big picture: reflections, assessments, outlook, approach

7/31/2019 Big Picture: Reflections, Assessments, Outlook, Approach

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Preserve

Protect

Prosper

Big picture: Reflections,assessments,Outlook & Approach

June, 2012

Prepared by:Henry L. Becker, Jr., CFP

164 W Main St Suite F, New Market, MD 21774 p: 800.944.5852 www.lighthousewlth.com
http://www.lighthousewlth.com/http://www.lighthousewlth.com/


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Preface

- Will Rogers

The above quote tells the story of where the investing markets have come from and where theycurrently reside.

The current economic, social and political period is best summed up as highly unstable anduncertain. There are a number of different trends and issues that must have our attention suchas sovereign debts, currency wars, trade wars, energy security, political unrest, and socialunrest. However, the past 12 years of cheap money and the building levels of debt are thesingle biggest threat to your wealth, freedom and further prosperity. Sure, history is littered

with reasons for investors to wring their hands in worry, but never in the last 90 years have wehad so many threats to your wealth at one time.

The ongoing debt crises in western economies is far from over and sits in the pole position ofmarket driving forces. In contrast, the current environment, as portrayed by mainstreammedia , is not lining up with the real world. This divergence between reality and media / marketperception can cause confusion, apathy and general distrust.

We believe the current environment, in the short to medium term, to be hostile to wealth andpurchasing power. Accordingly, asset protection, purchasing power protection, and return ofcapital should be the investment priorities at the moment.

In light of the above, Lighthouse Wealth Management is sharing our reflections, assessments,outlook and approach. Hopefully, we can provide some clarity of thought and guidance for the

road ahead.

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How did we get here? (a synopsis)

- Marcus Tullius Cicero

1971

One can reach far back into history to answer the question in the heading above. We will limit the scopeof our historical discussion and take readers back to August 15, 1971. This is the day the United Statesreneged on a promise to allow foreign holders of US dollars to exchange their dollars for gold at a ratio of$35 for an ounce of gold. Formally, this action was called the closing of the gold window.

After World War II, the Bretton Woods Agreement linked the US Dollar to gold at $35 per ounce. Foreigngovernments agreed to peg their currencies to the dollar and the dollar would be backed by gold.Therefore, all currencies were technically backed by gold. The US agreed to intervene in gold prices tokeep it at $35 per ounce and other countries agreed to intervene in their currencies to maintain theircurrencys value relative to the US dollar. The problem was that the US could not resist printing morecurrency. Once other countries realized we were creating too many dollars, they also realized they couldtrade in their devalued dollars for now discounted gold.

Very simply, August 15, 1971, isthe day that, officially, the

worlds currencies became fiat.Fiat is latin for let it be done.In the case of currency, fiatd e r i v e s i t s v a l u e f r o mgovernment edict. Fiat currencyis backed by nothing but theissuers word.

Throughout history, going as farb a c k a s t h e R o m a n s ,

governments have wanted tocontrol the currency supply.The problem with governmentcontrol of the currency supply isthat governments can print andspend without restraint.

Since 1971 the United States has ramped up its deficit spending. The government spends more than ittaxes, creating a deficit that it funds through borrowing, i.e., selling US government bonds (chart at rightis red=spending; green=receipts).

Very simply, the US government has been spending beyond its means for decades. It is important toremember that debts of the government are paid for by taxpayers.

Debt

- Brutus, Roman Senator

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Below is a chart of Brutus worst fear: US federal government debt that cannot be repaid without debasingthe currency, financial repression of its citizens or default.

Deficits in the US have spikeddue to less tax collection, warc o s t s , e n t i t l e m e n t s a n dgovernment spending programsused to stimulate the economy.

In a large way the governmenthas been mishandling theincome and borrowing ability of

America. Over the last severaldecades productive use of

American capital has not beenhappening.

Both public and private debtshave reached unsustainablelevels, and economic policies areleaning heavily toward financialrepression. Therefore, we haveto recognize the dangers of

governments that are not only in distress but placing themselves above the law or outright circumventinglaws.

