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China and the United States, the primary sources of economic stimulus since 2008, will begin to unwind their stimulus in 2014. The Fed’s announcement of its first reduction in quantitative easing and China’s rising interbank interest rate are signals of what is to come. The main driver for the unwinding is concerns of bubbles, not that economies are strong enough.
Unwinding stimulus, especially one so large and prolonged, is fraught with unintended consequences. Bubbles tend to pop, not deflate slowly. Even though authorities are calibrating their tightening steps carefully to achieve a smooth landing, financial turmoil due to a bubble bursting is possible, which may drag the global economy into another recession.
Even if no financial turmoil emerges, some assets are likely to come under strong pressure. The economies that depend on commodity exports and/or hot money to plug their current accounts may see their currencies under more pressure. The Australian dollar and Brazilian real are highly vulnerable. The Indian rupee is another weak currency. The Canadian dollar and Russian ruble may come under pressure too.
Stimulus and Growth
After the 2008 financial crisis broke out, I predicted widespread monetary and fiscal stimulus all around, and such stimulus wouldn’t bring back sustainable and sound growth, eventually leading to another crisis. I also predicted that stimulus advocates will blame the failure on insufficient stimulus. My predictions are coming true halfway there. Another financial crisis will make them whole.
The magnitude of the United States’ stimulus could be measured by national debt rising from 62 percent to 100 percent of GDP and the Federal Reserve’s balance sheet more than tripling from 2007 to 2013. The impact on asset prices is reflected by a 60 percent increase in household wealth from the crisis low and 21.4 percent above the 2007 peak – a level considered a bubble that led to the 2008 financial crisis. During the same period the U.S. economy has expanded by 6 percent in real terms and 15.8 percent in nominal terms. The current level of total employment is still below the pre-crisis level. It is obvious that the U.S. stimulus policy has had an outsized impact on asset prices and small one on the real economy or employment.
Why would the Fed decrease its QE while the economy is far from healthy? When the Fed first sounded its tightening warning in June, I argued that it was trying to manage an asset bubble. Before 2008, property appreciation was driving the U.S. bubble. Financial markets have been doing the job since. It appeared that the U.S. stock market was ready to spike like in early 2000 when the Fed sounded its warning. The market consolidated afterward. But, when the Fed backed off in September, it went on a tear again. When the Fed took its first step in December, it was viewed as too small to have an impact. The market has continued its rally. The S&P 500 rose by 30 percent in 2013. It remains to be seen if the Fed could prevent a rerun of 2000: the market surges in the first quarter of 2014 and falls sharply afterward.
China’s stimulus, mainly through lowering the credit standard, led to a 175 percent increase in M2 from 2007 to 2013. The main growth consequences are a 61 percent increase in electricity production and an 82 percent increase in nominal dollar exports. While the growth data are still impressive, they are small in comparison to monetary growth. If such a relationship persists, hyperinflation is likely. Further, the growth numbers have come down in the past two years, while monetary growth has slowed less. The trend suggests that the effectiveness of monetary stimulus is declining. Hence, achieving the same growth target brings a higher inflation rate.
The growth dynamic in the past five years depends on local governments borrowing money to spend. The declining effectiveness of monetary growth reflects the same declining efficiency in local government expenditure. The growth dependency on local government spending is tied up with property speculation. As excessive monetary growth triggers inflation expectations, money has poured into land and property. As local governments control all the land supply, they have been able to raise revenues from selling land and borrowing money with land as collateral. These two are the main channels for money supply to turn into expenditure.
Neither China nor the United States has built a sustainable growth dynamic with stimulus. As the stimulus side effects – bubbles and rising leverage – become the main show unwinding stimulus becomes urgent. This is why both countries are likely to take tightening steps.
Smooth Tightening Is Rare
Unwinding stimulus is usually a dangerous business. One never knows how much hot air the stimulus has created. When it leaks, it could cause a big explosion. For example, the Fed’s tightening cycle in the past usually triggered an emerging market crisis. As the United States itself isn’t on a strong growth path, the risk at home is substantial.
I’m surprised by how weak the United States’ growth has been, considering how much household wealth has risen. Hindsight suggests that the wealth increase is concentrated in a small minority who are too rich to spend all the gains. Before 2007 property inflation was driving household wealth, which benefited most people. As Wall Street created financial products for the masses to borrow against property appreciation, the economy benefited from a powerful wealth effect. The surging stock market has been driving household wealth in this cycle. As 10 percent of the United States’ population own most of the stock, the wealth effect isn’t broadly based. This is probably the main reason for the weak economic response to the stimulus.
Similar to the past, the Fed’s tightening cycle could trigger another emerging market crisis. When the Fed mentioned that it could taper QE, emerging markets tumbled. Those with persistent current account deficits, like Brazil and India, saw a mini crash in their currencies. The hot money into emerging markets could be between US$ 3 trillion and US$ 4 trillion during the Fed’s easing cycle. If a fraction of it returns, the shock to the monetary condition in some emerging economies could be severe enough to trigger a banking crisis. I suspect that several major emerging economies would have to raise interest rates aggressively to maintain financial stability. Otherwise, a currency-cum-banking crisis could happen.
The risk at home for the Fed is much higher than during the previous tightening cycles. The U.S. economy is still quite fragile. The improving labor market is due to declining wages for the reemployed. Hence, its contribution to demand is limited. The stock market could be 50 percent overvalued. The Internet sector is a vast bubble similar to what happened in early 2000. If the bubble pops, it may lead to reduction in corporate capex, which could pull the economy back into recession.
