33 Days Away from a Potential Stock Market Collapse

12 October 2007.

That was the day the Dow Jones Industrial Average traded at a then all-time high of 14,093.08 points.

That was also the day the S&P 500 traded at a then all-time high of 1561.80.

But then, word got around that something inside markets was broken…

Four days after the two major US indices reached their hitherto all-time peak, China Daily reported:

The woes of the US housing market are dragging on longer than expected, and may lead to over one million foreclosure notices this year for homeowners, Treasury Secretary Henry Paulson said Tuesday.

Paulson, in a Washington speech, said the problems in housing represent “the most significant current risk” to the US economy and that policymakers and the private sector should mobilize to alleviate the pain and avert future crises.

“The ongoing housing correction is not ending as quickly as it might have appeared late last year,” Paulson said in remarks at Georgetown University Law Centre.

“And it now looks like it will continue to adversely impact our economy, our capital markets and many homeowners for some time yet. Even so, I believe we have a healthy, diversified economy that will continue to grow.”

What followed shortly after was the near catastrophic collapse of the world’s most important financial market. Over the next 18 months, the Dow Jones tumbled to an 11-year low of 6626.94. And the S&P 500 also fell to an 11-year low of 683.38. A decline of 52% and 56% respectively.

At the core of what we now call the US subprime crisis was the idea that US housing prices would always continue to rise.

Cheap credit allowed Americans to build and buy homes without adequate capital, which they could quickly ‘flip’ for profit. In some cases before the first mortgage payment was due. Of course, there was no actual cash in the homes, so when the subprime problems emerged, housing prices fell.

This week, Australian market research firm LF Economics published a report called ‘The Big Rort’ — a play on words on The Big Short, a movie about the subprime crisis. In the report, LF Economics attacked the Aussie housing market, writing:

The use of unrealised capital gain (equity) of one property to secure financing to purchase another property in Australia is extreme.

This approach allows lenders to report the cross-collateral security of one property, which is then uses as collateral against the total loan size to purchase another property. This approach substitutes as a cash deposits.

This has exacerbated risks in the housing market as little to no cash deposits are used.

Profitability is therefore predicated upon ever-rising housing prices.

‘…International wholesale lenders…may find out the hard way that they have invested into nothing more than a $1.7 trillion “piss in a fancy bottle scam.”

Bank-determined loan-to-value ratios for property are exacerbating the problem, says LF Economics. As is the ability of investors to use unrealised capital gains from one property to secure finance for another.

The timing of this report is intriguing: We are just a month away from when the US market began to fall as a result of their own highly leveraged property sector.

But attacking the highly leveraged property sector in Australia is nothing new.

Most Australians are well aware of the intensely leveraged property market. And for all we know, ‘The Big Rort’ could just be LF Economics putting out a report so that they’re able to say they saw the problem first.

But there is one person that disputes the idea of an Aussie housing market crash happening at all in the near future.

Based on my colleague’s analysis, a big US-style crumble in housing prices may be much further away than any of us think.

Real estate guru Phil Anderson, of Cycles, Trends and Forecasts, says the Aussie property market has longer to run. The way he sees it, the local property market is part of much bigger economic cycle.

This week in Markets & Money

Less than a week ago, my personal trainer asked me my professional opinion on Bitcoin. He’s 22, still lives at home, and wants to make some money…fast. Apparently, he has a mate that invested the equivalent of a first home buyer’s deposit into the cryptocurrency. In between bicep curls, this young man wanted to know if he should do the same.

My answer about any investment is always the same: Never put all your money into one asset class. Ever. That’s the quickest way to go broke.

With this said, I’m a fan of bitcoin.

On Monday, however, Vern Gowdie took a different view. Vern says any asset that’s risen 600% in 12 months reeks of a bubble. Asking readers if it was ‘bitCON’ and not bitcoin, Vern says the cryptocurrency doesn’t get his vote as the best place to park your dough. If you’d like to hear more, Vern explains here why you should stay away from digital money.

On Tuesday, resources editor Jason Stevenson talked about the ever-increasing political tensions around the world.

North Korea is successfully testing devastating bombs, and the US shows no signs of backing down from their sabre-rattling. In the past, I’ve called this metal the ‘true war metal’: As Jason explains here, nickel is the one investment that is likely to do very well as the world braces for conflict.

On Wednesday, Matt revealed that he had spent the better part of nine months researching a new way for investors to generate sizeable monthly returns. And he takes his inspiration from an unlikely place: Australia’s own sovereign wealth fund.

Few Aussies realise the best performing retirement fund in the country, consistently returning 7.8% per annum, only began 11 years ago. To discover the basic philosophy behind the Future Fund, click here.

On Thursday, Matt revealed how you can mimic this fund. The best part? It can be done with shares listed on the Australian Securities Exchange. Details here.

On Friday, Vern lifted the curtain on Australia’s positive second-quarter GDP results. The ABS cited strong employment growth and rising non-mining investment as contributing factors to the surprisingly good numbers. But when you account for how the ABS measures said growth, the figures leave a lot to be desired.

Work an hour last week? Congratulations. You’re now one of Australia’s 12-million-odd breadwinners. This is what qualifies as employment in Australia. And it’s what policymakers use to guide the economy.

What more evidence do you need to see why we’re in the mess we’re in?

Until next week.

Kind regards,

Shae Russell,
Editor, Markets & Money

Shae Russell started out in financial markets more than a decade ago. Working with a derivative brokering firm, she helped clients understand derivative markets, as well as teaching them the basics of technical analysis. Since joining Port Phillip Publishing eight years ago, Shae has worked across a number of publications. She holds the record for the highest-returning stock recommendation, in which a microcap stock returned over 1,200% in six months. Ask her about it, and she won’t stop yapping on. For the past two years, Shae has worked alongside Jim Rickards as his Australian analyst, translating global macro trends for Aussie investors, and how they can take advantage of these trends. Drawing on her extensive experience, Shae is the lead editor of Markets & Money. Each day, Shae looks at broad macro trends developing around the world, combining them with her distaste for central banks and irrational love of all things bullion.

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