Seeking clarity through history

There are many accounts of German citizens being asked why they stayed in Germany through the rise ofthe Nazi party and beyond. Many Germans claimed that changes did not happen overnight; they tookplace slowly and while many were not even looking. Then, before anyone realized trouble was upon theGermans and their freedoms were gone. For those that paid attention, trusted their powers of perceptionand had the audacity to go against the grain, they saved themselves and their families.

Today, the media onslaught is powerful and often less than straightforward. It is becoming more difficultto identify truth. Much of what we hear and see is skewed, half-true, and often useless.

Mainstream media is less about truth and more about management of perception and mass appeal. Forthe most part, the media does not challenge the system or official data from those in power. Worse yet,for those that do the work to find complete stories, they are often marginalized. Like him or not, 2012Presidential candidate Ron Pauls media blackout stands as a perfect example of what happens when themedia follows an agenda. One may not like or agree with everything Ron Paul has to say but, heunderstands how the economy works. The last we checked, the economy is a problem.

We must look past the smoke and mirrors of government data or the spin of media to come to our ownconclusions. Even more, in these challenging times, if one knows history, or is willing to look to the past,there are clues as to what may be ahead. This is not the first time nations have gathered massive debts ortried to debase their currency. The Romans did it, the Byzantines did it, the British did it, and the US hasdone it in its own past.

We all know that financial memory is typically very short. But understanding the current economic andpolitical environment and looking to history for answers offers a way to address what may be ahead.

- Thomas Jefferson letter to Treasury Secretary 1802

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The Current Global Economy

Since 1971 the government has been filling its budget holes by borrowing. Over time those debts havebeen piling up.

Lets fast forward to the year 2000. The economy just came off a boom from the technology bubble andwas heading into a recession. The stock market was suffering large losses and unemployment was rising.

The Federal Reserve stepped in and lowered interest rates to 46-year lows to attempt to stimulate theeconomy. While the Fed made borrowing cheap, the US government was also loosening regulations inhousing and the financial markets. Once the economy began to recover in 2002, we saw money flowing

back into stocks and real estate.

By 2003 the US stock market and US economy turned around, thanks to easy borrowing and a boomingreal estate market. In 2007 the cracks in the economy started to appear in the housing market. The year2008 ushered in the end of a multi-decade debt party coupled with the implosion of exotic financialinstruments, like collateralized debt obligations and credit default swaps. The result was an epiceconomic implosion brought on by a debt crisis.

Once again, in 2008 the stock markets were crashing, but this time the global financial system as a wholewas in jeopardy. Large, century-old Wall Street icons like Bear Stears and Lehman Brothers collapsed.Countless other financial entities that leveraged themselves too far and made too many bad bets turned to

a willing government for bailouts.

2008 - The aftermath

Since 2008 the global economy has been juiced by global central bank interventions via bailouts,monetary easing (money printing) and economic stimulus. Opinions on the interventions vary in terms ofnecessity and its assumed successes or failures. The bottom line regarding the economic interventions isthat it impedes the natural course of the markets. Bailing out failing enterprises is not a healthy way torun a free market system. As well, maintaining artificially low interest rates in a time where rates would

be rising distorts the bond, stock, commodity and currency markets.

What started in 2008 as a banking crisis, emanating from the United States, is now a global debt crisistaking companies and countries as it victims. The problem now is governments have tried to savecompanies; the governments are now are ladened with unsustainable debt levels. Who will bail outgovernments? We have seen global central banks injecting money into the banking system to the tune oftrillions of dollars with little impact other than sending the debt problems into the future. Many banksand countries around the world have more debts than assets and lack the ability to pay their debts.

Now, Japan, the UK, the US and many European nations are suffering under massive amounts of debt.Global investors understand the gravity of the problems and are making it difficult, if not impossible, for anumber of these nations to borrow further at reasonable levels.

Regardless of the above commentary, we have seen the US stock market rise to near all-time highs on theback of continuous monetary, interest rate and currency interventions. But the stark reality is very little,if anything, is better than it was prior to 2008. Consider that since 2008 banks assets are just asleveraged (if not more), western economy debts have exploded, the US dollar has lost a significant amountof purchasing power, unemployment around the world has risen dramatically, and US housing prices are

still weak and under pressure.