I have argued against the Fed’s monetary policy on the grounds that globalization has short-circuited the feedback loop between demand and supply. Wages, for example, are determined by globalization, not the strength of local demand. What’s happening to the U.S. labor market is similar to what happened to Japan and Taiwan in the 1990s. The economics behind the phenomenon are sound. What’s unstable in the United States is that its stimulus policy has vastly inflated non-tradables like housing, health care and education, which makes internationally competitive wages insufficient for a minimum living standard. This could be the driver for stagflation in the United States. As labor demands a living wage, say, doubling minimum wage to US$ 15 per hour, the Fed may be forced to restart QE to counter its negative impact on labor demand, which leads to a price-wage spiral.
The Fed’s tightening cycle this time is far from predictable, even though the Fed tries to project such an impression. If a financial crisis breaks out, either at home or among emerging markets, the Fed would be back to pumping liquidity to stabilize the market, which would be another step toward stagflation. If a labor movement at home depresses labor demand, it would be back to QE again, which also leads to stagflation. I predicted that stagflation is the ultimate outcome for the global economy. Most of the United States’ nominal GDP increase since 2007 is due to inflation, which already fits the description of mild stagflation. If the Fed is forced to back off from tightening, more pronounced stagflation is not far off.
China’s tightening is really about limiting local government borrowing. They are not interest rate sensitive. The current rise in interest rate is unlikely to dent their appetite. Indeed, China’s local governments went to the shadow banking system for money at high interest rates in 2013, as banks have become wary of too much exposure to them. Local governments depend on the perception that provinces and, ultimately, the central government will bail them out, if they can’t repay their loans. This is the reason that the shadow banking system is focusing on them. Private companies have been borrowing at low interest rates offshore and lending to them at high interest rate, either directly or through trust companies. Unless the bailout responsibility is clarified, China’s credit bubble would continue.
If the central government spells out its position of no bailouts clearly and convincingly, the reaction in the credit market will likely be massive. The shadow banking system, for example, wouldn’t roll over their loans. Unless the banks step in – probably forced by the government – a financial crisis is possible. If the banks do step in, it is actually a bailout by the central government, as it will be forced to bail them out if they go down. When moral hazard is the main reason for a credit boom, cooling it slowly is very difficult.
I have always argued that a hard landing would be a good thing for China. It flushes out all the financial excesses quickly and allows the economy to have a fresh start and soon. China’s labor shortage ensures that such a landing wouldn’t lead to social instability. Declining inflation would improve people’s living standards. Hence, it’s all good looking from the people’s perspective. The banks and local governments wouldn’t look at it that way. They all hope to stretch out the time horizon for paying off the legacy costs from the bubble. Or better that the people in charge now could walk away before the problems are exposed. Hence, the system’s bias is to drag it out. But, a bubble grows larger if it doesn’t burst. One cannot hold a bubble stable; it either shrinks or expands.
China is showing some resolve in reigning in the credit bubble. A credible anti-corruption campaign and rising interest rate are the visible signs. The tightening path is anything but assured. The system’s bias for stable appearance may cause the policy to change direction.
Global Growth Tilts Down
The global economy has depended on stimulus in China and the United States since 2008. As they embark on tightening, one clear implication is that the global economy will slow in 2014. One obvious market implication is that commodity economies will see their currencies dropping again.
At the beginning of 2013, I predicted that Australian dollar, Indian rupee and Japanese yen will tumble, though for different reasons. In 2014, the Australian dollar will continue its tumbling. Other commodity currencies like Brazilian real, Canadian dollar, Russian ruble and South African rand will all come under pressure. The simple logic is that they are really driven by China’s credit cycle. If China’s credit cycle reverses, their currencies will lose their gains on the way up.
Hot money doesn’t really go back to the United States per se. It just vanishes. When investors or speculators borrow dollars and buy local currency assets in emerging economies, the latter’s central banks issue local currencies and use the dollars, now called foreign exchange reserves, to buy U.S. treasuries. The consequence is an expansion in the global balance sheet of assets and liabilities. When the hot money flow reverses, the global balance just shrinks. Such deleveraging hits hard any economy that depends on hot money to finance its persistent current account deficits. India stands out as an example. Its central bank, since its new governor came in, has surprised on the upside. It has been tightening ahead of the curve. India could avoid a financial crisis. The price is much slower growth or even a recession.
The Japanese yen is likely to be range bound. Japan’s inflation has picked up. The Bank of Japan (BoJ) doesn’t have an excuse to push down the yen further. If it does, the reaction from U.S. automakers would be severe. In the long run, the yen will continue to decline. But, this doesn’t happen in a smooth curve. What the BoJ does is to concentrate the yen weakness in a short period, which gives the economy a lift. When the lift is exhausted, it pushes for another bout of yen weakness.
I believe that gold has already bottomed in 2013. In a Fed tightening cycle, gold tends to go down. Financial players in this cycle have been impatient to kick gold down as hard as possible. They short gold producers first and then gold. The gold stocks are much bigger in value than gold market per se. Hence, the trading strategy of shorting gold stocks and then gold could be lucrative. As more and more people pursue the same trade, the gold is kicked down way beyond its fundamentals.
Gold demand is from emerging economies. The latter have been experiencing high inflation. The demand for gold has been strong despite the weak gold price in 2013. The current gold price is already below the production cost of some of the biggest mines in the world. I suspect that, in 2014, some mines may be shut. The reduction in supply will become a counterforce against the Fed’s tightening.
