Share Market to be Hit By a Pile Driver

The action on the Australian share market at present reminds me of ‘whack-a-mole’.

Every time the All Ords sticks it head up above 5000 points…whack. Down it goes again.

The whack comes from the fact that there isn’t any real good news out there. And if there is a flicker of hope, it’s not enough to take markets to a higher level permanently.

The Great Credit Contraction just keeps on crushing in on all sides.

Not that long ago we were told that a falling oil price would mean a boost to the economy — savings at the bowser would be spent elsewhere. Personally I never bought this argument.  Unless there’s an increase in income, then all that happens is a spending redistribution — the petrol station gets a bit less and a retailer gets a bit more…it’s still a zero sum game without an increase in income.

Putting the mainstream bogus economic argument to one side, what a low oil price is really exposing is the solvency of deeply indebted oil producers. Investors are nervously watching the cashflow distress in this sector. Credit defaults are a comin’.

You’d think low oil prices would help the transportation sector. Not so. Container ship companies bemoan that business conditions are worse than in 2008. There are too many ships and not enough cargo.

Miners are falling like nine pins and those that are still upright report some very sad profit numbers.

In January, US manufacturing experienced its fourth month of contraction.

The US seasonally adjusted (which is code for ‘statistically doctored’) employment data bears no relation to what’s really happening in the real economy — lots of part-time service sector employment replacing high paid full time resource jobs.

On the employment front in Australia, the ABS’s latest release tell us wages are failing to keep pace with inflation. Real buying power is going backwards.

Yet, that doesn’t seem to be an impediment to borrowing and keeping the great Australian dream alive. Our love affair with all things property has earned us the hour of being one of the most indebted household sectors on the entire planet. Did I hear anyone say ‘housing bubble’?

Wouldn’t a busting housing market just be the icing on the government’s cake? Resources down the drain, followed by housing, followed by more boomer retirees joining the age pension queue. Little wonder Scott Morrison has lost his mojo lately and looks 10 years older. He’s between a boulder and a really hard place…and both are moving inwards.

The Chinese market looks good for a few days and then it too gets whacked.

On Thursday the Shanghai Composite Index fell 6.4%…taking that market back to a level first reached nine years ago.

At long last even blind Freddy can see the so-called China miracle is over.

Borrow truckloads of money for long enough and your neighbours will also think you’re a miracle. Bernie Madoff got away with this illusion for years.

In spite of this dawning reality, China refuses to alter course. The Chinese appear determined to borrow their way to prosperity.

In 2011, the Chinese Government invented the term Total Social Financing (TSF) to measure how much debt non-state entities (individuals and private companies) were taking on.

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In January 2016, the TSF registered loans totalling US$521.5 billion…a record number.

Where on earth is this money going to?

A week ago the Wall Street Journal wrote this:

Beyond the glut of steel and apartments that weighed down growth in recent years, Chinas economy is also saturated with surplus goods from farms and factories. Numerous small and midsize cities such as Suizhou, which boomed on easy credit and government support for agribusiness and construction, were supposed to provide the second wave in Chinas growth story. Instead they are now sputtering, wearing down prices, profits and job opportunities.

China has too much of everything — apartments, shopping centres, factories — yet they still borrow more…in record amounts.

With this level of over-supply and indebtedness, deflation is coming. China is going to export its little socks off.

If we leave China and go across the Sea of Japan, we get an insight into the world that most accurately reflects what awaits us.

Three years ago, Abenomics was going to revive Japan’s economic woes. Inflation of 2% was only a few trillion newly minted yen away.

Abenomics is yet another abject failure in a long, long line of disastrous stimulus policy decisions.

But not to be deterred, the Bank of Japan joins Europe in a walk into the negative side.

The Nikkei (Japan’s share market) loved the idea for a day or two, but it too has succumb to the reality of Japan’s situation…it’s stuffed.

The Wall Street Journal reported that even some on the inside think negative rates show too much desperation:

A clash Thursday between Japans central-bank chief and lawmakers highlighted the downside of negative interest rates: They are making the Japanese public feel negative. Bank of Japan Gov. Haruhiko Kuroda, who announced the nations first move into minus rates three weeks ago, found himself dodging a concerted attack in Parliament from lawmakers who charged the policy was victimizing consumers and sending a message of despair. Even a ruling-party member, Masahiro Ishida, called the policy hard to grasp. “It could have the opposite effect of confusing the market,” he said. The criticism has come as a surprise to central-bank officials who thought their efforts to spark lending and faster economic growth would gain more public support.

Central banks are running out of tricks. People are just not buying the hocus-pocus anymore.

In the end, money talks much louder than Central Banker BS.

The reality is starting to set in.

Investors are beginning to feel the pain. And they’re wondering if there’s more to come.

In February last year, after the RBA cut rates to 2.25%, all the analysts were saying how dumb it was to be holding cash. And it was even dumber a few months later when rates were cut to 2%.

The message was ‘be smart and get into higher yielding shares’.

A year later the share market has lost 15% of its value and dividends are being frozen or reduced.

In my simple (dumb) world, I always figured that 100% of my capital earning 2% was a heck of a lot better than say 75% earning 5%.

The spruikers’ one dimensional focus on income completely ignored the risk posed to capital.

My long held risk assessment question has always been; what cost is attached to that extra few percent of income?

Investors, the world over, who chased yield are starting to find out what the answer to that question might be.

For example, the Commonwealth Bank [ASX:CBA] raised $2.6 billion in October 2014 (PERLS VII) by offering a return of 2.8% above a three month bank bill swap rate.

The offer was priced at $100. It’s now trading around $87…a 13% loss. Why? Because in this world of growing nervousness, risk has been repriced.

The latest CBA PERLS offering is paying 5.2% above the swap rate and hybrids from other banks are paying closer to a 6% margin.

The reassessment of risk we are witnessing is only the start of what’s to come.

When all the deflationary forces at play globally start to increase in intensity — credit defaults, bank failures, corporate and personal bankruptcies, property bubble bursting, government expenditure cuts — the losses are going to be beyond what most people thought could possibly happen.

The signs are all there. Take heed.

At present the market is being hit with a padded whack-a-mole hammer. When the real action starts it is going to be replaced with a pile driver.


Vern Gowdie

Editor, Markets and Money

Editor’s Note: If you haven’t been on to our Facebook or YouTube page recently you have missed out on a series of short video updates from our publisher, Kris Sayce. The latest video is a blooper reel from the last few months. You can watch it here.

Vern Gowdie has been involved in financial planning since 1986. In 1999, Personal Investor magazine ranked Vern as one of Australia’s Top 50 financial planners. His previous firm, Gowdie Financial Planning was recognized in 2004, 2005, 2006 & 2007, by Independent Financial Adviser (IFA) magazine as one of the top five financial planning firms in Australia. He has been writing his 'Big Picture' column for regional newspapers since 2005 and has been a commentator on financial matters for Prime Radio talkback. His contrarian views often place him at odds with the financial planning profession. Vern is is Founder and Chairman of the Gowdie Family Wealth advisory service, a monthly newsletter with a clear aim: to help you build and protect wealth for future generations of your family. He is also editor of The Gowdie Letter, which aims to help you protect and grow your wealth during the great credit contraction. To have Vern’s enlightening market critique and commentary delivered straight to your inbox, take out a free subscription to Markets and Money here. Official websites and financial eletters Vern writes for:

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