The one item to keep in mind is that global markets float on top of the economic ocean and the economicocean is not healthy - its near toxic.

- Hugh Hendry May 1, 2012

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Currency and trade wars

A currency war is fought by one country through competitive devaluations of its currency versus othercurrencies. Why devalue a currency? The answer is to steal growth from trading partners. The theft ofgrowth comes by making the devaluing nations exports look more attractive than exports from othercountries. As an example, if a Chinese airline needed to buy a new airplane, they could look to Boeing inthe US, Airbus in Europe, or Embaer in Brazil. If the US successfully weakened its currency versus globalcurrencies, then the Chinese currency would buy more US dollars versus Euro or Brazilian Real.Therefore, the Boeing airplane would be cheaper.

Make no mistake that since the onset of the global financial crisis in 2008 there has been an ongoingcurrency war. History shows that often times currency wars spin off trade wars where countries beginretaliating against currency interventions by raising tariffs, trade barriers, excise taxes and capitalcontrols.

- James G. Rickards author of Currency Wars: The making of the next global Crisis

Below is the formula for Gross Domestic Product (GDP) which is the total of all goods and servicesproduced within a country:

GDP = C + I + G + (X-M)

The components of the formula are C=Consumption, I=Investment, G=Government Spending,X=Exports, and M=Imports (X-M = net exports). When an economy is slowing, consumption is moreoften than not slowing or stalled and unemployment rising. In an economic slow down, investmentin

business equipment slows due to a weaker outlook and businesses hunkering down. Governmentspending, under the flawed Keynesian economic policies, typically will increase to attempt to offset theslowdown in consumption and investment. Government support is problematic in that an economic slowdown typically results in lower employment leading to lower tax receipts. Since the government runs its

budget on tax revenue or borrowing, a period of lower tax receipts and higher government spendingresults in adding to government debt. Lastly, net exports (X-M) is the result of subtracting the amount ofimports from exports. An easy way to boost net exports is to devalue ones currency to make exportscheaper to foreigners.

Politicians find it hard to resist such an easy ploy as boosting exports through currency devaluation. Buteverything has consequences. Devaluing currency has many implications of which one of the worstimplications is the loss of purchasing power of the dollar. While devaluing helps US companies tocompete globally for sales, it pushes up prices of imports to the US and diminishes how far a dollar goesfor Americans. In addition, it irritates trading partners who must either devalue their currency through

inflating their money supply or lose exporting power as their currency will appreciate.

The fact that the US dollar, as reserve currency, is being massively devalued hurts all countries as thedollar is the common form of settlement of international trade. The days of the dollar as the reservecurrency appear to be numbered as many countries are looking to make transactions outside the US dollarthrough gold, barter, or their own currencies. The dollars potential demise is a whole topic all its own.Suffice it to say, if the US cannot tame its spending, debt and currency destruction then the reservecurrency status will be lost.

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Government Options for debts

In the book This Time is Different, Eight Centuries of Financial Folly, Carmen M. Reinhart and KennethS. Rogoff layout the five paths (or mix) of dealing with high debt levels.

1. Growth - increase income2. Austerity - spend less3. Monetary Inflation - backdoor default

4. Financial Repression - regulations in favor of government5. Default - not pay

Growth- For a government, higher growth normally translates to higher tax revenue. With the enormouslevel of debts that most western economies are dealing with, growth is not a possible strategy alone. Quitefrankly, growth is going to be hard in small amounts. Even significant economic growth and a completespending freeze would take decades for the US, UK and Japan to meaningfully reduce debt to GrossDomestic Product (GDP) ratios.

One of the worst parts of thestory for the US government isthat the demographics of

America are putting a strain onthe future. The US has an agings o c i e ty w h i c h me an s th e

workforce is shrinking. Ashrinking workforce is not aproblem i tse l f . But whencoupled with exploding debtsand entitlements, the twoopposite forces can tear a hole inthe economy. Less taxpayers

will have to cover more debtswhich means tax hikes, reducedgovernment spending or both.The chart on the right is theemployment-to-population ratio

which shows the percent of theUS population that is working.