I want to repeat my long term bullish call on gold. Its price is likely to top US$ 3,000 in five years. The currency market instability and the likely global stagflation will strengthen gold demand for wealth preservation in emerging economies. As supply is unable to grow, the price has to rise to balance the market.
By: Tom Chatham
The Chinese have made no secret of their discontent with the massive money printing by the U.S. that is threatening to diminish their massive holdings. They are currently on a massive buying spree to get every ounce of gold they can as fast as they can. The U.S. interests are holding down the price of PMs in an effort to fool the average person into believing that everything is just fine. This manipulation is playing right into the hands of China as they continue to buy.
The amount of gold moving from London to the east is creating a drain on vaults in the west and it is only a matter of time before they go empty. When that happens, the price of physical will skyrocket and no amount of paper will be able to stop it. The end of the line for paper gold and silver is getting close. With China buying over 1,000 tons of gold every year for the past few years plus what they mine themselves, their vaults are filling up fast. Once they have a sufficient amount, they will complete the destruction of the Dollar with massive dumping of their U.S. bonds.
China has already signaled the end of the dollar when it recently announced it would start invoicing all of its oil imports in Renminbi. It has also announced it will no longer be adding any more foreign reserves to its holdings. This is an indication that China will begin to build up its own middle class to absorb much of its production just as the U.S. did in the last century. This is a clear signal that the loss of reserve currency status for the U.S. is not far off.
As if to make an even bolder statement, China is working on an agreement with Nicaragua to build a canal that rivals the Panama Canal. China is also talking about operating their own oil futures market that will be priced in Yuan. At least half of the OPEC nations have expressed interest in the endeavor.
As if life were not difficult enough in the U.S. right now, the loss of reserve currency status will hit like a financial tsunami that will push Americans over the edge before they know what hit them. This will cause all of our imports to increase in price until we can no longer afford them. This is a fact that few Americans know or understand. Most like to pretend everything will be fine and keep their head in the sand to stop any negative information from getting through but this crisis is going to run up and bite them in the ass whether they want to know or not. This is why so many will lose everything they have in the coming months. They can ignore reality but they will not be able to ignore the consequences of ignoring reality.
There are going to be rough times ahead and most Americans refuse to admit it and prepare for the worst. There has usually been someone or some thing to step in in the past and cushion the fall for most but this time there will be no one there to stop the pain. The death of the dollar will be one of those times in life that everyone will remember for many years to come.
Inexpensive oil vanishing at alarming rate
The United States is awash in shale oil. Iran, once OPEC’s second-largest producer, is slowly ramping up output. Oil consumption growth in the Western world has been somewhere between negative and flat since the 2008 financial crisis. The “peak oil” theory has pretty much vanished, along with The Oil Drum, the bible of peak oil believers. Rest in peace.
Or turn in your grave, for the oil price charts tell a different story.
On the New York Mercantile Exchange, crude oil futures are up 13 per cent over one year. Since 2009, they have climbed every year except 2012. In Europe, the Brent crude futures are flat over the year after rising three years on the trot. Brent, the de facto global benchmark, trades at about $108 (U.S.) a barrel; West Texas Intermediate, the North American benchmark, is at $97. For the sake of argument, let’s say the world is valuing oil at $100. You would think the price would be far less as the United States challenges Saudi Arabia for top producer status.
While the oil forecasters were pumping out bearish calls, the market itself has stuck to its triple-digit price outlook. Oil buyers apparently know the Western world’s economic recovery will boost consumption, since growth and oil use are aligned. That’s not all. They also know that the math doesn’t work: Prices can’t go into gradual, long-term decline, or even stay flat, when the world’s conventional oil fields are in fairly rapid decline.
Exotic production – oil sands, biofuels, natural gas liquids – are supposed to fill the gap. But this so-called unconventional production is highly expensive and quite possibly insufficient to cover the drop off in cheap, conventional production. Prices will rise to the point that demand will have to level off or fall. The “peak oil” and “peak demand” theories are really opposite sides of the same coin.
A few days ago, Richard Miller, the former BP geochemist turned independent oil consultant, delivered a sobering lecture at University College London that laid out the case for dwindling future oil supply. His talk was based on published data from the U.S. Energy Information Agency, the International Energy Agency, the International Monetary Fund and other official sources.
The data leave no doubt that the inexpensive oil is vanishing quickly. Conventional oil production peaked in 2008 at about 70 million barrels a day and is declining by about 3.3 million barrels a day, every year. Saudi Arabia pumps about 10 million barrels a day. The math says a new Saudi Arabia has to be found every three years to offset the conventional oil drop off. Good luck. Now you know why Russians, Canadians and Americans are so keen to lock up the Arctic, the alleged keeper of vast new reserves.
About one-quarter of conventional production comes from the 20 biggest fields and most of them are in decline, some precipitously. North Sea oil production peaked at 4.5-million barrels a day in 1999. This year’s production is forecast at between 1.2 million and 1.4 million barrels a day. The so-called Forties field, the North Sea’s biggest, has been losing 9 per cent a year for more than 20 years. Ditto two other North Sea biggies – Brent and Ninian.
Great Britain shed its status as an energy powerhouse about a decade ago, when it became a net energy importer. Its energy import bill is horrendous. Last year, Britain spent almost £22-billion ($38-billion) buying foreign oil, natural gas and coal.
