Preface: Boyd & Boyd, P.C. often acts as the attorney for the trustee of our clients’ revocable trust. In our role as attorneys for a trustee, our job is to protect the trustee from actions or inaction that might cause a beneficiary to want to bring an action against the trustee. Sometimes our advice relates to protecting and preserving the trust investment portfolio. In this second part of our 2024 Outlook series, we want to share reasons why trust portfolios may need to be reviewed and possibly re-aligned in light of current events. This newsletter is not intended to be investment advice. Instead, it is meant to educate trustees on the duties they have under the Uniform Trust Code (MGL ch. 203E) and on how to comply with those duties. We will share some of the tactics and strategies we employ when the firm acts as a trustee or co-trustee.
Late last year, two articles came to my attention. The events described in each of the articles have the potential to negatively impact investment markets. Taken independently, the possible occurrence of the events described in the articles seems relatively low. And most prognosticators retain a relatively positive market outlook. But taken together, these articles provide a timely New Year’s’ reminder that Trustees must make an effort to protect gains from potential future market downturns. Please remember, as you read this, that the two articles that prompted this article are speculative in nature. The use of the events described herein is not meant to be a prediction but rather a reminder that current events can negatively impact investment markets and that trustees should work with their investment advisor to protect trust assets from a potential market downturn.
We must remind the reader that Boyd & Boyd, P.C., does not provide investment advice. But we do act as trustees or co-trustees on many trusts. As a result, our role as the managing trustee requires that we stay on top of investment market issues. If you are a trustee or co-trustee of an irrevocable trust, under Massachusetts law, you too have a duty to prudently manage the trust and its investments. Trustees also have a duty to control and protect trust property; this includes a duty to protect the trust portfolio from market loss to the same extent a prudent investor could do so. In that light, let’s look at the two articles:
The first article relates to mainland China’s desire for reunification with Taiwan (if you are interested, you may read it here). As you may recall, President Biden had an important meeting with China’s President Xi in November 2023. One important conversation was not reported at the time but came to light near the year’s end. Essentially, Xi made what has been characterized as a “blunt” statement that China will reunify with Taiwan. He also wanted a joint statement that the US supports reunification. The Biden administration rejected that request. What is so disconcerting about this previously unreported conversation is that it makes clear that China will reunify whenever it is ready. According to one article, “Xi told Biden in a group meeting attended by a dozen American and Chinese officials that China’s preference is to take Taiwan peacefully, not by force, the officials said.” While Xi stated his “preference,” he did not rule out military action. Xi’s statement is consistent with Chinese military philosophy that dates back to the 5th century BC, as written in Sun Tzu’s “The Art of War.” But there are several factors that might indicate 2024 is the year when reunification may occur. First, Taiwan’s election this year may push China to act sooner than later. Second, the 75th anniversary of the communist takeover of China occurs later in 2024.
Why is China’s interest in Taiwan relevant to US investors? As of 2024, Taiwan Semiconductor Manufacturing Co. (TSMC) alone manufactures roughly 50% of the world’s semiconductors. Because semiconductors power so much of the world’s technology, US markets that are technology-based, like the NASDAQ and the S&P 500, could see a significant drop if reunification interferes with the availability of semiconductors.
Enter Article #2: Late in the year, several news outlets shared a prediction by Harry Dent. Mr. Dent is predicting that 2024 will be the year that the “everything bubble” will burst. Dent is the founder of Dent Research, HS Dent Investment Management, and is the director of H.S. Dent Publishing. Dent’s investing thesis, spending wave theory, states that consumer spending associated with family generational formation has a significant impact on the market value of investments such as financial instruments, real estate, and gold. According to Dent’s spending wave hypothesis, young adults spend less in the larger economy and spend more while raising children. It peaks when children leave home and then gradually declines throughout the last 15 years of working life (48–63). According to Dent, the present generation of US baby boomers entering retirement will create a significant slowdown in the larger macroeconomy as well as a reduction in the value of financial markets.
Mr. Dent has been predicting market cycles for decades, but his accuracy has not been stellar. Nevertheless, there have been occasions where his predictions have been on target. Mr. Dent believes that the “everything bubble” (stocks, bonds, gold & real estate) may burst in 2024 if January markets are weak.
While we take Mr. Dent’s predictions with a significant degree of skepticism, it is the convergence of these two articles that has led our firm to take some action on many of the trusts where we act as a sole trustee or as the managing co-trustee to protect against market downturns in the first six months of 2024.
How might these two articles reveal the potential for a market downturn? If China moved forward with reunification in 2024, the semiconductor supply chain could be critically weakened, and the technology markets would then decline. Will this be enough to trigger the burst of the “everything bubble”?
- Harry Dent’s Prediction of the “Everything Bubble” Burst in 2024:
Harry Dent, an economist known for his contrarian views on financial markets, predicts a significant market crash in 2024, referring to it as the “Crash of a Lifetime.” This forecast is predicated on various economic indicators and demographic trends, particularly the spending habits of the Baby Boomer generation. Dent argues that as this demographic cohort moves out of the peak spending phase, there will be a natural decline in economic activity, leading to a contraction in asset values across various sectors, including real estate, stocks, and commodities.
