” is often misused, both in finance and in our daily lives.

You are either investing, trading or speculating at all times, and in all areas of your life, whether you realize it or not. This is as true in your art and in your relationships as it is in your work, and to navigate life effectively, it’s important to recognize that these terms are not synonymous. Not even close.

If it were up to me, investment would have an exceptionally narrow definition: An investment is something that pays you for owning it.

The most important part of this idea is that you do not have to sell an investment, ever, to gain from it. You earn by owning, not by selling. Fundamentally, you are getting paid to be responsible for something.

Here’s the obvious example: If you buy a profitable business, and that business gives you a small portion of its profit— enough so that over time it pays you more than it costs you to own—then that is an “investment”. It could be a website or a hot dog stand or record label or anything else you might like. What is important is whether or not, over a long enough period of time, it pays you more than it costs to own.

Anything that can generate enough revenue to more than pay for itself can be considered an “investment” in this business-y sense: If you can buy a car or an apartment or a studio—or even develop a new skill—and then turn around and rent it out for more than it cost you to own, that is an investment.

A beautiful thing here is that you don’t actually need any money to invest. Investments can be built.

Obviously, you can build skills at little-to-no cost in terms of money. The same is true of a website, and I suppose if you were handy enough, a hot dog stand, too.

You can build relationships as well. The best of these cost little or nothing in terms of money—though they do cost something very real in terms of time, attention and understanding.

Relationships also pay, though they rarely pay in money. Like any investment, for a relationship to be a good one, it should provide more than it costs. If this sounds at all Machiavellian to you, it is only because you are not thinking it through far enough.

For a relationship to pay more than it costs, it is not at all necessary for one person give more than another. The beauty of voluntary exchange is that each person must simply give something that the other person cannot provide quite as easily alone. In this way, both people are richer than they would be separately. In a good relationship, both gain more than they give. It is a kind of mutual investment. No surprise then, that many of the best investments involve many people, each of them, through the power of voluntary exchange, gaining even more than they give.

Of course, in the worlds of business and finance, you tend to get paid in money. But remember that money is optional. “Profit” can take any form you like. This is because all profit really means is “gain”, and you can take your gains in life in any form that you like. So it is time to stop vilifying that word, profit. 

When it comes freely from voluntary exchange, “profit”, or more simply, gain, is the most wonderful thing in the world. It is what we are all after, fundamentally. All it means is more of that which we desire. We can profit in terms of peace or love or knowledge or satisfaction or anything else, just as we can in terms of money. Money is a fairly convenient and widely-accepted form of profit, but it is not the only one, nor is it necessarily the best. As in all things, it can be wise to diversify.

Either way, there are only two questions that are important in classifying something as an “investment”: The first is whether you gain more from it than it costs you. And the second is whether you make those gains for owning, for taking responsibility—not for selling.

If the answer to is “yes” to both, then what you have on your hands is investment. If the answer is “no” to either, then oops. That’s not an investment. That’s not even an asset. That’s a liability, and liabilities are meant to be sold or otherwise disposed of. Not to gain anything, but to keep from continuing to lose.

Remember that if you have to sell something to make money, then you are doing something, but it’s not investing.

You might be trading—which is buying something in one place or time to provide it to someone else who is reasonably certain to value it more than you in some other place or time.

Or, you might be speculating, which is a lot like trading, but without the degree of certainty. (Though hopefully not without the reason.) Still, either way, if you have to get rid of something to gain from it, then you are not investing at all. There is a place and time for this as well, but it is not the same idea.

Ultimately, the art of investing is the art of taking responsibility. What you are responsible for is ensuring that the things you are taking responsibility for provide more gain than they cost.

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“Objective Merit”, Subjective Values, and Arguing About Taste

It’s easy to forget that there is really no such thing as “objective merit”. At some level, all judgements of merit are based on human preferences, and driven by individual tastes. There is no other way.

While I would quickly agree that some preferences—and some systems of judging merit—may be “better” than others, I’d have to just as quickly agree that I need to make a subjective leap of faith in order to do so.

You and I might agree for instance, that based on objective evidence, things like peace, or trade or avoiding nuclear war are preferable to their alternatives—perhaps because these things are more likely to lead to greater human flourishing.

But this begs the question: How does one first establish that “greater human flourishing” is preferable to the absence of human flourishing? To do so requires a subjective leap at some point. (Admittedly, one that I am more than willing to make.)

All we can do is to say that greater human flourishing leads to more of other things that we like in the world, perhaps more love or discovery or art or really good episodes of House of Cards to binge watch. But how can we establish that these things are themselves good without first pointing to some other subjective value?