Repeat all over the world, from Mexico to Indonesia. Indonesia’s oil production has been in steady decline since the mid-1990s, and the country has gone from oil exporter to importer, at which point it got kicked out of the Organization of Petroleum Exporting Countries. While new exploration and technologies will extend the life of some of the gasping old fields, the long-term downward trend is intact.
The conventional fields are running out of puff just as world demand is climbing again, which can only put upward pressure on prices. This week, the IEA estimated that oil demand will rise by 1.2 million barrels a day in 2014, or 1.3 per cent, to 92.4 million barrels.
The increase is driven by economic recovery and ever-rising demand in China and elsewhere in the developing world. China is willing to pay almost any price for oil because oil drives growth more than it does in the West, where energy use is less intensive per unit of economic output. China has also developed a love affair with traffic jams. The number of cars and motorbikes in China increased twentyfold between 2000 and 2010. It is forecast to double again in the next 20 years.
The oil shills, the tech geeks and most, but not all, oil companies would have you believe that non-conventional energy will fill the gap as the cheap, easy-to-pump oil heads gently into the night. It might, but at what price and cost to the environment? Or it might not at any price.
Deep-sea production is monstrously expensive and risky, as BP found out when its Macondo well in the Gulf of Mexico blew up. The Alberta oil sands also spew out more carbon dioxide than conventional production. Most biofuels, such as U.S. corn-based ethanol, are taxpayer-subsidized economic horror shows with dubious environmental benefits.
The peak oil crowd has thinned out, to be sure, but it won’t disappear. Gushing U.S. shale oil doesn’t mean oil is about to become cheap and plentiful. The fall off in conventional oil production is real, and scary.
If you can keep your head when all about you
Are losing theirs and blaming it on you,
If you can trust yourself when all men doubt you,
But make allowance for their doubting too;
So, let’s say you’re a prudent person who has concerns that our economy isn’t ‘recovering’ as robustly as you’d like.
Perhaps you still remember the speed and depth of the 2008 credit crisis’ arrival, and its toxic impact on asset prices, jobs, and overall trust in the financial system. Maybe you took notes during the preceding tech and housing bubbles and their aftermath. If so, you likely swore that “Never again!” would you put your wealth at risk during such obvious times of public mania.
Chances are, you’ve probably logged a lot of online hours over the past several years trying to read the economic tea leaves more closely. Are things becoming more stable, or less? What are “safer” measures for protecting and building wealth than simply putting all your chips into the paper markets (stocks & bonds) and real estate?
As a result, you’ve probably had a smaller percentage of your wealth in the stock/bond markets over the past few years than your peers. You probably also own some gold and silver, likely having bought much of it between 2009-2011 with the stock market collapse still fresh in your memory. Chances are also good that you’ve made a series of “preparedness” investments (stored food, etc.) as an insurance policy in case really tough times were to break out. Most of your family and friends didn’t take these steps, nor are they particularly interested in talking about your reasons for taking them.
So, if this sounds at all like you, five years after the 2008 crisis, how is the “prudent” strategy looking today?
Looking Like an Idiot
As one who took similar steps, I’ll confirm that it looks pretty lousy to the casual observer.
Stocks & Bonds
There has been an absolute party in the stock market over the past two years. The S&P is up nearly 40% (!) since early 2012 and has almost tripled since its 2009 lows. It’s been nearly impossible not to make money in the stock market recently (unless you’ve owned mining shares).
Bonds have remained at historically elevated prices. And although 2013 has seen prices come off slightly from their highs, prices are still substantially above pre-crisis levels.
The pumped-up performance of paper assets here is, of course, due to the staggering amounts of new money that the Fed has been creating since 2008. Starting with a balance sheet of $880 billion pre-crisis, the Fed has since expanded it by an additional $3 trillion, in less than 5 years. And it’s continuing to expand to the tune of $85 billion (some calculate $100 billion) per month.
Most of that money sits in excess reserves enriching the banks at zero risk, at high hidden cost to the public (a rant for another day). But enough of it is sloshing over into the markets where it does exactly what excess liquidity always does: rise all boats.
So, if you decided to stay out of the markets, you’ve watched the party boat pass you by. They say don’t fight the Fed, and so far, the Fed is indeed winning. In reality, it will likely prove to be the Charlie Sheen version of “winning”, but to the casual observer whose 401k is up 20% this year, the Fed definitely appears to be playing the better hand.
How soon we forget. Home prices have resumed climbing at historically aberrant rates. Case-Shiller just reported that year-over-year, its national home price index grew by 11.2%.
A number of markets have re-entered bubble territory. San Francisco, where prices are now higher than at their 2007 peak, saw a 26% year-over-year increase in average prices. Las Vegas, the poster child for housing price excesses six years ago, saw a 29% average price increase from 2012 to 2013.
The tell-tale sign of an overheated housing market – house flipping – is back.
If you’ve been holding off on purchasing real estate (as I have) – expecting that a stumble back into recession, or higher interest rates, could bring prices down to saner baselines – again, you’re watching prices get away from you.
Ugh. There’s no denying that it has been a very rough two years for gold and silver holders. As I’m writing this, gold and silver are dropping to near 4-year lows.
For those burned by the last crisis who purchased precious metals near their zenith in 2011, hoping to protect the purchasing power of their capital, the nauseating declines since early 2012 (especially in silver) have done anything but.
Those who bought PMs pre-2008 enjoyed a long stretch of validation while prices appreciated year after year. With a material percentage of that appreciation now gone, and month after month of relentless losses punctuated by vicious price smashes, it’s harder to feel as smart as it once was.
