I thought the following section of an email conversation with a savvy friend and long-time client on Sunday would be instructive for our readers. It was in response to his feedback regarding a superb essay that I discovered over the weekend and excerpted from — in response to my friend’s emailed question/comment regarding Saturday’s blog post — to emphasize much of what I’ve been writing about over the past year+.

I’ll add parenthetic clarity where I think it’s needed. I’ll also add emphasis where my comments relate to today’s rally.

Speaking of today’s rally; while the Dow closed up over 800 points (2.95%), the S&P 500 managed only a 1.17% gain, while the Nasdaq Composite actually closed down 1.53%. Our core allocation closed up 1.21%:

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Friend (referring to the retirement asset wealth currently held by Baby Boomers): “$28 trillion in retirement assets. That money will be spent or inherited won’t it? Does that change the debt super-cycle?”

Me: “Good point regarding money inherited/spent, and, therefore, going back into the economy… But, keep in mind, the money that buys the stocks from the Baby Boomers has to come from somewhere else… I.e., the cash, in theory, is already in the economy… Buying stocks with it just moves it from one hand to the next, no new money to buy stuff with… The question being, is the new holder of the old cash more apt to spend it (vs buy stocks) than the old holder?

Ah, but that’s where the Fed comes in… Although quantitative easing (money printing) doesn’t put money into the economy, it just puts more reserves into the banking system; the banks have to lend against those reserves to actually create money in the economy…

So that’s where the government borrowing and spending comes in… The treasury issues debt, the Fed buys the debt (actually banks will buy much of the debt, then the Fed will print and buy it from the banks while crediting their reserve accounts), the government spends that cash in the economy… say, on infrastructure… now that’s new money in the economy… But it’s also new debt on the government balance sheet… As you and I agree, government allocation of all the money (socialism) leads to far less than optimal outcomes… But stocks will likely love it for a while nonetheless….

Also keep in mind, while this all spells a bad long-term setup for stocks, it, as you’ve pointed out, doesn’t necessarily (for a while) matter when the government is stimulating everywhere… I.e., there is a legitimate case for further upside for stocks while all of this plays out…. I think with huge, potentially VERY huge, corrective (bear market) phases along the way…

Imagine (the “end-game” in the title) what the stock market does when the Fed’s back is against the wall in terms of pensions, etc., and they announce, say, the issuance of pension bonds to shore up all of that underfunding (essentially rescuing the pensioner and taking over the system), and, I highly suspect, the purchase of stocks (via equity ETFs) straight from the market (not necessarily in that order; I suspect the latter would come much sooner)… It’ll likely scream even higher, for a bit…

You would expect real assets to do better than US stocks over the very long-term going forward…

Our target is — after adjustments we’re making this coming week — 18% fixed income (10% cash, 90% ultra short-term corporate bonds), 35% U.S. stocks, 17% developed foreign mkt equities, 7% emerging mkt equities, 23% commodities/currencies (gold the largest position)..

Within the U.S. equities, we’re about to cut utilities by 30% and add to energy stocks with the proceeds… Within our non-US exposure, we’re cutting Europe by 22% and adding to emerging mkts with the proceeds…

The energy exposure gives us more tilt toward commodities (and, btw, materials is now our largest U.S. sector target), plus it’s off ~50% from its peak, and has seen tremendous capacity destruction the past few years… I suspect people will think a Biden win is negative for fossil fuels, but they’re missing the fact that Trump was opening up public land for drilling.. of course Biden will squash that in a hurry… Again, lack of capacity, with any amount of demand coming back likely bodes well for the sector (via the price of oil) in the months/years to come…

Also, gold works beautifully in the debt super-cycle, etc., phase (the final) we’re in / entering… We’ll be looking to add more I’m certain going forward…”