Austerity- To stabilize or reduce the current debt levels will require significant reductions in governmentspending. The problem with reduced government spending is that it will reduce economic growth incountries where government spending is a large part of the economy. The following are examples ofgovernment spending as part of GDP: US - 41%; Japan - 43%; UK - 57%; France - 43%; and Spain 42%.

As one can imagine, a reduction in government spending will certainly impact economies. It is verydifficult to implement austerity after decades of free spending and the creation of entitlement spending.

At this point, government programs are looked at as birthrights and will not be removed or diminishedeasily. The social uprisings that are beginning in Europe are a fight against austerity and will certainlygrow in strength as governments attempt to tighten belts further.

Monetary Inflation - Historically, monetary inflation has been a common way of reducing debt. Monetaryinflation is simply the expansion of the money supply. A growth in the supply of money, over time, willallow nations to payoff debts with devalued currency. The unfortunate result of creating more money

while production stays level or falls is that the price of goods increases.

Inflating debt away is a debt reduction scheme commonly referred to as the silent default. If inflationexceeds the rate of interest one can earn, it is a slow destruction of wealth. Inflation depreciates thepurchasing power per unit of currency, thereby reducing the value of wealth and debt. For bond holdersor those on fixed income like social security or pensions, inflation erodes purchasing power as prices riseand incomes remain level or growing slower than the rise in prices.

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Of the five options above, by far the most popular way to reduce excessive debt by governments is throughmonetary inflation. The reason for this is that monetary inflation has immediate results. Another reasoninflation is the government choice is that it is easy to shift blame to faceless speculators or other economicreasons. The reality is monetary inflation is created by central banks and those central banks are hopingthey remain in the shadows as the creator of inflation, the business cycle, and worst of all, creators ofeconomic crises.

Financial Repression - This is a term used to refer to direct measures employed by governments tochannel funds to themselves versus going elsewhere in the private sector. Typically, financial repressionis executed through coordination of the government, the central bank (Federal Reserve), and the financialsector. Today, in the US financial repression is upon us in a multitude of ways. The overt form offinancial repression we have today is that of negative real interest rates. In other words, inflation ishigher than interest rates which is like a tax on savers and bond holders. Other forms of repression arecapital controls limiting movements of money and investments as well as interest rate caps.

Governments use financial repression to reduce the real value of their debt and reduce the cost ofservicing debt. The first action is to lower interest rates. Secondly, the government strong arms financialinstitutions, such as banks and pensions, to buy their governments debt (bonds) at low rates. We can seethis today where the Federal Reserve allows banks to borrow at near zero interest and turn around topurchase US Treasury bonds that are yielding a higher rate than they borrowed from the Fed. Thedifference between borrowing at zero and earning 1% - 4% is a guaranteed, virtually risk-free, return onlyavailable to banks.

- Carmen Reinhart 2011 author of This time is different: Eight centuries of Financial Folly

Default - A default is when a country, entity or person borrows money and does not pay back the fullamount. Default is generally avoided at all costs by nations. But there have been a number of sovereign(national) defaults. The most recent defaults have been Greece (2012), Argentina (2002) and Russia(1998). When it comes to a country defaulting, it is often a long road to the decision to default. Manycountries will first resort to one of the other options above before succumbing to a default. In most cases,once a country defaults on its debt, it can no longer borrow through conventional channels and resorts toaid from wealthier countries and entities like the International Monetary Fund (IMF).

Today, it is the wealthier supposedly more stable countries that are swimming in debt. The US, viaTreasury Secretary Timothy Geithner, has proclaimed default is not an option for the US. A default by the

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US would have grave implications as we have the largest economy as well as control of the worlds reservecurrency.

Outlook and associated thoughts

As a brief review, unless a modern day industrial, technical or energy revolution took place today

alongside a rapid reduction in government debt it is going to be impossible for the US economy to growout of the debt burdens. Accordingly, we must brace ourselves for a mix of inflation, austerity, moneyprinting, sovereign defaults and a healthy dose of financial repression. It is important to keep in mindthat the economic problems are now global. But it is also important to understand that each country orregion is in a different state of being.

Surveying global governments

When we look at the options for dealing with debt that we outlined in the last section, there are finiteoptions that each country or region is likely to pursue. Below we opine about the likelihood of each option

by country/region.