We could go down the rabbit hole on this for hours, and if you’re not convinced, I suggest you try it for yourself sometime. You’ll soon find yourself in a loop of subjective values with no end:

Greater human flourishing is preferable because it increases the amount of love and science and art in the world, which is good in turn because it promotes greater human flourishing, which is good because it increases the amount of love and science and art in the world which is good because….ad infinitum.

Getting stuck in this kind of infinite loop will force you to recognize that objective arguments are wonderful and extremely useful, but that they cannot stand on their own. They can only be used, ultimately, in support of some subjectively-held value.

At some point in any objective argument, you’re just going to have to resign yourself to say that something is good or desirable “for it’s own sake.” And as soon as you have done so, you have made a subjective value judgment and would have to recognize that at root, there is no such thing as “objective merit” on its own. There is only merit in the context of some subjective value.

This is not just some idle thought experiment, however. It has very real practical implications in your career, your relationships and your daily life, whether you make art, run a shop, trade stocks or build furniture.

When you recognize that there is no inherent “objective” truth when it comes to values, you may more readily begin to notice that different people tend to value different things differently. We are diverse in that way.

As much of a nuisance as this can seem when you want things to be your way or the highway, this quirk of our nature is precisely what makes voluntary exchange so effective at improving outcomes for everyone. This is a basic economic reality is known as “subjective value“:

When you buy a cup of coffee at a deli for a dollar, you are demonstrating that you value the cup of coffee more highly than the dollar. In turn, the deli owner is demonstrating that he values the dollar more highly than the cup of coffee.

The fact that the coffee and the dollar do not have one single “objective” value is what makes the exchange possible at all.

The beautiful thing is that through this trade, and through your mismatch in subjective values, both you and the deli owner are made better off than you otherwise would have been. You have each gotten something that is worth more to you than what you gave up.

Without this kind of inequality in values, voluntary exchange—and the very advance of society that we have come to take for granted—would not and could not occur. We would be stuck in place, frozen in time, ready to decay.

This is an important realization to make: Even a dollar does not have a fixed value. It has different value to different people. So does a cup of coffee. So does your art. So does everything. The implications are enormous.

Start by understanding this, and the world of business and of market transactions will come into much greater focus overnight. If you want to make an honest living doing anything, whether it is playing music or selling coffee or designing buildings, this is essential to understand.

In some sense, this realization is also at the root of what people mean when they say that “there is no arguing about taste.”

Art is perhaps the realm in which we get to play most heavily and directly to subjective values, with the most minimal reliance on objective argument. In art, you either appeal to people’s subjective preferences or you do not. A good story does tend to help, but even that story is itself a form of art.

In making art, in appealing directly to others’ subjective values, you may challenge some of their values even as you confirm others. You may often end up bundling subjective values that others quickly accept with ones that they may not. (At least at first.) And you do so by bypassing objective arguments almost completely, instead confronting subjective values right at their source.

This is both the strength and the danger of art. It can appeal to us even if it doesn’t appeal to our reason. This is also why people will likely continue to argue “objectively” about art as long as there are people.

But when people argue about art, they are not arguing about taste. They are merely arguing around it.

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Featured on “The Investor’s Podcast”

Over the weekend, some my thoughts on current market conditions were featured on one of the most popular business & finance podcasts on all of iTunes, The Investor’s Podcast.

If you manage your own savings and investments, I strongly recommend you check it out! It really is one of the very best. (And of course, if you don’t have any savings or investments, it’s time to get started.)

In this episode, Preston and Stig discuss George Soro’s book, The Alchemy of Finance, and then turn to questions and comments from investors.

That’s where you’ll get to hear me reiterate some of the thoughts from my most recent blog post—and hear Preston Pysh give some of his thoughts on the degree to which commodities are likely to be undervalued at the moment.

Check out the episode here. (Or skip to 14:05 if you want to hear the section where I bring up commodities in the current market, and Preston gives his analysis.)

Like me, Preston is a value-focused investor, and also moved to a heavier cash position before the recent market turmoil after taking a long hard look at the fundamentals of the US stock markets.

At the time, we both were exploring foreign value stocks, commodities and physical stores of value. Since this episode was recorded, I’ve made some significant moves in those directions, and Preston too has been preparing to make the leap.

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The Great Bubble of 2016 (…and 2017)

2017 Note: As of May 2017, nothing in this analysis has changed. If anything, the issues noted below have only increased in magnitude, and logic dictates that the three potential outcomes noted below remain exactly the same.

I’d like to turn from music for a moment to write a little something about the current financial markets.


