There has been a constant stream of bad news over the past few months. You’d think the financial markets would have taken a beating. But no moves emerged. It’s been smooth sailing. And strange, to say the least.
When you consider how bad things really are, the headlines seem boring. A possible shutdown of the US government over budget disagreements is pathetic compared to the complete fiscal crisis it faces, which is now within ‘spitting distance‘. How far you have to spit isn’t clear.
Chinese lending-rate increases are paltry when you look into how much real estate in China is uninhabited. Even without a price crash, the growth can’t continue indefinitely. But it continues, for now.
And Portugal’s request for a bailout is petty cash for those waiting for Spain to fall. Each time a nation collapses, banks and the EU quiver. The EU is listing. But will it sink?
Few look behind the headlines. So the world muddles on. For now.
How will it end?
If you know it will end badly, do you really have to know how? Shorting everything probably isn’t a great way to put your money where your mind is.
That’s why part of a healthy contrarian attitude is believing there are bull markets out there somewhere. Dan made predictions on what some of them might be in his best-selling book The Bull Hunter, of which there are a lot of copies floating around the office.
But where should you look now? It seems everything is too intertwined. What can an investor invest in without getting caught up in broader market turmoil? Perhaps a better way of putting it is ‘where can an investor hide their assets?’
One strategy is to chase high-risk big winners with small allocations of capital over a short timeframe. Our very own Kris Sayce does this at the Australian Smallcap Investigator, where he picks stocks he believes will jump in three-digit increments. It’s lots of fun, but high risk.
Burying precious metals in your garden is the polar-opposite strategy. It’s proved no less successful though – on a risk-adjusted basis.
So perhaps a combination of the two is in order. The low risk and the high risk. Avoiding the in-between is the point we’re trying to make. It’s the establishment that will get hurt when the structural issues of the financial system begin to take hold. Holding vast portfolios of diversified stocks is asking for trouble. There are too many people willing to sell and not enough left to buy. It’s the same for bonds.
The baby-boomers’ boom has run its course. They invested in assets that will have to be sold en masse for retirement. And they indebted future taxpayers who are supposed to provide the buying support for those assets.
So even the best investors could get burnt if they find themselves in the wrong place at the wrong time. Capital and Crisis editor Chris Mayer elaborates on how:
Dear Capital & Crisis Reader,
Let me tell you the story of Timothy Bancroft. It’s a good one, and if you haven’t heard it, I think you’ll like it.
Bancroft was a smart and shrewd investor. He dodged the Panic of 1857, which he said was due to “easy money policies” and “overconfident speculation in the railroads and farmlands of the Western states.”
Instead, Bancroft said you should “buy good securities, put them away and forget them.” He thought the best investments were those “dealing in essential commodities that the Union and the world will always need in great quantities.”
When Bancroft died, he left an estate of $1.3 million. As Adam Smith (George Goodman) points out in his The Money Game — from which this tale comes — “If you remember that those are untaxed mid-19th-century dollars, and that a full eight-course meal at Delmonico’s cost less than a dollar at the time, that is quite a fortune.”
What did Bancroft own? He owned good stuff from the earth. He owned Southern Zinc and Gold Belt Mining. Hard assets. (Although he did own a couple of questionable things that, I am sure, seemed like good ideas at the time, like American Alarm Clock.)
Sounds smart, right?
It wasn’t. And here is where Bancroft erred.
He made it so his heirs couldn’t touch that portfolio for a time, because he wanted them to hold onto these investments. By the time they could access the estate, it was worthless. Zero. Zip. Nada.
Bancroft’s tale reminds us that nothing is a good idea all the time.
As a Markets and Money reader, you know what time it is – time up. Be the first to cash out and recognise the game is up. Don’t commit to long-term mainstream investments. Don’t get caught in the crowd and stuck in the middle. Look where others haven’t been looking.
Will the Fed raise rates?
Reuters ran an article on why the Fed won’t raise rates: ‘Seven reasons why the Fed won’t follow the ECB’, it’s called. Some of the reasons are absolutely hilarious:
- There is no party to take away the punchbowl from
With corporate profits soaring and at remarkable heights, for some industries anyway, there is certainly a party to ruin. Banks have been borrowing for negative real rates, meaning they can’t help but make money. The Fed could start there.
- ‘The Fed’s inflation-fighting credibility is considered iron-clad’
This is enough to make you fall of your chair. If inflation rose to the point that it required higher rates to reign it in, the interest bill on the US government’s debt would swallow its revenues whole. The genie cannot be let out of the bottle… but it already has. Meaningful rate rises are out of the question.
- ‘The ECB has a single mandate to fight inflation. The Fed has two goals, price stability and full employment.’
Employment isn’t terribly great if you can’t buy anything with your income. And with huge unemployment, wages won’t be going anywhere fast. But all that QE money has to go somewhere, so prices will rise.
- ‘ECB officials focus on headline inflation, which covers all prices. U.S. officials focus on underlying “core” inflation, which strips out volatile goods like gasoline and food.’
Oil and food happen to be great places to park your borrowed money if you are a banker. With lending from the Fed at 0.25% interest p.a. and inflation at 1.6%, according to the lowest measure, you have quite a margin. That’s the irony in blaming speculators for higher prices. The speculators are being funded by the very people doing the blaming! As always, it’s worth pointing out that Americans spend a lot on food and gasoline, so excluding them is just ridiculous in the first place.
Many believe QE3 is already factored into the market. Those that disagree probably don’t doubt the Fed will come to the rescue with QE3 if needed. But what if inflation picks up too much and the Fed is forced to raise rates?
This is where the inflationists have two aces up their collective sleeve. Firstly, it would be quite unlikely for the Fed to raise rates faster than inflation accelerates. If it does so any slower, it would still be stimulating the economy and not slowing it. Real rates would still be falling. (That’s why the rate rises leading up to 2007 didn’t slow the bubble.) So even rate increases probably won’t be real rate increases.
Secondly, higher rates put the squeeze on government budgets, as mentioned above. This is something Bernanke won’t do to his employer. Certainly not at rates that turn real interest rates higher.
So for every downturn there is a QE. And for every price increase there won’t be a true tightening. Inflation it is.
For Markets and Money Australia