But it’s maddening. With the $3 trillion in new currency recently created by the Federal Reserve, shouldn’t precious metals be appreciating? Wildly? Isn’t that their central promise: to hold value as the purchasing power of paper money inflates away? But instead, they’re decreasing in dollar price, even as the money supply continues to expand. How is that possible?
And Bitcoin! From almost out of nowhere, a new alternative currency skyrockets from nearly valueless to (briefly?) match the price of gold. It’s like adding insult to injury for the 99.9% of precious metals holders who don’t also hold Bitcoin. How can the world suddenly wake up to the advantages offered by non-fiat currency, and yet still treat the granddaddy of sound money like kryptonite?
In 2009 and 2010, those of us who had warned our friends of the lurking risks in our economic and financial system suddenly looked like geniuses, instead of the kooks that folks had dismissed us as. Now, we’re back to being kooks.
A chart Chris has been sharing recently with our enrolled members shows that at no time in the past 30 years has sentiment been this bullish, not even during the Internet stock mania of the late 1990s:
Faith in the current system is as high as it has ever been, and folks don’t want to hear otherwise.
This extreme optimism extends beyond the Economy. In the Energy sphere, in news headlines discussion of the “shale miracle” is still omnipresent – without, of course, any mention of net energy, extraction costs, or depletion rates. In the Environment, coverage of the real-time collapse of key fisheries or water shortages likely to impact food production rarely gets any mainstream notice.
In short: If you’re one of those people who thinks it prudent to have intelligent discussion on some of these risks– that maybe the future will turn out to be less than 100% awesome in every dimension – you’re probably finding yourself standing alone at cocktail parties these days.
The Madness of Crowds
Charles MacKay’s excellent classic reference book, Extraordinary Popular Delusions and the Madness of Crowds, explains the nefarious nature of public manias: They strive to suck in as many participants as possible before collapsing.
We are seeing classic signs of the abandonment of concern by the public in favor of not missing out on ‘easy gains’. In addition to the examples mentioned above, signals that the fear trade has given way to the greed trade are abundant these days:
- Stock chasing – Here’s a quote the WSJ recorded from an actual retail investor buying shares on the first day of the recent twitter IPO: I messed up not buying any Facebook so I want to get some Twitter. I’m just buying because everyone’s talking about Twitter. Not because of its product (which she admitted she didn’t use). Or its business model (which has never been profitable and unclear whether it ever will be). The purchase decision was based purely on hype.
- Priority abandonment – At Peak Prosperity, we speak with professional financial advisers frequently. The advisers we know best focus on risk mitigation and remain skeptical of the sustainability of the prolonged market rally. Many of their accounts signed on after 2008, clearly declaring that they prioritized protection of their capital over everything else. Yet a growing number of these investors are watching the continued rise in financial asset prices and are now pushing for more aggressive management. They’re abandoning the prudence that was so important to them just a few years ago.
- Bear capitulation – The path to a bull market peak is littered with the carcasses of bearish analysts that dared to challenge its rise. As the % bearish Investors Intelligence chart above shows, there are few bears left to be found anymore. Just last week saw a major defection from the bear camp, with the perennially critical Hugh Hendry throwing in the towel, exclaiming:
I can no longer say I am bearish. When markets become parabolic, the people who exist within them are trend followers, because the guys who are qualitative have got taken out.I cannot look at myself in the mirror; everything I have believed in I have had to reject. This environment only makes sense through the prism of trends.I may be providing a public utility here, as the last bear to capitulate. You are well within your rights to say ‘sell’.
- Warning sign dismissal – It’s not as if there aren’t clear alarm bells being sounded by the very experts the public looks to for such warnings. It’s just that these warnings are being ignored by the market. No one wants the party to end:
“All markets are bubbly”
“In many countries the stock price levels are high, and in many real estate markets prices have risen sharply…that could end badly. I find the boom in the U.S. stock market most concerning,”
“Now, five years later, signs of frothiness, if not outright bubbles, are reappearing in [at least 17 global] housing markets”
“What we are witnessing in many countries looks like a slow-motion replay of the last housing-market train wreck. And, like last time, the bigger the bubbles become, the nastier the collision with reality will be.”
When this latest global asset bubble bursts as Roubini reminds us, by definition, it must; the public will cry,“Why didn’t anyone warn us?” The media will reflexively utter, “Nobody saw this coming,” But the truth is, there is evidence galore for those who choose to look for it.
The Wisdom of Looking Like an Idiot Today
The other key characteristic about popular manias/bubbles is that they collapse suddenly. Much more swiftly than they took to build.
The resultant carnage catches the masses like deer in headlights. The Kubler-Ross stages of grief begin quickly, and since Denial is Stage 1, most folks delay taking action out of disbelief. Soon the Bargaining stage is reached, and they continue to delay reaction as prices continue falling – praying for the chance to get out if a reversal would just happen. It’s not until Acceptance that most will take action, selling after the down draft has largely run its course.
Here are some useful stats to keep in mind that show how sudden and savage the 2008 market collapse was:
- Week of Oct 6, 2008 – The Dow Jones drops 18%; its worst week ever in terms of both absolute and percentage loss.
- March 6, 2009 – The nadir for the stock market. By this date, 5 months after the crisis began, the Dow was down 54% since October
The takeaway here is that the wealth destruction caught most investors flat-footed. Most were unprepared –both psychologically as well as with their portfolio positioning – to react.