History shows that credit bubbles tend to pop once every 7-9 years, and it appears that the next big bubble pop may be upon us now. This one, unfortunately, involves not just the stock market, but bonds as well.

Actually, it’s arguably much bigger than that, with several simultaneous bubbles occurring at once: In student loans, in consumer car loans, in stocks, in high-end art and collectibles, in private debt, and in government debt.

The reality is that housing prices still need to come down significantly compared to rents, wages and other prices. This is almost as true now as it was in 2008. College tuition prices need to fall dramatically. So do car prices and medical costs and stock prices, as well as bond prices, relative to their yields.

All have been propped up by extensive money “printing”—along with other factors. And, although I believe none are being properly accounted for in consumer price indexes, it is clear that each of these is priced unsustainably high compared to median incomes.

The end game is that these prices will either fall dramatically, or stabilize at current levels (in response to heaps of additional money printing) as the prices of everything else rise around them.

Now that the US central bank, The Federal Reserve, has stopped “printing” money, asset prices are just beginning to fall, and quite dramatically. January 2016 saw, literally, the worst beginning to a year in stock market history.


If you think this through logically, there are really only three potential ways for this to play out in the near term:

Scenario 1: The Great Deflation

I think that this is actually the least likely scenario. One could reasonably argue that this is what should happen, but in any case, chances are that the central banks around the world won’t let it happen.

In the absence of interference, a major debt deflation likely would have occurred way back in both 1999 or 2008 at a smaller scale, but central banks prevented this.

In our last two crashes, inflated asset prices should have dropped dramatically (which they did), many more bad businesses and bad banks should have gone out of business (which they didn’t) and a whole lot of excess credit and money should likely have disappeared from big business’ as well (which only happened a little bit.)

Instead, the Federal Reserve started dropping “money from helicopters” in the form of Quantitative Easing, a 21st century approach to flooding the markets with newly-minted dollars. This re-inflated asset prices. effectively kicking the can down the road. We have now just stumbled upon that can once again.

The new Federal Reserve Chair, Janet Yellen, has effectively gone on record saying that they will take this same can-kicking approach once again in response to any large market downturn, because, in her words she believed the Fed’s Quantitative Easing program “worked so well” the last two times we tried it.

This approach essentially means firing up the “presses” and printing as much money as is necessary to avoid a deflationary outcome in the near term.

If a Great Deflation actually did occur, we would have a very severe recession with a tremendous number of personal and business bankruptcies, and a default on a good portion of the US government debt as well.

This would likely result in the most short-term pain, but potentially the most long-term gain, if were were to make necessary reforms.

It’s also the least outcome to occur, because it is not in the Federal Reserve’s interest, nor is it in the interest of the bankers who own it, or politicians who select its Chair.

Scenario 2: The Rollercoaster Crash

Not a bubbleI believe this is the second most-likely scenario.

There is a reasonable chance that the Federal Reserve would allow asset prices, debt levels, and money supply to fall significantly before rushing in with “helicopters dropping money” once again.

This would mean a tremendous drop in asset prices, followed by an enormous increase in all prices. However, the prices that would rise the most would likely be hard assets, commodities and consumer goods (as well as foreign stock prices) as the market sought a new equilibrium.

Until now, we have been stuffing a good deal of newly-minted dollars into domestic asset prices and bailed-out banks’ balance sheets. But we have also been “exporting” much of our inflation, in the form of foreign holdings of US dollars, thanks to our status as the world’s reserve currency.

As soon as more money printing occurs, foreign holders of dollars are less likely to hold onto them, instead exchanging those rapidly-devaluing dollars for hard assets, effectively “bidding up” prices across the board. This would exacerbate increases in the cost of living for everyday Americans.

Scenario 3: The Great Stagflation

This strikes me as the most likely scenario for the near-term, though it may occur in concert with Scenario 2.

I believe that the Federal Reserve will most likely jump in with additional money printing before markets drop too excessively and a massive deflation sets in.

This would cause inflated asset prices to stabilize more or less where they are, while hard asset prices and foreign equity prices go through the roof in comparison.

This would result in massive declines in purchasing power for Americans, runaway increases in the cost of living, and we’d see a marked increase in consumer prices, while unemployment rises.

It would basically be what happened in the 1970s on a somewhat more dramatic scale.

However, people’s 401ks and home prices would not fall to dramatically in nominal terms—Only in real, inflation-adjusted terms. That is one factor that makes this “solution” much more politically viable.

Americans who have big mortgages or a lot of student loan debt would benefit to some degree (There are a lot of them.) They would be able to pay back their loans with essentially “cheaper” dollars.

