Weekly Article 06-19-2018
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In a statement that hit me like a ton of bricks someone said “The trading machines know the price of everything and the value of nothing”. As Warren Buffett says “Price is what you pay, value is what you get”. Mr. Buffett also says “when the tide goes out you find out who’s been swimming naked”.
Why are these statements so important today? Because, as I have been saying for years, this system of HFT (high frequency trading) and algorithms can only work as asset prices are rising. It appears to me, as I have observed over the past few years as the passive investing craze has taken off, that it is not hard to find someone to pay a higher price as prices are overall rising. The machines themselves appear to push the prices higher as higher prices lead to higher future expectations and more buying.
On the other side of the equation, however, is when the market is overall declining or certain stocks are declining it can lead to more machine selling, lower future expectations and further machine selling.
This appeared to happen a few months ago when the DOW dropped 1000 points in minutes and after being down 1600 points one minute was “only” down 1100 points a minute later which led to even Jim Cramer saying “this isn’t real”. At that moment an entity (most likely a central bank) stepped in to turn the tide. I say that because while I have no proof it was a central bank there are few- if any other entities- that could have that type of an impact in an average as large as the DOW.
While I have been suggesting that this could happen at any time- and by the way looking like a fool all the way along- even though the likelihood has existed for at least 7 years now there are many others who are noticing this problem today.
A few weeks ago Goldman Sachs Chief Markets Economist Charlie Himmelberg warned that “HFTs- due to their inability to process nuanced fundamental information- may trigger surprisingly large drops in liquidity that exacerbate price declines, and result in flash crashes”. He believes that “liquidity is the new leverage”. Personally, I believe that the liquidity conundrum is in ADDITION to the most ridiculous leverage the world has ever seen.
There are many out there who may disagree but their most telling argument is that every time an “event” takes place- just like a few weeks ago- the central banks step in and save the day.
In a chart from Bank of America (Merrill Lynch) in an article on Zerohedge (6-17-2018) they show that in every major shock since 2013 the central banks have, indeed, stepped in even if only verbally to stem the downward tide. Of course, we have to remember that central banks are supposedly preparing to reduce the liquidity they have been providing in the near future. Whether they will actually do that or not is certainly not guaranteed in my opinion.
Over the past 30 years or so the central banks have become more and more proactive in markets where, in many cases, they ARE the markets- think the Japanese Central Bank owning more than 70% of all Japanese ETFs, purchasing ALL Japanese government bonds in the past 3 years and the ECB buying all sorts of corporate and government bonds to prop up countries and companies across Europe. Many call the Swiss National Bank the best performing hedge fund. They are the largest shareholder of Apple stock and actively buy stocks with money “printed” out of nowhere. How successful would anyone be if they could conjur money up for free and buy stuff?
We have recently seen how, by purchasing assets, mainly government bonds in such a quantity that these assets can be used as weapons to force the will of the central bank onto the citizens- in this case the citizens of Italy. Just a reduction in purchases during a political crisis caused the yields to spike and panic to set in as the Italians favored an anti-Euro politician.
It was reported on King World News also that $34 billion in gold (paper- not physical metal) was sold just prior to Friday’s market open while most of Asia was closed which means there were no buyers available. Of course, it was a market order which anyone actually investing may not want to do because it pretty much guarantees a sale of that size will knock the price down and cause losses in that position. Unless you are shorting the market prior to that. By the way, last week saw the largest weekly shorts EVER in silver. Isn’t it amazing how insightful the insiders are to be short just prior to a huge sale that will likely produce large profits for those that are expecting lower prices? If only we could get on that email list!
I am also watching the dollar strengthen (personally I believe it may be its last gasp but may last a while) and many emerging market countries being forced to defend their currencies. One of the standard ways to protect a currency is to raise interest rates. As the rates rise it is expected that others will view the higher rates as a reason to purchase that country’s assets and prop up the local currency. The problem here is that, as rates are rising in many locales, the ability to carry the record levels of debt becomes harder and harder and chokes off economic activity and investment because of the rising debt service costs. Lower rates are perceived to be necessary to fuel future investment but higher rates are perceived to be needed to keep the value of the currency elevated. Much of this has to do with the debts being OWED in dollars but being paid with local currencies. As the dollar strengthens it is the same as their already record debts increasing without any corresponding assets being acquired.
The world is starting to see that the “printing” that has taken place had virtually all winners in the beginning but now there are obvious winners and losers in the “printing” battles. I have said for a long time that this situation can only last while central banks work together. It appears the cracks in that foundation are becoming increasingly apparent.
It appears to me we are heading for a reset in prices. Those being artificially propped up will likely fall hard and those being held lower will likely explode higher after years of money “printing” and all sorts of financial shenanigans. As Jeremy Grantham is famous for saying there will be a “reversion to the mean”. He has also said in the past that most times there is an overshoot while the prices reset.
While times like these test everyone’s patience those who can stick to a plan have a better chance of thriving in the future.
Mike Savage, ChFC, Financial Advisor
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