Approach U.S. Japan U.K.

Healthyparts ofEurope

Unhealthyparts ofEurope

Growth Low Low Low Moderate Low

Austerity Low Low Moderate Moderate High

Inflation High - Current High - Current High - Current High - Current High - Current

Financial Repression High - Current High - Current High - Current High - Current High - Current

Default Low Moderate Moderate Low High - Current

A significant driver in the fight to deal with debts is a countrys ability to control its currency. Obviously,in the US we have control of our currency and have been using the currency as a tool to stimulate theeconomy at the expense of the rest of the world.

The US is firmly on the path of monetary inflation (money printing) and financial repression. Europe istrying to force austerity on the weaker, over-indebted parts of Europe and is creating dangerous fissuresin the European Monetary Union. Countries like Germany and Finland have had relatively stableeconomies and lived within their means. On the other hand, countries like Portugal, Italy, Greece andSpain have lived well beyond their means. The big problem is that all of these countries have a commoncurrency which limits the options of dealing with debt for the weaker players. In the end it creates amoral hazard where the stronger countries have to decide to either bail out the profligate nations throughmoney printing or let the weaker players leave the monetary union causing serious economic disruptions.

Government movesThe unfortunate reality is that the overwhelming majority of global central bankers and Wall Streeteconomists are Keynesians. John Maynard Keynes was an early 20th century economist beloved by mostpoliticians. Politicians gravitate towards Keynesian economics because Keynes believed in governmentalintervention and that increasing demand through government spending could help the economy.Obviously, most politicians see Keynesian economics in a good light as it allowed for governmentspending and marginalized the negative impacts of government deficits. Since 2008 the world is findingout that deficits do matter and that government spending diverts capital away from private industrythereby slowing economies.

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- Anonymous joke

The Fed and other Keynesian leaning global central banks are in the same position as our friend theswimmer. They have jumped into the money printing, low interest rate, moral hazard waters with bothfeet. Now, half way (or more) out into the money printing river, they are committed to more of the same.If they reverse and swim back the economy will surely falter immediately. If they keep going across the

river, they buy time but will create larger debt problems and likely a currency/economic crisis.

Decades of unproductive, deficitspending, lack of political will,energy dependence, a shrinking

workforce and aging society areall hitting America at once. Tomake matters worse debt levelsare soaring and the prospect ofinterest rates rising are going toadd to the challenges.

For the last 30 years the playb o o k f o r s t i m ul at i n g t h e

economy out of slowdowns hasbeen the same - lower rates andprint money. The recenteconomic malaise that started in2008 has been non-responsiveto zero interest rates, trillions ofdollars in money printing and

banking systems bailouts. Now,we dare say, it is debatablewhether we are fortunate that the last few recessions saw v shaped recoveries in the stock markets. Wesay this because the stock market recoveries have come at a great cost. Those costs are an economydependent on ultra-low interest rates, massive public and private debts and too big to fail financialcompanies that hold the economy hostage to its greed and risk taking.

As we are all coming to realize, politicians and central bankers do not proactively deal with problems;more-so they react to crises. The last fifteen years are littered with politicians, regulators and central

bankers missing what would become crises (dotcom mania, real estate bubble, banking collapses,European debt crisis). The trajectory of debt build-up in the US, Europe and Japan coupled with ostrich(head-in-sand) economics is delaying a fiscal day of reckoning that is certain to come based on mathalone. The size of the debt problems in the global economy is just too big to be reconciled by growing outof the debt burdens. If you grow your economy by increasing debt, there comes a time when theproductive engine of the economy (private sector) cannot possibly pay off the debt. Many nations are atthat point and beyond.

For Americans, we have heard repeatedly that the US will not default on its debts. The thinking is that wecan print more money and inflate the debts away. Western economy politicians lack the political will toinstitute the level of austerity needed to lower debt and spending. The sheer size of government andunemployment in the US is going to limit the ability to grow out of the debts. This leaves, attempts at

what we have seen thus far, monetary inflation and repression.

European governments are trying to implement austerity but the citizenry are not digesting it very well.In the few places like Greece and France, where some steps have been taken to cut spending, they arefaced with political revolts. It will not be long before many European nations either go into a debt spiral(self -reinforcing debt cycle) or decide to follow the US into monetary inflation and more debt.