- The Geopolitical Landscape and Chinese Reunification with Taiwan:
The potential Chinese reunification with Taiwan is a complex geopolitical issue with far-reaching implications. Estimates of the probability of a reunification in 2024 range from a low of 20–30% to as high as 60%, depending upon a range of factors and assumptions. However, the symbolic significance of the 75th anniversary of the communist takeover of China and China’s increasing assertiveness, balanced against the risks of severe economic repercussions and international condemnation, all lead toward the need to recognize the possibility of reunification this year and the need to be prepared for a negative market reaction.
- Impact of Chinese Reunification on Global Investment Markets:
A reunification attempt, whether peaceful or forceful, would likely introduce significant volatility into global markets. It could lead to disruptions in global trade, especially considering Taiwan’s critical role in semiconductor manufacturing and technology supply chains. The immediate reaction would likely be a flight to safety, with investors moving towards more stable assets like gold and government bonds. Equity markets, particularly those with high exposure to Asian economies, would face downward pressure due to increased uncertainty and potential trade disruptions.
- Triggering the Burst of the “Everything Bubble”:
In the context of Dent’s prediction, the tension around Taiwan could act as a catalyst for the bursting of the “everything bubble.” The added geopolitical risk would exacerbate existing economic vulnerabilities, hastening the decline in asset values forecast by Dent. Investors, already navigating the demographic shifts and economic contractions predicted by Dent, would find the geopolitical tensions a significant additional headwind, leading to a rapid reevaluation of asset values and increased market corrections.
- Mitigation Strategies for Investors:
In light of these predictions and potential scenarios, trustees would be wise to adopt a more cautious approach as 2024 progresses. Diversifying portfolios to include assets that are less sensitive to market cycles and geopolitical tensions, such as certain commodities or government bonds, could be prudent. Additionally, maintaining liquidity to capitalize on potential market corrections and investing in sectors less impacted by geopolitical risks would be strategic.
In conclusion, while the probability of a Chinese reunification with Taiwan in 2024 remains uncertain, its potential impact on the investment markets, coupled with the predicted “everything bubble” burst, warrants a cautious outlook for 2024. The interplay of geopolitical tensions with underlying economic vulnerabilities could lead to significant market corrections and shifts in investment strategies. Therefore, trustees should closely monitor these developments and adjust their portfolios accordingly to mitigate risks and capitalize on potential opportunities. Despite the dire outlook this article may imply, Trustees need to recognize that predictions of reunification of China and Taiwan coupled with the bursting of the “everything bubble” are speculation. Events discussed in this article are not expected to occur. However, given the possibilities of a market downturn these events could cause, it seems wise for trustees to revisit asset allocation and structure portfolios so that they are less susceptible to market volatility in 2024.
One strategy to consider is to place a “Trailing Stop Loss” order on equity holdings. This will allow trust investments to continue to participate in an upward-trending market, but it will also provide an exit strategy and some limitations on losses should some external events negatively impact the equity markets. The risk with “stop-loss” orders is that the loss may not be as limited as desired if an event occurs when the market is closed. The next market open may be below the target of the stop loss. This will result in a sale, but the loss may exceed the target. Let’s look at an example: A trustee places a good till cancelled, 10% trailing stop loss order on VTI when it is trading at $233/share. The sell order will trigger if the share price drops to $210. One month later, an event occurs after the market closes that causes the market to drop. Then next morning trading on VTI opens at $199 per share. The trailing stop-loss order is triggered, but the sale price will be $199 per share, not the $210 in the order. If the market continues to slide, the trust is protected from further loss. But if the market recovers, the sale may have occurred at an inopportune time.
There is a tactic that provides stronger protection for an investment portfolio, but it comes with an upfront cost. This approach involves option trading. In some cases, options may be used in a way that is analogous to buying an insurance policy. For example, by buying a put, one investor will pay another investor for the promise or guarantee that the second investor will buy a holding from the first investor at a pre-agreed-upon price. So, using VTI trading at $233, the first investor might buy a put contract to sell VTI after a 10% drop in price, with an execution date 60 days in the future. If the same price drop were to occur and the price of VTI was trading at $199, the first investor may exercise the right to sell VTI at $210 to the second investor, even though VTI is trading at $199 per share.
While options can be used as a tool to limit volatility, historically, options trading was “high-risk.” So most trusts do not give the trustee the power to trade in options. If you think that giving your trustee the power to use options trading will be beneficial, please call the office at (508) 775-7800 to request our options trading amendment. We can add this power to your revocable trust.
A trustee of an irrevocable trust should use the beginning of a new year as an opportunity to review the trust portfolio with their financial advisor. Trustees who reasonably rely on and follow the advice of a professional investment advisor can limit their exposure to claims from beneficiaries for the recovery losses sustained during a market downturn. If you don’t have an investment advisor, we are happy to make a referral.