Many investors thought themselves savvy and nimble enough to avoid the losses they ultimately suffered, telling themselves an ill-fated narrative similar to what Charles Prince told his shareholders:
“When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing,”
Most readers remember how Citigroup’s price dropped from over $500/share, when Prince made this comment, to $10/share in March 2009. Prince was booted from his CEO role in late 2007 due to emerging losses resulting from the bank’s MBS and CDO positions, investment classes which proved to be at the heart of the 2008 crisis.
So, a smart question to ask at this time is: Is the moment in time we’re in today closer to January 2006, when there were several years left of exuberance to ride? Or is it more like September 2008, poised at the precipice?
A smarter answer is: There’s no way to know with acceptable certainty.
Like grains of sand piling up or snowflakes falling on a cornice, we can assess the growing level of risk, but we can’t identify the grain of sand or snowflake that will cause the eventual cascade. We can’t predict the collapse timing with confidence. We can – and will – continue to make our best-educated estimates, but the exact timing is unknowable.
So, given that fact, as John Hussman so pithily captures, bubble markets force us to make a choice:
The problem with bubbles is that they force one to decide whether to look like an idiot before the peak, or an idiot after the peak.
And so your choice is upon you. Look at the evidence around you – a movie nearly identical to one you saw in 2000 and again in 2008 – and either decide to party with the herd while the music plays (look smart today), or park yourself in safety now (look smart tomorrow).
Since the timing of the next correction is unknowable, the prudent choice is obvious. But it’s not easy, for all of the reasons mentioned at the start of this article.
A helpful question to ask yourself is: If I could talk to my 2009 self, what would s/he advise me to do?
For most of us, our past self, recently reminded of the anguish of wealth destruction, would say, “Run to safety!” at the first whiff of anything bubblicious. Research has shown that when the chips are down, the benefits of loss aversion are always preferred to the joys of gain.
Don’t put yourself in a position to relearn that lesson so soon after the last bubble. Exercise the wisdom to look like an idiot today.
The Need for Discipline is Greater Than Ever
Okay, so what should today’s “idiot” focus on doing?
- Build cash – It’s not sexy. And it’s not fun to see the dollar price of nearly every asset known to man escalate while you hold cash. But bubbles are designed to take as much as possible from as many people as possible. During the popping of a bubble, the real wealth (underlying assets like companies, land, minerals, etc.) doesn’t vaporize like the high prices do. Those assets are simply transferred at a lower (more attractive) price to those people who still have money. Be one of those people.
- Hold on to your precious metals – I know. It’s painful right now. For most PM owners, just hold onto what you have right now. Those with stronger stomachs should be dollar-cost averaging. Remember, the fundamentals for owning gold and silver have not changed AT ALL over the past few years. Stay largely with physical bullion. Don’t speculate with the mining stocks at this time unless you’re a risk junkie (or masochist?) and then only with money you can afford to lose.
- Scout out locally-based hard-asset investments for the future – Once this bubble pops, higher interest rates and lower prices will result. Look around your local area for assets (businesses, housing, farmland, livestock, etc.) that you would consider holding at least a percentage ownership in. Calculate what price would make you an interested investor. While that price may be years away, when the impact of a market correction hits, you’ll be poised to move ahead of the other savvy investors to secure the opportunities you want (and play a role in stabilizing the community in which you live).
- Design your trading plan for a market downdraft – What steps will you/your financial adviser take if the market starts cratering? If you don’t currently have a plan in place, now is the time to design it. Will you employ stops? What “safe assets” will you move to? (Treasurys, cash, other currencies?) Will you strictly be a sidelines observer, or will you take any active short positions on the downside? Will there be opportunity to generate income using vehicles like covered calls? Whatever makes sense for you, devise your strategy in the calmness of today vs. on the fly while the markets are melting down around you and everyone is panicking. And if your financial adviser is unable to provide you with a comforting answer as to his/her strategy for captaining your money through another 2008-like (or worse) correction, we have a few recommended advisers you may want to consider talking with.
- Build your roof while the sun is shining – So many of the most valuable investments are not financial (emergency preparedness, energy efficiency, community, health – to name just a few). Use the gift of time we have now to invest in expanding your degree of resilience. If it’s been a while, take a fresh skim though our What Should I Do? Guide to identify any areas where you aren’t satisfactorily prepared. These are the investments that it’s infinitely better to have in place “a year early vs. a day late.”
- Increase emotional fortitude – Being “wrong” in the eyes of society is trying. And it’s stressful for many, especially if your partner or others of those close to you don’t share your views. Keep learning by reading this site and a wide range of others, including those with opposing commentary. Develop your opinions based on the data you determine is most accurate – your ability to stand resolute against popular sentiment will be grounded in your confidence in the “big picture.” Seek support from the thousands of other Peak Prosperity readers who are wrestling with the same issue set you are, by participating in our Groups. We created them to help people support each other both virtually and “in person” within their local communities.
- Develop an income loss plan – If we’re correct in our prediction of a major downdraft, a return to deep recession is likely, and with it, a return to higher unemployment. Loss of income is a stressful trauma, especially if it happens unexpectedly and is compounded by a hobbled job market. Take some time to assess your job’s level of vulnerability to another recession. If it’s higher than you’d like, ask yourself what you would do if a sudden layoff occurred. Start doing the work now to at least sketch out the path you would take if that happened. If possible, develop some relationships or related skills now that would give you an exceptional advantage, should you ever need to head down that route. The first third of our book, Finding Your Way to Your Authentic Career has a number of exercises that provide useful guidance for those looking to do this.
