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Dear ,
"Manage Your Tails!"
What the heck? Manage my tails? What in the world does that mean? Great question. Let me explain.
The quote above was made by Mohamed El-Erian who is the CEO of PIMCO Mutual Funds. He appeared in John Mauldin's most recent video presentation "The Post Election Economy". You can view the video here. (Disclosure: I am not making a recommendation for or against Mr. Mauldin's services. I am simply providing a link to the video because I found it educational)
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Here is the lineup of guests. As you can see the video is about an hour and twenty minutes long.
One of the key questions that John asked was whether his different guests thought the Fiscal Cliff was a big deal or not. What do you think? With the exception of Barry Ritholtz, most of the guests said that in their view the Fiscal Cliff was indeed a big deal. Mr. Ritholtz was the lone voice saying that he didn't think it was that big of a deal.
But what I want to write about today are Fat Tails and specifically what are some of the fat tails we may be facing.
Fat Tails-What Are They and Are They Edible?
First off, no they aren't edible. But what are they? Events that statistically should hardly ever happen.
In a normal bell curve 68.26% of your data points will fall within one standard deviation of the mean. 95.44% will fall within two standard deviations and 99.74% will fall within three standard deviations. Anything outside of three standard deviations is considered a fat tail. Things that statistically have about a ¼ of one percent chance of ever happening.
Then why should we manage them you might ask? Because even though statistically they should hardly ever happen, they seem to happen much more frequently than they should. Weird huh? Take a look at these examples.
Some of the things on this chart were almost statistically impossible and yet they happened. Here is a list of things going back to 1982 that were fat tail events.
The chance of Russia defaulting on their bonds in August of 1998 was calculated at 1 in 20 million and yet it happened. The chance of having three major declines in august of 1998 was 1 in 500 million and yet it happened. The chance of October 19, 1987 happening were less than 1 in 10 to the negative 50th power, a number that does not occur in nature, and yet it happened.
What is the lesson here? Manage Your Tails!
What Are Some Current Fat Tails?
There are a few possible fat tail events on the horizon. One of them is the possibility that the US may indeed go over the Fiscal Cliff. Right now the odds that I'm hearing from lawmakers are that there is a 50-50 chance we will go over the cliff. In other words they have no real idea. Are you prepared if that happens? How will that affect your portfolio if it happens? Have you figured out a defensive strategy to protect your wealth in case this fat tail becomes a reality? If not give us a call and we'll help you develop a strategy.
Muni Bonds
Here is an issue that I have been mentioning lately. There is a lot of talk about possibly taxing part of the returns on muni bonds.
Why might that happen and is it a big deal? The reason that it might happen is that it fits right in with the attack on the wealthy. Rich people have a lot of money in muni bonds and they are adding to those holdings every day because it is pretty apparent that taxes will probably be going up.
Because the wealthy get out of paying taxes on the money in muni's the President has tried twice and is now trying a third time to make the interest from munis partially taxable. Why is that a big deal? The tax treatment is about the only advantage that munis have over corporate bonds. Munis pay a lower yield for a comparably rated bond over corporate bonds. But because munis get preferential tax treatment, the net after tax return is greater with munis.
And just to be clear, munis weren't invented just to give the rich a place to invest tax free. The original reason that munis were tax exempt was for the good of society. The proceeds from munis are used to finance things that are good for society. Things like schools and hospitals and such. By giving them special tax treatment it lowered the financing costs of these projects therefore benefitting society.
So what happens if they tax 7% of the muni interest which is the number that they are talking about using right now? The value of your muni bonds is likely to crater because the tax comparative yield is now less because of the taxation of the previously tax free interest. How likely is this to happen? It's a fat tail. But what if? Are you prepared to play defense if this happens?
Does the Government Really Want My 401k?
Hard to imagine isn't it? This is an issue that I have been warning about since 2008. Could it happen? I think the more appropriate question is what makes you think it couldn't? The fact that we are hearing about this more and more is what makes me more concerned than ever that this is a real threat. Here is the most recent article on the subject by Dr. Jerome Corsi.
Now Obama wants your 401(k)
So again we are talking about a fat tail event. Not likely to happen but what if? Have you thought about how you would protect your retirement money if it should come to that? Have you laid out a plan of action so that you are ready to move if this thing gets serious? If not give us a call. As I said above we have been warning about this since 2008 and we have also been developing and refining a strategy to deal with this fat tail should it come to pass.
So until next week folks, manage your tails and protect your wealth!
Sincerely,
  
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