The Math Behind a 45% Market Correction

This week, the three-month U.S. Treasury yield hit an unexpected high of 5.2%, a level not seen since “Big Willy” left the oval office, all but guaranteeing a recession.

These rich debt yields barely keep up with inflation running over 5%.

We know this is unwelcome news. Like most Americans, the majority of your retirement is held hostage in a 401k with limited selections.

You cannot rely on a corporate retirement plan alone to sustain you in your golden years…

…Not with a Fed pushing poor policy as it tries to balance an unreasonable dual mandate…

…Not with a political climate paralyzed by tribalism and steeped in stupidity…

…Not with corporate stakeholders more interested in unnecessary activism than meeting their fiduciary responsibilities…

…and not with a possible 45% MARKET CORRECTION!

But don’t bother asking a financial advisor whether you should prepare for the worst. They’ll tell you that it always works out in the end.

They live by the motto that the four most dangerous words an investor can utter are: “this time is different.”

Guess how well that worked out for Dick Fuld, the last CEO of Lehman Brothers.

No, if you want a retirement worth living, you MUST adapt or perish.

It’s as simple as that.

Fortunately, you’ve already taken the first and most important step to protect yourself and your family — staying informed.

Information is power.

It’s not about how smart you are but how well-informed.

That all starts with reading this timely piece by Bob Carlson, our retirement expert.

Bob digs into what he refers to as “The Retirement Dead Zone.”

His critical analysis is a must-read for anyone looking to protect and grow their retirement portfolio.

So, before we take you through our most recent discovery, take five minutes and read this URGENT piece by Bob Carlson.

It will tell you PRECISELY how to navigate the disaster that awaits us.

CLICK HERE TO READ MORE!

Free Money Ain’t Free

When a company makes a profit, they must choose from the following options:

1. Invest in growth or cost-cutting measures
2. Pay off debt
3. Buy back shares
4. Pay a dividend

Every company out there chooses between these based on their opportunity cost or their weighted average cost of capital (a.k.a. WACC).

WACC is the cost of debt and the cost of equity weighted by the proportion of each according to the company’s balance sheet.

Debt is typically cheaper, and interest payments can be deducted from taxes. But, interest payments have an ongoing cost and must be repaid, unlike equity.

When a company’s share price goes down, its cost of equity goes up.

Think about it like this. If I need to raise $1 million, I will have to issue more shares if a stock trades at $75 than I would if the stock trades at $100.

Here’s the kicker.

Both debt and equity costs go up when the Fed raises interest rates.

Higher interest rates mean a higher cost of debt across the board.

But higher interest rates also increase the opportunity costs for investors. Consequently, they require a lower share price for the same stream of profits.

It’s a double whammy that companies are facing right now.

So, let’s assume for a moment that, all things being equal, if the cost of debt is what it is now, and knowing that we’re heading for a recession, that the dividend yield for the S&P 500 should be roughly the same as it was when the three-month Treasury yield was this high.

The current dividend yield for the S&P 500 is 1.72%.

The last time the three-month Treasury yield was this high was in January 2001. You could also argue that it’s not about when it was last there but when it last rose to that level, which would have been November 1999.

In January 2001, the S&P 500 dividend yield was 1.21%, and it was roughly the same in November 1999.

If we assume the cost of capital should be proportional to yield, it means our current market is overvalued by 1 – (1.21% / 1.72%) = 29.7%.

That would put the S&P 500 as down somewhere around $2,857.

Let’s take this a step further.

If you add in corporate buybacks to dividends, you will get a current composite yield of 4.62%. Back in January 2001 and November 1999, it was roughly 2.5%.

That means the S&P 500 is overvalued by 1 – (2.5% / 4.62%) = 45.9%, which would put the S&P down by about $2,198.

Surely We Missed Something

We guarantee that within seconds of reading our findings, some of you are rationalizing away our analysis.

Good. You should be skeptical. We would expect nothing less.

Now, ask yourself this one question…

Will, or better said, CAN the Fed backstop equity markets with free money this time?

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