We Won’t Tire of Warning You…

  • Third ‘crash warning’ signal flashes red
  • ‘Cash on Demand’
  • We’re with (the late) Mr Packer

Yesterday I wrote to you about two of the ‘crash warning’ signals, which are still brightly flashing.

Today, I’ll revisit another of our ‘crash warning’ signals.

If you’re sick of me going on about it, I won’t apologise for it.

The way I see it is like this: if you spotted a major potential problem with something, I would be disappointed if you didn’t tell me about it.

So, as far as our relationship goes, when I see things that trouble me, I just have to believe you would be disappointed if I didn’t tell you.

Of course, if you’d rather ignore these warnings, that’s fine. Nobody forces you to open and read Port Phillip Insider. You can go right ahead and leave it unopened in your inbox.

Just be aware, ignoring these warnings could cost you money, and potentially even cost you a comfortable retirement.

Because, when we talk about a ‘crash warning’, we’re not talking about a measly 10% or 20% drop. We’re talking about a fall of 40–50% or more…from the current level.

That’s why these crash warnings are so important. You should pay attention. In a moment, we’ll provide more evidence for why a major crash may not be far away…


Overnight, the Dow Jones Industrial Average index gained 112 points, or 0.6%.

The S&P 500 index added 21 points, or 1.1%.

In Europe, the Euro Stoxx 50 index closed up by 0.7%.

The FTSE 100 index closed 1.2% higher, while the German DAX climbed 0.6%.

In Asian markets, the Nikkei 225 index is currently down 0.2%. China’s Shanghai Composite index is down 0.8%.

In Australia, the S&P/ASX 200 index is up 0.3%.

On commodities markets, West Texas Intermediate crude oil is US$38.11 per barrel. Gold is trading for US$1,226 per ounce.

The Aussie dollar is trading at 75.93 US cents. That’s down from a peak of 77.3 US cents just last week.

Third ‘crash warning’ signal flashes red

Let’s get back to the latest developments in one of our ‘crash warning’ signals.

If you’ve followed Port Phillip Insider over the past nine months, you’ll know that we’ve closely watched mergers and acquisitions (M&A) activity.

We explained that, historically, there is a clear correlation between the peak of a stock market, and a peak in M&A deals.

The reason should be obvious, but I’ll explain anyway.

During a recession — and the early stages of a recovery — companies are afraid to take big risks. Also, due to the perception (or reality) of a weak economy, banks or other lenders may not be keen to lend money to companies or consumers.

Consequently, some companies will go bust because they can’t generate cash flow, or raise cash from loans.

Other companies, those that want to expand, may choose to fund expansion from existing loan facilities or from free cash flow. They look to expand organically. That is, by growing their existing business.

So, it’s not often that you see takeover deals during an economic downturn — unless a target company is in such distress that an acquirer just can’t refuse to buy it.

Then again, attitudes change. As the economy recovers, businesses and consumers regain confidence. Businesses take more risks, and reinvest more in their business. Banks and other lenders start loosening their wallets, as do consumers.

Soon enough, a self-perpetuating boom is born. Confidence grows further, so businesses and consumers take even bigger risks.

As the economy grows, the number of takeover deals grows too.

But then, something happens. The economy reaches a peak. Except, many don’t know this at the time. They can only see it with the benefit of hindsight.

When the market hits a peak, takeover valuations soar. Target companies demand a big takeover premium to what is already an inflated share price. The acquiring company will often pay these premiums, because management is desperate for the company to keep growing.

But, eventually, those high premiums aren’t sustainable. Companies realise they can’t afford it. And shareholders realise the company can’t afford it either, crushing the share price and voting against the deal.

And, just as importantly, banks and other financiers realise the outsized deals aren’t sustainable either. The boom in M&A activity soon turns into a bust.

The deals dry up. But this doesn’t all happen in isolation. At the same time, elsewhere in the markets, investors start to realise that the glory days of a rising stock market are over — the crash begins.

This all brings us to the news in today’s Financial Times:

The collapse of Pfizer’s $160bn merger with Allergan on Wednesday brought the total value of abandoned deals this year to its highest since the eve of the financial crisis and sent shockwaves through corporate America.

That’s a big number.