- Develop an income enhancement plan – The resilience that comes with multiple income streams really helps you sleep at night, as you’re less vulnerable to having your entire life upended if a sudden pink slip appears. Also, having extra income to direct to other goals (retirement, education, homesteading, etc.) enables you to reach them faster. We’re all busy, but thinking creatively for a moment: What could you start doing today to secure extra income streams in the future? This is a topic that Chris often helps folks think through in his consultations.
Essentially, the approach here is to dismiss what is not in our control and focus on what we can best do with what is.
Be practical. Be prudent. Be dull to those watching you from the dance floor.
John Hussman signed off his latest report with the advice: “Risk dominates. Hold tight.” I agree. Now is the time act with the courage of our convictions.
As Kipling put it, at the end of his poem:
If you can force your heart and nerve and sinew
To serve your turn long after they are gone,
And so hold on when there is nothing in you
Except the Will which says to them: ‘Hold on!’
If you can talk with crowds and keep your virtue,
Or walk with Kings – nor lose the common touch,
If neither foes nor loving friends can hurt you,
If all men count with you, but none too much;
If you can fill the unforgiving minute
With sixty seconds’ worth of distance run,
Yours is the Earth and everything that’s in it,
And – which is more – you’ll be a Man, my son!
~ Adam Taggart
One of the men that won the Nobel Prize for economics this year says that “bubbles look like this” and that he is “most worried about the boom in the U.S. stock market.” But you don’t have to be a Nobel Prize winner to see what is happening. It should be glaringly apparent to anyone with half a brain. The financial markets have been soaring while the overall economy has been stagnating. Reckless injections of liquidity into the financial system by the Federal Reserve have pumped up stock prices to ridiculous extremes, and people are becoming concerned. In fact, Google searches for the term “stock bubble” are now at the highest level that we have seen since November 2007. Despite assurances from the mainstream media and the Federal Reserve that everything is just fine, many Americans are beginning to realize that we have seen this movie before. We saw it during the dotcom bubble, and we saw it during the lead up to the horrible financial crisis of 2008. So precisely when will the bubble burst this time? Nobody knows for sure, but without a doubt this irrational financial bubble will burst at some point. Remember, a bubble is always the biggest right before it bursts, and the following are 15 signs that we are near the peak of an absolutely massive stock market bubble…
#1 Bob Shiller, one of the winners of this year’s Nobel Prize for economics, says that “bubbles look like this” and that he is “most worried about the boom in the U.S. stock market.”
#2 The total amount of margin debt has risen by 50 percent since January 2012 and it is now at the highest level ever recorded. The last two times that margin debt skyrocketed like this were just before the bursting of the dotcom bubble in 2000 and just before the financial crisis of 2008. When this house of cards comes crashing down, things are going to get very messy…
“When the tablecloth gets pulled out from under the place settings, you’re going to have a lot of them crash and smash on the floor,” said Uri Landesman, president of Platinum Partners hedge fund. “That margin’s going to get pulled and everyone’s going to have to cover. That’s when you get really serious corrections.”
#3 Since the bottom of the market in 2009, the Dow has jumped 143 percent, the S&P 500 is up 165 percent and the Nasdaq has risen an astounding 213 percent. This does not reflect economic reality in any way, shape or form.
#4 Market research firm TrimTabs says that the S&P 500 is “very overpriced” right now.
#5 Marc Faber recently told CNBC that “we are in a gigantic speculative bubble”.
#6 In the United States, Google searches for the term “stock bubble” are at the highest level that we have seen since November 2007 – just before the last stock market crash.
#7 Price to earnings ratios are very high right now…
The Dow was trading at 17.8 times the past four quarters of earnings of its 30 components, according to The Wall Street Journal on Friday. That was up from 13.7 times its earnings a year ago. The S&P 500 is trading at 18.7 times earnings. The Nasdaq-100 Index is trading at 21.5 times earnings. At the very least, the ratios are signaling that stock prices are rich.
#8 According to CNBC, Pinterest is currently valued at more than 3 billion dollars even though it has never earned a profit.
#9 Twitter is a seven-year-old company that has never made a profit. It actually lost 64.6 million dollars last quarter. But according to the financial markets it is currently worth about 22 billion dollars.
#11 Howard Marks of Oaktree Capital recently stated that he believes that “markets are riskier than at any time since the depths of the 2008/9 crisis”.
#12 As Graham Summers recently noted, retail investors are buying stocks at a level not seen since the peak of the dotcom bubble back in 2000.
#13 David Stockman, a former director of the Office of Management and Budget under President Ronald Reagan, believes that this financial bubble is going to end very badly…
“We have a massive bubble everywhere, from Japan, to China, Europe, to the UK. As a result of this, I think world financial markets are extremely dangerous, unstable, and subject to serious trouble and dislocation in the future.”
#14 Bob Janjuah of Nomura Securities believes that there “could be a 25% to 50% sell off in global stock markets” over the next couple of years.
#15 According to Tyler Durden of Zero Hedge, the U.S. stock market is repeating a pattern that we have seen many times before. According to him, we are experiencing “a well-defined syndrome of ‘overvalued, overbought, overbullish, rising-yield’ conditions that has appeared exclusively at speculative market peaks – including (exhaustively) 1929, 1972, 1987, 2000, 2007, 2011 (before a market loss of nearly 20% that was truncated by investor faith in a new round of monetary easing), and at three points in 2013: February, May, and today.”
