Has there been a better time in the past two years to liquidate your entire share portfolio?
We’ll get back to that question in a moment. It’s probably a good time to raise the issue, though, because the stock market’s performance in the last six months is the best in two decades. If you want to sell at the top, this might be your best chance for a while.
“The median local share fund surged 39.5 per cent last year, outperforming the 37.6 per cent rally recorded by the S&P/ASX 300 Index in calendar 2009, according to figures compiled by Mercer, an investment consultant,” reports Eric Johnston in today’s Age. But why would you sell just when things are getting good?
Well, when things can’t get any better, they usually don’t. Of course the S&P ASX/200 could make a new high. That would be better. For the record, the index is still over 25% below its October 2007 high. A rally from these levels to a new high would be a 38% move.
Put on your Imagineering cap for a moment and figure out how to get an index that much higher from its current level. As the two charts below from the RBA’s latest chart pack show, stocks are already expensive based on historic price-to-earnings ratio AND the average dividend yield on Aussies stocks as returned to pre-crisis levels.
The average P/E on Aussie stocks is now around 23. That’s nearly as high as it was 1991. There are two ways for the P/E ratio to down. Earnings can rise or prices can fall. We stepped into the way back machine and asked Murray what happened in the Australian market back in the early 1990s. The answer was: a post-recession rebound in earnings (off a low base) which the market priced in, racing ahead massively for the next two years.
So is that possible now? Is the P/E ratio blowing out because we’re at the bottom of the earnings cycle or the top of the price cycle? And normally, stocks give their best value when yields are high. High yields indicate you actually have to pay investors to own stocks, given their risk. Yields now are hardly compensation for the risk we think you’re taking on.
That doesn’t rule out new highs this year, though. Stranger things have happened. With China-based euphoria in its early stages, a blow out in commodity exports coupled with higher resource prices (on a sinking U.S. dollar) could catapult the indices into the stratosphere.
But here is our suggestion: liquidate your portfolios into the market strength. This period in the market – the confident but shallow recovery in stock prices following a terrifying drop – reminds us exactly of August and September of 2007. The market did in fact go on to make a new high in October of 2007. But that two month period between the August low and the October high was the perfect place to exit the market into strength.
Writing in Diggers and Drillers at the time, we said: “I’m putting a sell recommendation on all of our North American shares…The fallout from the credit bubble could wipe out many years of gains in solid resource stocks. The way to prevent that is to take profits now and use the cash to rebuild a portfolio for the new financial reality we’re entering.”
Of course we didn’t liquidate everything. That 2007 strategy was based on the U.S. dollar being a major casualty of the credit depression. Even if the market had moved up, the move down in the dollar would have crushed your currency-adjusted returns as an Aussie investor. We stayed in a handful of Aussie resource positions, which much to our disappointment, were equally crushed by the deflating bubble in global stock markets.
Today feels a lot like then. The psychological similarities are obvious. Of course this could be a weakness, analysing the current scenario in terms of a highly unpleasant and fearful situation that’s front in centre in the mind. It’s possible we’re thinking too much about the past and not enough about future earnings.
But when it comes to earnings, the massive recovery (in year over year terms) has already happened. The stimulus helped a bit. And the 2008 base flattered 2009 earnings, which the stock market duly priced in. Our sense is that your best strategy now is to reduce the percentage of your assets allocated to shares. You can do so now by selling into a rising market.
How much longer it will rise is anyone’s guess. But the fundamental momentum, that seems tapped out. And more importantly, the rally in markets has been rigged by a money-printing scheme generated on Wall Street and in Washington. You’ve got a looming sovereign debt crisis in Greece and real, immediate problems in how the U.S. plans to finance its deficit. It’s a financial minefield out there. Step lightly.
While some of these currency events ought to be bullish for the Australian dollar, we reckon they will lead to a spike in volatility and a huge aversion to risk. Like it or not, Aussie equities are treated as emerging market equities by international investors. We’ve seen how quickly capital flows into Aussie stocks can reverse in the past. If and when it happens again, the retesting of the 2003 lows could happen a lot quicker than you think.
Seem impossible? Well, it’s true that the Aussie market is also rigged to rise. Compulsory super plus a compulsory allocation in Aussie equities by Super Funds means there’s always money flowing into Aussie stocks. The “weight of money” argument says they have to go up with so much mandatory liquidity.
But even in a bath tub, liquidity is a two way street. Super funds can take your money and buy stocks, bidding them up. But if value disappears down the drain even faster, your money disappears in a nice little whirlpool. This is the downside of compulsory super: you are compelled to support a scheme in which everyone else gets paid regardless of performance and you take all the risk.
So that is today’s big revelation in today’s Markets and Money: retire now! Today is that rainy day.
Investors have been led to think that there is always some asset class or equity sector where your money will do better both absolutely and relatively. But we’d suggest now is a good time to consider liquidating a portion of your financial assets and exchange them for practical, useful things you’ll need in your retirement.
Yes, part of this is based on our bearish position on paper (fiat) money. Paradoxically, we’d suggest a higher allocation to cash simply because of its utility. Cash gets smashed in an inflation. It’s arguable you’re better off in stocks if inflation runs rampant. But we reckon having liquid assets will be highly desirable in the coming 24 months.