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Conclusions

If we were going golfing this morning, before we left the house we would dress for the weather. If it werecold, we would wear pants; hot we would wear shorts, and so on. Most people (depending on the part ofthe world) do not wake up and put on the same type of outfit everyday. Once on the course, before hittingthe first tee shot, it is prudent to assess wind direction and slopes. In addition, a players level of play(score) often has a lot to do with the conditions. It is very likely that one will have a worse score on a

windy, rainy day versus a calm, sunny day. Preparing to face the global markets is no different. Letsconsider the current global, market environment:

Western economies swimming in unsustainable debts (and growing) that can never be repaidwithout extreme economic interventions

Banks (globally) continuing to be bailed out or nationalized at taxpayer expense Record low interest rates supporting weak economies and distorting risk Prospect of rising global interest rates Entire countries in Europe bankrupt In the throes of a global currency and trade war US stock market closing in on all-time highs in the midst of a dire economic backdrop Europes monetary system in tatters Surging global unemployment Banks still taking on higher levels of risk and stamped as too big too fail

In isolation, each of the items above are worrisome, but they are all here at once and are exceedinglyhostile to your capital. If we put our heads in the sand and invest according to the environment from 5,10, or 20 years ago, wealth will be destroyed.

Possible economic outcomes

The least likely scenario is that the marketmagically stabilizes. We are not taking apessimistic stance here. We are looking at therealities of dealing with massive debts thatare still growing and that history shows thereare only a few ways out, and magic is not one.

We currently view the world as being in areflationary debt trap. A reflationary debttrap is where global governments and central

banks attempt to reflate the global economyby taking on debt. Attributes of a reflationarydebt trap are:

Debt reduction measures do notstabilize financial markets

E c o n o m i e s c o n t i n u e t o f i g h tdeflationary forces with inflationarypolicies like quantitative easing, andfinancial repression

Economies stumble along sideways through cycles of positive economic news coinciding withmonetary stimulus followed by economic weakness when stimulus stops

Less healthy countries begin to default on debts Weak economic growth perpetuate low interest rates fueling more government debt

A reflationary debt trap is not an end scenario. As we all know, economies and markets are fluid andalways in motion. The danger in a reflationary debt trap is that the next step may be a deflationary dropor an inflationary spike. Possible elements of a deflationary drop or inflationary spike are in the tableabove.

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Tug of war

The global tug-of-war between inflation and deflation has a very small chance of ending quietly andwithout notice. The drastic measures taken to continue the spend and pretend policies of globalgovernments as well as the notion of too big to fail banks will have drastic consequences. The problemis that there is no clear answer how the global economy will play out. But we do know where we are todayand can see the trajectory central banks are taking as well as reactions around the globe.

The measures taken thus far show that the resolve of global central banks is to avoid a deflationary drop atall costs. At the time of writing we are already seeing depression-like statistics coming from Greece andSpain. It is important to remember that just because the central banks and government are fightingdeflation does not mean they will win. In the end, it will be the will of the majority of people that will tellthe tale of how the current crisis ends.

Our goal as stewards of other peoples wealth is to help our clients carry their wealth forward and planappropriately. Unlike an ostrich, we chose to keep our head above ground, observe the world around us

and formulate a plan. In the short-term, we see the deflation/inflation fight happening within areflationary debt trap. This may be followed by a brief period of deflation in the medium term as globaleconomies slow. Then, if recent history is a good guide, we will see the financial powers resorting to moreinflationary policies like money printing and heavier financial repression. A large push of inflationarypolicies may be the item that breaks one of the western nations currencies. This will likely usher in a newglobal monetary system to replace the fiat system we have today.

