Scoops Lane
Thursday, September 26th, 2013
Melbourne, Australia
By Dan Denning

‘Doing nothing at this meeting would increase uncertainty about the future conduct of policy and call the credibility of our communications into question.’

Dallas Fed Chair Richard Fisher at the recent FOMC meeting

  • Punch drunk and priced in
  • Mixed price signals
  • The war on self-reliance
  • The case for cash
  • 15 rules to avoid becoming a victim

Punch drunk and priced in

Well this can’t be how Ben Bernanke imagined things would go. When the Fed announced it would keep spiking the punch bowl with $85 billion a month in bond purchases last week, it was supposed to be bullish for stocks, commodities, bonds, and America. But it’s not working out as planned.

The S&P 500 closed at 1692.94 on Wednesday. That’s down almost 2% since the ‘no taper’ call. The Dow has retreated from its assault on 16,000. It’s down 2.37% since the 19th of September and closed at 15,275.80 yesterday. On the other hand, the All Ordinaries are down just 0.24% since the big news. In a way, you could call that outperformance.

Emerging markets, gold, and ‘risk assets’ are supposed to outperform in an easy money market. When money is cheap and plentiful it surges to the far reaches of the global market to get the highest return. But the Fed’s Hamlet-like public squabbling over what policy to pursue is quite literally giving mixed signals.

That raises the possibility Bill Bonner brought up earlier this week, that future quantitative easing is already priced into the market. In other words, investors have already bought all the stocks they can stomach based on the expectation of easy money. The prospect of more easy money for longer is not enough to lure them into bidding stocks higher.

If Bill’s right, then the stock market now resembles the proverbial punch-drunk boxer at the end of a 15-round bout. He’s taken body blows and upper cuts and the occasional rabbit punch to the ribs. At the end, you don’t have to knock him out with a haymaker. You push him over with your pinkie. That’s all it takes.

Of course stock markets are not prize fighters. But the real issue is the Fed’s credibility and investor’s credulity. Belief can be a fragile thing, especially if you’re particularly unfaithful. Investors have taken the Fed at its word because it’s been convenient to do so. Don’t think. Just buy stocks.

But now the Fed’s at war with itself. Investors looking on at the bickering governors of the board could lose belief quickly. It’s a little like watching your parents get divorced when you’re a kid (speaking from experience). You learn quickly that love isn’t all about romance and rising stock prices.

The powers that be have managed to avoid most crash scenarios since stuffing up badly in 2008. But it’s a fine line between using words to manage stock prices and causing a crash. The Fed is right up against the line. And it’s losing its balance.

Mixed price signals

If you want to know what mixed signals from the Fed can do to prices, check out the 30-day gold chart below. Gold fell nearly 8% from late August to mid-September. Then it rallied 4.5% in a day. Then it fell. And today it rallied it again. Today it was up another 1.26% to US$1332.90. I’ll be trying to figure out what all this means next month at the Gold Symposium in Sydney.

The war on self-reliance

Do Australia’s financial authorities, regulators, and central planners have a philosophical objection to financial self-reliance? You’d think so after reading the Financial Stability Review, published yesterday by the Reserve Bank of Australia (RBA). Self-managed super funds (SMSFs) are basically causing a bubble in property, according to the RBA, although it didn’t say so quite directly.

The Bank said that, ‘One risk of the increase in property investment by SMSFs is that at least some of it is a new source of demand that could potentially exacerbate property cycles.’ It said that SMSFs are, ‘a vehicle for potentially speculative demand for property that did not exist in the past.’ The bank made no mention of its role in fuelling speculation by rigging the price of money at artificially low levels.

Why is it so worried about a bubble? Probably to save its own reputation. But the facts show that since 2006, the value of property investments in SMSFs has risen from $20 billion to $80 billion. Property-related investments are tax-free for anyone over 60, which is one piece of the puzzle. Another is that in 2007, a rule change allowed SMSFs to borrow to invest.

None of this bothers me that much. It’s your money. You can do whatever you want with it. I’m as baffled as the next guy why the RBA would care what people do with their money. It’s none of their business really. But they are making it their business.

Vern Gowdie pointed this out when I forwarded the article to him, Kris Sayce, and Greg Canavan. Vern says:

The RBA now join APRA & the ATO in this pursuit. I would not like to be the trustees of one of these funds. I wonder how long before a trustee and/or property spruiker is publicly hung as a warning to others?

Two which Kris Sayce replied…

Property in SMSFs is just a beard. The real target is SMSFs themselves. This will all be part of a general review of what they’ll call the ‘systemic danger’ of SMSFs…Look for a major crackdown on SMSFs, including compulsory investment in infrastructure assets, higher fees for SMSFs and minimum account balances…

To which Greg Canavan replied…

They’ve pretty much done that last two. Get the first one over the line and it will be called GDSMSF’s (gov’t directed SMSF) It’s pure evil. The RBA causes the freaking bubble with its ‘lower interest rates and pray’ strategy and then turns around and has a go at those reacting to its policy. I’d be targeting accountants who have some sort of affiliation with real estate agents.

The RBA is particularly worried that cashed-up SMSFs will put money in the banking system which the banking system then uses as a ‘force multiplier’ to expand the property bubble…by loaning to SMSFs to buy property! It said this dynamic could, ‘Become a concentrated financial exposure between two parts of the financial system.’

Note to the RBA: too late!

Interestingly enough, the RBA reckons that 77% of the money going into property has gone into commercial property, with 23% into residential property. That said, everything happens at the margin. And because there are $1.4 trillion in the superannuation sector, small shifts in money flows make a big difference.

That last point is probably the big one. There are a lot of pigs with their snout in the superannuation trough. The pot of money is too large for anyone in the financial services industry to ignore. The authorities may say they’re interested in the welfare of individual retirees and the viability of super. But on behalf of industry, they’re probably just as worried about people managing their own money and not paying big fees to do it.

