Weekly Article 11-01-2018
There are many signs that the latest pullback in the US stock markets may not be the big pullback that I am expecting. I say that because someone or some entity is keeping the bond market in check and that is positive for stocks. In addition to that, many companies who were reporting earnings were not allowed to buy their own stocks back for a period of time. According to Deutsche Bank during the first few weeks of October, particularly between October 5-26, as many as 80% of companies that may be buying back their own shares were prohibited from doing so. As the rest of the year plays out those who are barred from buying back their own stock will be reduced throughout the year.
This says two things to me. Number one is that part of what may have caused some of October’s weakness may be alleviated in November. Number two it shows me how fragile this market is. If I look at the REAL purchasers in this market- (Central Banks, Sovereign Wealth Funds, Hedge Funds, Programmed Traders, ETFs- and corporate buybacks) it becomes clear that everyone has to be all-in or the type of action we have previously seen could be the norm rather than the exception.
The market action is, in my opinion, FAR from healthy even though there is a massive amount of “money” being created throughout the world- out of nowhere- and being deployed mainly into bond and stock markets globally. This distorts all prices so that the “market” has no idea of the value of virtually ANY asset. That makes it tough to determine what may be over-valued or under-valued.
However, let’s take a look at why we may be close to the cliff I am expecting.
2018 started off with a substantial gain, particularly in US stock markets. Between the January highs and June, according to Bloomberg, world stock markets LOST $10 Trillion in value. The summer was spent with markets here in the US rallying and to a lesser extent around the world. Another high was made in August basically recovering part of the $10 trillion and, since then another $8 trillion in market cap has been lost. It has been quite a roller-coaster ride. This is far more typical in a bear market than a bull market. Buyer beware!
I would not just brush aside the weakness around the globe. Generally when trouble starts it starts with the weakest links and progresses to the stronger hands also. I believe it pays to keep an eye on high-yield spreads (some of the weakest links in the bond world) also.
The US dollar has been strong against other fiat currencies this year and has led to major problems particularly for emerging market economies. As the dollar strengthens and with around $250 trillion in global debt- much of it based in US dollars- debt loads become more cumbersome with no additional income or economic activity to pay for the increased debt burden. It appears the weakest hands are showing serious signs of stress already.
I have written in the past about good debt- a debt that is used for a productive purpose and generally has a cash flow to ultimately retire the debt. Bad debt- generally a debt that provides little value and has no means of being paid off with any economic activity that it may create- like handouts that provide immediate stimulus but then the debt remains with no cash flow to repay. I wonder how much of that $250 trillion in debt has already been handed out, spent and all that’s left is the debt?
It appears to me that this is a result of our needing to borrow far more than we have in the past to keep up the illusion of normalcy in our economy and government. In other words, we are borrowing so much it is crowding out others and leading to a shortage of dollar liquidity and driving the price of our dollar higher. I also have to wonder how much of this new debt we are taking on is of the handout variety.
Many may ask why I am still bullish on emerging markets. The answer is rather simple. If the US doesn’t do something about the dollar’s strength I believe the rest of the world will. I have written many articles about China, Russia, India, Brazil, South Africa and others who want to trade sans dollars. We are now seeing MANY others join the chorus including Iran, the EU, Africa in general, Venezuela, etc.
It is a matter of time before the dollar returns to its intrinsic value of – probably not much.
This leads me to a final point that gold appears to be coming off the lows reached over the summer and it has outperformed equities substantially in October. The gold/silver ratio (meaning how many ounces of silver to buy one ounce of gold) is at historical highs. In the past, this has been a sign that these assets are mispriced. In 1792 the US put a price for silver at 15:1 meaning you needed 15 ounces of silver to buy one ounce of gold. Without fiat currencies this would likely be the most accurate price. The historical average in the 1900s was 47:1. Currently, at 84:1 it is off the charts and this has typically led not only to silver’s outperformance of gold in the short term but also rising prices for both.
Anyone who is concerned that rising interest rates will stall a rise in gold consider that during the time our rates were raised from 6% in 1971 to over 15% in 1980* gold rose from $35.00 per ounce to over $800.00 per ounce. It didn’t have a yield then either. To me, the gold holding is an asset that moves generally in a different direction from paper assets and really shines when there is uncertainty and chaos in the world. It appears to me that uncertainty and chaos are coming at us like a freight train and it is coming from all directions- economically, socially, politically, geopolitically, etc.
If I am right and stocks, bonds and real estate are being artificially propped up with money from nowhere and gold and silver are also being artificially suppressed in the same way then by definition gold and silver are artificially cheap and stocks, bonds and real estate are artificially expensive. How can I tell?
As interest rates are rising home sales, car sales and most sales are falling. This means that these things were too expensive for most people to start with but with cheap credit it appeared to be plausible. As the cost of credit rises affordability recedes. Remember, they can “print” money but they “print” it for themselves. People’s incomes have not come anywhere near to keeping up with inflation- particularly in homes, cars, education, taxes, etc.
Without money from nowhere stocks, bonds and real estate could likely never gotten so far out of hand as they are today. I also believe that without paper trading at the COMEX gold and silver- with real price discovery would be multiples higher than they are trading at now. Of course, those with the cash (and in my opinion also the brains) like many countries, major banks and central banks are taking advantage of the cheap prices and loading up in unprecedented amounts.
As I said before, with price signals being suppressed by entities “printing” money and buying assets it is hard to tell what is expensive and what is cheap- and most people buy high because of euphoria or a fear of missing out and sell low when they panic in a pullback. However, in seeing what has been going on with central banks buying all sorts of assets and watching first hand the price suppression of metals to, in my opinion, to mask the damage being done to fiat currencies by all of the “printing” and credit creation, it is apparent to me that when they go too far (they already have but when people realize they have gone too far) and this illusion ends those who have something other than those paper assets will likely wish they had more real stuff and less of someone else’s promise to pay.
Mike Savage, ChFC, Financial Advisor
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