The best course of investment action is to first find investment opportunities that look favorable in eitherdeflationary or inflationary periods. Below are general investment categories and their usefulness in eachscenario:

Reflationary Debt Trap Deflationary Drop Inflationary Spike

Cash Negative Cash Positive Cash Very Negative

Stocks Neutral Stocks Neutral/Negative Stocks Positive

Bonds Negative Bonds Neutral Bonds Very Negative

Commodities Neutral/Positive Commodities Neutral Commodities Positive

Precious Metals Positive Precious Metals Positive Precious Metals Very Positive

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A new investment world (for now)

The most important point to understand regarding theoptions the western world faces is that financialrepression, inflation and default are all synonymous

with wealth destruction and loss of purchasing power.Defaults are generally avoided at all costs because theyare blunt and visible. Alternatively, financial repression

and inflation are covert and silent and this is why theyare the preferred debt reduction tools of governments.This is much like the frog placed in boiling water who

will jump out but the same frog placed in cold waterthat is slowly heated will be cooked to death.

The mechanics behind monetary inflation and financialrepression, as they currently impact US citizens, arezero interest rates, inflation running ahead of interestrates that can be earned on bank deposits/government

bonds, and capital controls. These mechanisms distortmarkets and cause misallocations of capital. Forexample, artificially low interest rates encouragespeculation and forces savers to take more risk than

they normally would to achieve their investment andincome goals.

Since 2008 the Federal Reserve (Fed) in the US has tried to boost housing and employment with little orno success. But the Fed has been successful in reflating stock markets through forcing investors intostocks by keeping interest rates so low. The problem with ushering everyone into one area to look for areasonable return is that it sends those assets (assets everyone are forced to) past fair value. In other

words, cheap money increases risk taking and misallocation of investments.

There is another dangerousdynamic afoot in the bondmarket. For the last thirty yearsinterest rates have been on adownward slope to the currentlevel of zero (blue line image atright). Declining interest ratesare very good for bond markets.Consider if you have a bondpaying 5% and interest rates inthe market fall to 4%; your 5%

bond is very attractive as it yieldsmore. Suppose you have thesame 5% bond and interest ratesrise to 6%; your bond at 5% isless valuable. So, for the lastthirty years the bond and stockmarkets have had the wind attheir back as interest rates havemade a steady decline to zero. The decline to zero has significant implications regarding how one investsnow.

Over the last thirty years the investing universe espoused that investors can buy and hold a diversifiedportfolio of stocks and bonds, rebalance once a year and the world will be fine. This worked well becausethe safe assets in the portfolio (bonds and money market) were safe and generally moved opposite ofstocks. This inverse relationship between stocks and bonds helped investors. When stocks were notdoing well, a safe harbor could be found in many areas of the bond markets. With interest rates at zerothere is no where for rates to go but up or sideways. When rates rise, the bond markets will be in trouble.Historically, the Fed would raise interest rates to cool a rapidly expanding economy. The problem is that

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rising rates, in the current environment, will crush any prospect of an economic recovery in the short-term considering the weak economy.

Changing expectations

There are two cycles at play inthe investing markets. The firstis the long-term boom and bust

cycle the market has been onwh ich re la tes to th e Fe d smanagement of interest rates.In the chart at right you can seethe mountains (red line) theS&P 500 has climbed in thedotcom rise, then up to the2008 bust, now we are on the

way up again. The spur for eachmountain formation in the charthas been the low interest rates(blue line) that now sit at zero.

The other cycle is the short-term

cycle we are following thatrelates to money printing cycles.In the chart below you can see the impact the Feds money printing programs have had on the S&P 500.The printing is well received by Wall Street, followed by down drafts when Wall Street thinks the printinghas ended only to be lifted with the announcement of the next money printing plan.

Our concern with revisiting all-time highs in stocks is that, as mentioned previously, global economieswere much healthier in previous pushes this high. In addition, the Feds zero interest rate policy going outto 2014 will be the longest that rates were held this low this long. What derails the global economy next isimpossible to know. It is a safe bet that it will likely be something that is not on everyones radar. Ourconcern is what happens to the markets after the next economic downturn. Interest rates are already zeroand debts are already getting outof control. It is a safe bet thatthe next economic downturn

will not be followed by a vshaped recovery in stocks. Thenthere is the whole sticky issue ofrising interest rates and theirnegative impact on bond prices.In the past bonds have been asafe haven in times of marketturmoil. But if the next malaisein stocks coincides with risingrates, many investors are goingto be struggling to find cover.

