Because Investing In a Bubble Worked Well Last Time

Japan’s Nikkei index is in a bear market. Stock markets across the world are sagging. Australia’s indices are tumbling faster than most.

But you needn’t worry about the world’s stock markets. The central banks will lower interest rates if anything bad happens. If they can’t go any lower, money printing will save the day. Stocks can only go up from here.

Sound familiar? How well does this kind of thinking work out for investors?

Fund manager John Hussman has the startling facts: ‘… the last two 50% market declines – both the 2001-2002 plunge and the 2008-2009 plunge – occurred in environments of aggressive, persistent Federal Reserve easing.’

You mean central bank intervention causes market instability? The kind of instability that causes a crash? No way, what a surprise!

Not only that, but central bank intervention makes the crash even worse when it does come, as Hussman’s research shows:

‘… the maximum drawdown of the S&P 500, confined to periods of favorable monetary conditions since 1940, would have been a 55% loss. This compares with a 33% loss during unfavourable monetary conditions. This is worth repeating – favourable monetary conditions were associated with far deeper drawdowns.’

That’s how things shape up in the stock market. In the property market, things are even more extreme.

Leading up to 2008, people in Europe and the US borrowed ridiculous sums of money under the assumption that house prices always rose and interest rates would fall if there was any trouble. Combine the two and you got an epic housing bubble. One that burst, leaving the entire global economy teetering on the edge.

Yes, ladies and gentleman, investing your money in risky assets because ‘the central banks of the world will save you’ is downright dangerous. Probably for your health as well as your wealth. The central bankers of the world don’t got your back.

In fact, in a recent speech to Princeton graduates, Ben Bernanke finished off with the words ‘give em hell’. And that’s exactly what he’s doing in his professional life – giving you hell.

And hell comes with hellish decisions. When interest rates are low and falling, inflation higher and gnawing, and the stock market is off and soaring, what do you do?

You can a) stay in cash and bonds, watching your wealth wither away slowly, or b) invest in stocks and hope you pull out before another crash shreds your wealth to pieces.

Are you smart enough to call the top of the market? If not, sticking with option a might be a better choice. But it’s still not very good, is it? And do you have the belief and patience to sit out a rally like we’ve seen?

How to Invest in Bubbles

If you want to invest in bubbles, you’ve got to be there from the beginning. Even though the Nikkei is down more than 20%, it’s still up impressively since policy makers embarked on their money printing experiment.

You also need a plan for selling out. You might decide on predetermined ‘targets’ to sell at. Or maybe you could sell out gradually, or steadily raise your stop losses as prices rise (a trailing stop loss). Without safety triggers like these, investing in a bubble is just too dangerous.

Turning a winning position into a big loss is very painful. One Chinese immigrant to the US recently attempted to commit suicide in public in New York after making a million bucks on the stock market and then losing it. (He blames the American tax office, but doesn’t everyone?)

Newsletter writer John Mauldin often prays for an opportunity to profit from a bubble: ‘Dear God, please let me invest at the beginning of a bubble for once in my life,‘ he said in a speech we were at once.

But of all the people who do manage to pile into the investments that soar, how many pull out at the right time? How many pull out in time to avoid ending up with a loss? Plenty of fortunes have been made in the stock market. Almost as many have been lost, we’ll bet.

So what’s option c)? Where do you put your money?

Surprisingly, there are plenty of decent answers. As long as you have a strategy that doesn’t rely on the broader stock market going up, you might be onto something.

There’s Always a Bull Market Somewhere

That’s the motto of Dan Denning’s book The Bull Hunter. Unsold copies get used as a computer stands around the office these days. But that also puts the content under the nose of all the editors in the office. And opening it up will remind you that all you have to do is find the bull market.

So where is one now? In technology – not Apple, Google or GE, but small companies that are working on the innovations which seem outrageous. Like reversing ageing, hypersonic travel, asteroid mining, personalising medicine and much more.

A few months ago, a company revealed a ring with which you can control the appliances in your house with hand gestures. Today, we read another company has done away with the ring altogether.

You just wave your hand in a certain way to turn on lights, change the volume on your stereo and change the channel on the TV. Now that’s progress.

Port Phillip Publishing is onto the technology trend. A new newsletter is being polished right now for your viewing pleasure. More details on that soon…

Not that piling all your wealth into tech stocks is a great idea. It’s still risky. That’s what drives the returns, after all.  But for all the hundreds of tech companies that went bust during the tech boom, Amazon is up 17,755% since 1997. So if you made a total loss in 99 companies and picked Amazon as your 100th, you would be laughing.

And you’ll need some cheering up given what’s coming down the stock markets’ road. Central bankers’ focus on goosing stock markets to improve the world’s net wealth is now holding them for ransom.

As the Federal Reserve’s Richard Fisher recently said, ‘we cannot live in fear that gee whiz the market is going to be unhappy that we are not giving them more monetary cocaine.’ The world’s investors are living in that very fear.

Nickolai Hubble.
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Having gained degrees in Finance, Economics and Law from the prestigious Bond University, Nick completed an internship at probably the most famous investment bank in the world, where he discovered what the financial world was really like.

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