On the tangible side, there is gold, other precious metals, and real estate (land you want to own, not house price speculation). And we would maintain a portfolio of resource and conventional and unconventional energy companies. You can consider these call options on scarcity and a crashing U.S. dollar.
New companies emerge in disruptive times to make a fortune. And in the energy space, oil and gas are scarcity bets, while alternatives like coal-seam-gas or “tight gas” from shale-bearing rock formations give you the leverage that only small stocks and resource stocks have.
Those are what we think Nasim Taleb would call the good kind of “Black Swan” – namely a low probability but high magnitude event. The thing doesn’t happen often…but when it does happen, it’s very good and usually very bullish for stock prices. You want to own a portfolio of positive Black Swans, or a flock, if you prefer.
Are we being overly fearful ? Nope. The writing is on the wall for retirement assets held in conventional ways. A report last week in Business Week shows that the U.S. Feds have 401(k) assets in their sites. Now ostensibly, the plan to offer an annuity option for 401(k) plans will seem sensible. But don’t be fooled.
This is the beginning of a money grab by the Feds for the $3.6 trillion in assets held by U.S. 401(k)s. The Feds need that money to finance the deficit. This is where some of the money to fund the deficits may come from, answering a question we asked earlier in the week. What you can’t take, you’ll have to print.
But right now, the Feds can’t just take that 401(k) money. Well, they could. But it would crash stocks and infuriate the public, leading to some civic violence. What’s more, it would feel like theft as well as looking (and being) like it. So they have to dress the plan up as something that’s better for savers.
They’re trotting out the idea that a defined benefit pension plan is better than defined contribution plan (which is true, if it’s funded well). A defined benefit plan guarantees you income in your old age years. A defined contribution plan (what we have now) just guarantees money flows into the stock market (which is good for the financial services industry, but don’t guarantee you’ll have any money when you really need it later in life).
The U.S. Treasury Department and the Obama administration are exploring ways to encourage U.S. savers to buy more annuities or investment vehicles composed of “safe” assets. What constitutes safe? Why 30-year U.S. government bonds of course! Thus, the government can encourage people to buy what the Chinese and the Japanese and most other U.S. creditors don’t want to touch any longer.
The trouble with an annuity or 30-year bond is that you get crushed by inflation. In principle, it’s not different that a zero coupon bond. You get your nominal investment back upon redemption. But you are not compensated for inflation and your money is tied up, instead of working harder for you elsewhere.
It’s obvious what the Fed’s get out of this: a ready source of new funds to buy their bonds. This kicks the can of unsustainable deficit spending down the road a few months, or perhaps a few years. But it doesn’t change the fundamentally destructive path of U.S. fiscal policy.
What it does tell you is that mischief is afoot among the wealth stealers of the modern nation state. Faced with a failed funding model, they are beginning their cash grab. This takes the form of higher taxes. But the big bounty is the retirement savings of millions of Americans…and Australians.
Yes, it could happen here too. How long before Super Funds are compelled to buy Aussie debt because it’s “safe?” This solves the problem of having to sell the debt to foreign investors. And it solves the problem of having to make tough budget deficits. Just issue more debt and make the super funds buy it with your money.
If you think that’s balderdash or won’t happen, you’re being naïve. It won’t happen overnight. But it will happen gradually. It’s evolving towards that already. If they can’t get it through tax or royalty revenues, the tax posse will get it by any means necessary, which means your super assets are an obvious target.
Alarmist? Irresponsible? You decide. But we can see the evolution of this as clear as day, even if saying it in public is bad form or taboo. But now is the time to say the taboo things.
That’s why we’ve been working with our colleague Jim Davidson to re-launch his visionary newsletter, Strategic Investment. For twenty years, Jim railed against the dangers of the credit cycle and deficit spending and bad public policy. And by his own admission, it was a giant waste of time.
We visited Bill Bonner in France in September and agreed Jim’s big-picture macro and historical analysis would be an extremely valuable investment tool right now. So even though we’re in Australia and he travels between Brazil and the United States, we agreed to partner up and publish his new version of Strategic Investment.
And we’re glad we did. Reading the draft of his latest report we came across the following observation yesterday. We don’t mind giving you a peek into the January report yet, even thought it hasn’t been published. It’s a critical point that bears on today’s reckoning.
Jim, writing about the possibility of a sudden breakdown in U.S. finances, writes, ” I pause to acknowledge that the threat of collapse is a taboo thought. It trespasses one of the most cherished civic conventions of Americans, namely the view that the United States is a blessed country immune from the dire consequences of irresponsible policies that bring ruin elsewhere. Of course, as a literal proposition, this is preposterous.”
“I certainly would not wish to rely upon it for my future and the security of my family. Would you? I ask this rhetorical question, knowing that most Americans will refuse to bring themselves to prepare for a fiscal crisis of the welfare state until it is too late.”
“As you think about it, bear in mind that you cannot depend on the investment establishment, politicians and the news media to give you an advanced warning of the advent of the dire second and deeper stage of the credit cycle unwinding. They did not warn you about the subprime crisis and the first stage of collapse. You can count on them to be equally oblivious now. If anyone will help you prepare for what may lie ahead, it will have to be you.”
Whether the second and dire stage of the credit cycle is upon us just now is, of course, exactly the matter at issue. With the market rising and the sun shining, it doesn’t feel like we’re reaching a critical stage. But it didn’t feel like that in September of 2007 either, and that turned out to be your last best chance to sell before the crash.
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