In regard to investment, thecurrent environment has been

turned around from what wehave become accustomed to. Inmany cases, what was once safeis now risky and what was oncerisky is much safer. In light of the extremely low interest rate environment and western nations drowningin debt, we believe investors must adjust their approach to the market and alter their expectations for thetime being.

For the last three decades the western world led the global economy; now the emerging world is where thewealth can be found as well as positive demographics. For the last three decades declining interest rates

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have been the wind at the back of the bond and stock markets; now rates are at zero and will have to rise.For the last three decades the western world has slowly dug a massive deficit hole that now needs to beresolved which will slow growth. For the last three decades the US dollar has been the reserve currencyand relied upon for settlement of trade; now nations around the world are looking for alternatives to theUS dollar. The bottom-line is, the world is different and investors must adapt.

Investors must come to grips with the fact that the current investing environment is very different thanwhat they have come to know over the last thirty years. While portfolio growth was the primary goal for

most investors in recent decades, risk management and wealth preservation must be top priorities in thecoming years. This means investors must be prepared to give up some of the short-term upside to protectfrom portfolios from the growing chance of a significant fall in the investing markets.

The question for investors should be, where can I avoid or at least minimize potential losses and carry mypurchasing power into the future versus in the past three decades the question has been where can Irealize the highest possible returns. There are times to take risk and grow your capital and there aretimes to protect your capital. We believe the current environment is a capital hostile environment whereprotection is pinnacle. In the short-term more fortunes will be lost and not made by taking undue risks.But the future will certainly have a better risk-reward opportunity where you will want to invest witheverything you have.

It is our opinion that in the next five years the most successful investors will be the ones who avoided thebig market downturns and protected their capital. Once global economies and financial systems clear the

bad debts (which will require some short-term pain), the next great investing bull market will take place.This will be a point where great fortunes can and will be made. The key will be ensuring that you have thecapital to deploy when you can make investments of a lifetime. It is important to remember that while theGreat Depression was an awful period in history, great investment opportunities were presented in itsaftermath. But only those who protected their capital during the period had capital to invest afterward.Those that took untimely and unnecessary risk were wiped out and could not participate in the once in alifetime investment opportunities that followed.

The question is are you willing to play it safe in the short-term, capital hostile environment to make sureyou have capital (or more capital) to invest in the next great bull market?

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Disclaimers

No part of this document may be reproduced in any way without the prior written consent of Lighthouse WealthManagement.

Investing involves substantial risk. Lighthouse Financial Advisors, Inc, dba Lighthouse Wealth Management, isregistered as an investment advisor with the SEC and only transacts business in states where it is properlyregistered, or excluded or exempted from registration requirements. SEC registration does not constitute anendorsement of the firm by SEC nor does it indicate that the advisor has attained a particular skill level or ability.

Lighthouse Wealth Management (LWM) makes no guarantee or other promise as to any results that may beobtained from their views.

The Standard and Poors 500 (S&P 500) is an unmanaged group of securities considered to be representative of thestock market in general.

No reader should make any investment decision without first consulting with his or her own personal financialadvisor and conducting his or her own research and due diligence, including carefully reviewing investmentprospectuses and other public filings of any issuer.

To the maximum extent permitted by law, LWM disclaims any and all liability in the event any information,commentary, analysis, opinions, advice and/or recommendations in the update that prove to be inaccurate,incomplete or unreliable, or result in any investment or other losses.

The information provided in the update is obtained from sources which LWM believes to be reliable. However,LWM has not independently verified or otherwise investigated all such information. LWM does not guarantee theaccuracy or completeness of any such information. The commentary, analysis, opinions, advice andrecommendations represent the personal and subjective views of LWM, and are subject to change at any timewithout notice.

The update is not a solicitation or offer to buy or sell any securities.

Securities and Advisory Services offered through SII Investments, Inc., Member FINRA, SIPC and a RegisteredInvestment Advisor. Advisory Services also offered through Lighthouse Financial Advisors, Inc., dba LighthouseWealth Management a Registered Investment Advisor. SII does not provide tax advice &Lighthouse Financial TaxService & Lighthouse Financial Advisors, Inc. & SII Investments, Inc. are separate companies.

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big picture: reflections, assessments, outlook, approach

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