The case for cash

Incidentally, Vern’s been addressing the risks of an all-cash position in his weekly updates for Gowdie Family Wealth. New readers have raised the issue of ‘systemic risks’ with the banks. If you have all your cash in the bank and the bank fails, isn’t your position even riskier than being in stocks? Vern’s addressed those issues in the last two weeks.

With respect to the all-cash position itself, it seems to be catching on. In ‘The Case for Cash’ in last Friday’s Wall Street Journal, Brett Arends writes:

If the events of the last 15 years have shown anything, it is that turmoil and financial bargains seem to come along with great frequency. If there are no compelling opportunities on offer at the moment, wait a while. One will be coming along soon-in the next great panic about Europe, or emerging markets, or US subprime mortgages, or gold, or China, or commodities, or high oil prices, or low oil prices, or inflation, or deflation, or something else entirely.

Others may sing the praises of stocks, bonds, real estate, and hedge funds. Let me offer qualified praise for the one asset which will leave you completely free to invest in the fire sale of tomorrow-the only asset that is truly considered a four letter word on Wall Street.


Wall Street hates cash because it doesn’t pay large fees. But some of them are coming around. GMO, the Boston-based investment firm, had 50% of its portfolio in cash earlier this year, according to a presentation it made at the Value Investors Conference in London. Sir John Templeton pointed out that by being in cash you can avoid losses when stocks fall and afford to buy them when they’re cheap.

The last point is probably the most important one. You build a cash position if you think stocks are going to fall. After all, fire sales only happen after a fire. Vern reckons Australia is in the middle of a secular bear market. The fire is burning. But it’s not raging yet. Yet.

15 Rules to avoid becoming a financial industry victim
By Vern Gowdie
Editor, Gowdie Family Wealth

An ounce of prevention is worth a ton of cure.

The investment world is full of people wise after the event.

Madoff’s victims; Margin lending losses; Securitised debt products, etc.

Barry Ritholtz, CEO of Fusion IQ and author of Bailout Nation published a handy guide on how to avoid becoming another statistic. It is titled ’15 Inviolable Rules for Dealing with Wall Street’.

These rules are an invaluable guide for professionals and novices alike. The financial world is full of sharks and Ritholtz rules make sure you do not become their prey.

1. Reward is ALWAYS relative to Risk: Any investment or product that is offered to you as having the potential for great gains also has the potential for even greater losses.

2. Overly Optimistic Assumptions: Investment institutions use computer models to project possible gains and losses. These models are flawed by optimistic assumptions. The programmer is instructed to ramp up the gain percentage and reduce the percentage applied to potential losses. Remember, once you leave the security of a bank account, you must factor in the fact that an investment can fall 30%, 50% or even 100% in value. Does the upside compensate you for that level of loss?

3. Legal Docs protect the preparer (and its firm), not you: ‘What the big print giveth the small print taketh away.’ The institutions prepare lengthy legal documents to protect themselves, not you. When it ‘hits the fan’, you can bet your last dollar (and this may be all you have left) the fine print will shaft you.

4. Asymmetrical Information: Who knows more about the product being bought and sold? The owner of the used car knows more about its faults then the potential buyer. The same is true for the institutions putting the investment deals together. They know the real risks; remember Goldman Sachs trader Fabrice Tourre infamous email, ‘I’m managed (sic) to sell a few abacus bonds to widow and orphans that I ran into at the airport,..

5. Motivation: Why is this person selling me this product? Do they have my wellbeing at heart or is it the commissions and/or fees they will earn?

6. Performance: What impact will the product’s fees and costs have on performance – especially in a low return environment?

7. Shareholder obligation: The institutions have a primary obligation to deliver maximum profits to shareholders. Is the product being recommended better for the shareholders than it is for you?

8. Other People’s Money (OPM): Will the institution or adviser you’ve engaged to look after your money treat your money as their own or as OPM? Are there hidden incentives for them to take more risk than you would if you were managing your own money?

9. Zero Sum Game: If I win who loses? And if I lose who wins? Is the product designed to enable the institution to share the profit but the investor wears all the losses?

10. Keep it Simple, Stupid (KISS): Rule of thumb is, ‘If it’s complicated there’s a hidden catch.’ This is why I prefer simple investments – Cash and index tracking Exchange Traded Funds. They are transparent and easy to understand.

11. Counter-Parties: Who is on the other side of your trade? Any income/revenue/dividend hedging you do means there is a party that stands to win if you lose. Who are they, what are their motivations?

12. Reputational Risk: Who suffers if this investment fails? Will anyone be fired or voted out of office if this implodes? Who suffers reputational risk? Wall Street has paid billions in fines but no one of any importance has been held accountable for the mess they created.

13. New Products & Services: Never be the first to invest in a brand new financial product. This is no different to a buying the first version of a computer programme or new model car. Wait for the bugs to be ironed out and let someone else be the crash test dummy.

14. Lawyer Up: You can rest assured the institutions have engaged the best legal brains money can buy. Make sure you see a good solicitor before committing to an investment deal.

15. There is no free lunch: In the financial world there is always, I repeat, always a price to pay. Before you commit, make sure you know what price you are really paying.

The GFC and its aftermath made it abundantly clear the institutions completely lost their moral compass. Use Ritholtz’s 15 rules as your guide to avoid becoming an unwitting victim of poor advice, over-priced services and products with dubious benefits.

A good creed to remember is, ‘If in doubt, opt out.’

When GFC MkII hits you will be ever so thankful for these 15 ounces of prevention.

Thanks for reading. Have a great week!

PS. If you have any comments or criticisms, or your own scoop you’d like to share, drop us a line at