Meanwhile, Americans with low debt who diligently save money in dollars would be hammered pretty hard. (There aren’t nearly as many of them these days, unfortunately.) This because each time a new dollar is printed, it detracts relative purchasing power from a dollar that already exists.

Because of that demographic reality—the US now has a huge proportion of borrowers compared to savers—this will likely be considered the most politically acceptable outcome. (At least for the very immediate term, which is all politicians really care about.)

And so, I believe this is the situation most likely to occur.

Actionable Tips

No matter what, in each of these three scenarios, the same underlying phenomenon occurs:

The real value of US stocks, bonds and bank holdings goes down. Meanwhile, commodities and other hard assets get bid up. And, in either case, the purchasing power of Americans goes down compared to those who live in developing economies throughout the world.

The silver lining is that this will likely lead to less inequality on a global level. But that silver lining is hard to see when it comes at the expense of your retirement savings.

So, if you want one actionable tip, here it is: If your savings are not yet diversified into some reasonable percentage of commodities and foreign stocks and, now is the time to do it. They are both currently dirt cheap in dollar terms.

In the case of massive deflation, their values are very unlikely to drop as much as the value of stocks and bonds, because they have already dropped so far, as deflationary expectations are essentially already “priced in”. In the somewhat more likely case of significant inflation however, those prices will once again go through the roof.

Even if their value didn’t increase in real terms, their relative value would increase compared to other assets, helping you to retain your purchasing power and storing value until more reasonably priced equity and bond investments are available in the future.

Whatever happens, there is no likely case in which the prices of commodities and hard assets would not rise relative to most other paper assets in the coming years.

Especially cheap right now are oil, silver, platinum, palladium, steel, copper, and many soft agricultural commodities.

Gold prices are already starting to ratchet up dramatically, and while they are not the cheapest buy, they are likely to rise first, most quickly and most dramatically do to the metal’s history as a hedge against paper currencies.

There are also great deals in foreign equity markets, when compared to the US stock market. Some of these deals may get better still as the Federal Reserve continues to “play chicken” with interest rates and suggest that it may continue its current tightening cycle.

(Incidentally, many investors still do not recognize that the current tightening cycle actually began way back in 2013 with the “tapering” of QE programs, so we’re actually quite very far into it.)

But as soon as the Fed flinches, which it most likely will, these prices will likely skyrocket. Historically, stocks tend to rise slowly and fall rapidly, while commodities tend to do the exact opposite.

If the Fed actually does continue tightening, these already-depressed values are likely to go down less compared to others, as they have already fallen very significantly on deflationary expectations.

So be forewarned. That’s what’s coming in the relatively near term. Those your likely scenarios. If anyone wants to discuss what happens in the longer term, that’s quite interesting as well.

2017 Update: Those who are blindly buying US stocks today at even higher valuations, under the rationale that potential tax breaks or deregulation may justify such prices in the future, appear, in reality, to be betting on outcome #3—likely without recognizing it.

They seem to wagering their life savings on a “silent crash”. While this might be wise if nominal returns were all that mattered, in the real world, it is inflation-adjusted purchasing power that is the true measure of your investments’ performance.

If the current, excessively-high, broad-market valuations do end up being justified by future growth in earnings, all that will mean is that inflation will have accrued to such a degree that the purchasing power of your stocks holdings will have decreased. Don’t make the mistake of confusing nominal gains for real ones. I’ll do another post on that in the future.

Justin Colletti in an educator, and engineer, and an econ nerd.

PS: Obviously, you should talk to your financial advisor before making any major changes to your portfolio.

I can’t give specific financial advice, but I can tell you what I have done and am doing. And that’s to diversify a reasonable portion of my savings into more modestly-priced non-U.S. equity markets, commodities and physical assets.

Your needs may be different, and remember that there is no one-size-fits-all advice. Investing, even wisely, always carries some risk.

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Advanced Mixing Tutorial: Parallel Compression “Secrets”, In-Depth

Readers at SonicScoop have been asking me for a more detailed and hands-on version of the parallel compression video I did a little while back. Thanks to a partnership with B&H I got to do just that. Check it out, and if you have any more questions, reach out anytime:

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A Better Way to Start a Mix

Sometimes the worst way to to start a mix is at the beginning. What does that mean? Click below to find out:

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Pro Tips on Panning for Stereo Width, Acoustic Treatment, Soundproofing and More

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Check out part 4 on panning techniques for enhancing stereo width.

I’ve also got a new video out on Soundproofing and Acoustic Treatment which you can see below:

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On Finding Fans: “How to Get Your Music Heard”

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