As I mentioned at the top of this article, this stock market bubble has been fueled by quantitative easing. Easy money from the Fed has been artificially inflating stock prices, and this has greatly benefited a very small percentage of the U.S. population. In fact, 82 percent of all individually held stocks are owned by the wealthiest 5 percent of all Americans.
When this stock market bubble does burst, those wealthy Americans are going to be in for a tremendous amount of pain.
But there are some people out there that argue that what we are witnessing is not a stock market bubble at all. That includes Janet Yellen, the new head of the Federal Reserve. Recently, she insistedthat there is absolutely nothing to be worried about…
“Stock prices have risen pretty robustly,” Yellen said. “But I think that if you look at traditional valuation measures, you would not see stock prices in territory that suggests bubble-like conditions.”
We shall see who was right and who was wrong. Let’s all file that one away and come back to it in a few years.
So where are stocks going next?
If you had the answer to that question, you could probably make a lot of money.
Yes, the current bubble could burst at any moment, or stocks could continue going up for a little while longer.
After all, the S&P 500 has risen in December about 80 percent of the time over the past thirty years.
Perhaps that will be the case this December as well.
Do you feel lucky?
Talking Real Money: World Monetary Reform
By Michael O’Brien
Today’s AM fix was USD 1,283.25, EUR 955.23 and GBP 801.53 per ounce.
Yesterday’s AM fix was USD 1,276.00, EUR 951.25 and GBP 798.75 per ounce.
Gold rose $4.40 or 0.35% yesterday, closing at $1,273.30/oz. Silver slipped $0.19 or 0.92% closing at $20.56. Platinum fell $5.55 or 0.4% to $1,424.20/oz, while palladium fell $9.50 or 1.3% to $727.97/oz.
Gold inched up again after Federal Reserve Chairman nominee Janet Yellen said the U.S. economy and labor market must improve before QE is reduced. This lifted confidence as silver prices recovered from their lowest levels since August. “The focus for the bullion market may shift to the upcoming testimony by Yellen,” James Steel, an analyst at HSBC, commented. “Chinese gold demand remains brisk. However, gold is likely to remain on the defensive in the near term”, wrote Steel.
The latest long term gold trend research from Nick Laird at ShareLynx indicates that the price of gold may rise in the near future. In the chart below, Nick references those periods from the past when it was prudent to buy and to sell. He also indicates that this particular period, November 2013, may be a prudent time to to buy. This chart reaffirms GoldCore’s long term outlook for the price of gold.
Long Term Gold Trend (www.sharelynx.com)
“Sometimes it’s not enough to know what things mean, sometimes you have to know what things don’t mean.” Bob Dylan
The Bank of England says the UK recovery has taken hold and Chancellor George Osborne is reported as saying “the report was proof the government’s economic plan was working.” The governor of the Bank of England, Mark Carney, said the bank will not ‘consider’ raising interest rates until the jobless figure falls below 7%.
However, The Bank of England threw a get-out-of-jail card on the table and said that there was a two-in-five chance of the unemployment rate reaching the 7% threshold by the end of 2014. And then added that the corresponding figures for the end of 2015 and 2016 are around three in five and two in three respectively. What exactly does the Bank of England mean or what does this not mean?
The financial crisis of 2007-2008 has sparked the most intense interest in international monetary reform since Richard Nixon closed the gold window at the New York Fed and devalued the U.S. dollar in 1971. Nixon’s action was widely seen at the time as presaging the end of the dollar-based world trade and financial system. On the face of it, this probably wasn’t an unreasonable expectation at the time. Within fewer than ten years, however, it was proven to be far off the mark. The dollar fell alright, but by the middle 1980s had recovered strongly.
In retrospect it is clear why the dollar sceptics were wrong. To begin with, the U.S. economy was still the world’s largest and the U.S. was still the leader of the “free world,” that is to say the world outside the communist bloc. The NATO countries of Western Europe were wholly dependent on the U.S. for security as well as for markets.
The same applied to Japan, South Korea and Taiwan, while the signatories of the secret UK/USA intelligence agreement (the U.S., UK, Canada, Australia and New Zealand) represented the Anglo core of the old British Empire, a group with no interest in seeing the dollar replaced. Communist Russia and China were in no position to register an opinion, much less offer an alternative. By default, the dollar soldiered on, thanks to the geopolitical realities of the time.
But what about today’s realities? Continue this fascinating story in our November edition of Insight – Talking real money: World Monetary Reform.
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5 Years After the Financial Crisis, The Big Banks Are Still Committing Massive Crimes | Washington’s Blog
- The Big Banksters At Work (infiniteunknown.net)
- Max Keiser and Greg Palast on Larry Summers and the Financial Crisis (jessescrossroadscafe.blogspot.com)
- What We Really Should be Yellin About When it Comes to Who Runs the Fed (correntewire.com)
- Jaw-Dropping Crimes of the Big Banks (ritholtz.com)
- Are Big Banks Criminal Enterprises? (ritholtz.com)
- 7 Things About Prosecuting Wall Street You Wanted to Know (But Were Too Depressed to Ask) (alternet.org)
- Five Years After Lehman Brothers Fall, Big Banks Even Larger Pt. 2 (therealnews.com)
- Wall Street Hijacks Yet Another Commodities Market (wallstreetpit.com)
- William K. Black: Bhide: Pick a ‘Boring’ Fed Chair Because Supervision Is the Key and It Requires ‘Dullness’ (huffingtonpost.com)