And, even though this deal collapsed due to potential changes in US tax laws, the principle remains the same. The deal collapsed because it was no longer financially viable.

That’s the reason behind most takeover collapses. The numbers no longer stack up. Although it’s the biggest deal to fail, it’s not the only deal to fail this year.

As the FT reports:

The abrupt end of Pfizer’s turbulent three-year hunt for a deal to escape the US tax authorities came as government action left another large deal in doubt. The US Department of Justice sued to block Halliburton’s proposed $25bn takeover of rival oil services group Baker Hughes.

Halliburton is contesting the suit, but the implosion of the Pfizer-Allergan merger brought the value of deals withdrawn so far this year to $376bn — the highest since 2007 by deal value, when $405.9bn worth of transactions were scuppered, according to Dealogic.

As the chart below shows, the peak of M&A activity in 2007 coincided with the stock market peak.

Source: Bloomberg
[click to open in new window]

For the record, many stock markets (such as the S&P 500, FTSE 100, and DAX) hit an all-time record high in 2015, which has so far coincided with a peak in M&A activity.

Last year, there was a total of US$5.7 trillion-worth of announced deals. So far this year, the number totals US$1.1 trillion. Annualised, that’s around US$4.4 trillion, well short of last year’s number.

Of course, even though things don’t look great for M&A activity so far this year, it’s possible that things could pick up through the rest of the year…we guess.

But we’re not betting on that. We’re betting that the slump in M&A activity is an early warning that the market’s best days are over.

Last July, we introduced you to four ‘crashing warning’ signals. Today, three of them are flashing brightly. We hope you heed the warning.

‘Cash on Demand’

Remember to check out the ‘Cash on Demand’ series, where I interview colleague Matt Hibbard.

You can watch the latest and previous episodes here.

In the videos, Matt explains how he can help investors potentially boost their income using exchange traded options.

I know, for many people the ‘O’ word (options) is a red flag. They’ve heard all about the huge risks of derivatives, and they may have heard stories about people losing a stack of money trading options.

Many of those folks may have lost money trading options themselves. I won’t deny that options can be risky. But if you really understand how they work, and you take the time to learn a couple of key strategies, it’s possible to use options in a way that can reduce your risk, compared to buying a stock outright.

It’s probably hard to believe, considering what most people think about options. In that case, I encourage you to check out the ‘Cash on Demand’ video series. You can watch it here.

We’re with (the late) Mr Packer

I dislike taxation. I consider it to be the theft of private property.

If the tax man turned up on the doorstep each month, demanding that people hand over one-third of their possessions, there would doubtless be an uproar.

But when the taxman takes one-quarter, or one-third — or more — of the money from peoples’ salaries, few say a thing. They usually trot out the old Oliver Wendell Holmes (former US Supreme Court judge) quote about ‘taxes are what we pay for civilised society.

Of course, when Holmes wrote that in 1927, the highest US federal tax rate was 25%. And it only kicked in when incomes hit US$100,000 — the equivalent of US$1.36 million today.

Today, the top US federal tax rate is 39.6%, and kicks in at US$464,850.

So, when it comes to taxes, I take the Kerry Packer approach. As Mr Packer told the Print Media Inquiry in 1991:

I am not evading tax in any way, shape or form. Now of course I am minimising my tax and if anybody in this country doesn’t minimise their tax they want their heads read, because as a government I can tell you you’re not spending it that well that we should be donating extra.

Hail to that, and hail to this report from our friends over at Fitzroy Press. If you’ve got any interest in minimising your taxes, I recommend checking out this report.

I read the report last year and have already put some of the tips into action. Like Mr Packer, I’ve got no interest in donating any extra money to the government, regardless of who’s in power.

Details here.



End of day market data

If you have any ideas about what you would like us to include in our end of day market data drop us a line at letters@portphillipinsider.com.au, and type ‘Market data’ in the subject line.

52-week highs: 20 stocks, including CI Resources Ltd [ASX:CII], Onthehouse Holdings Ltd [ASX:OTH], STW Communications Group Ltd [ASX:SGN], and Think Childcare Ltd [ASX:TNK].

52-week lows: 19 stocks, including Contact Energy Ltd [ASX:CEN], Millennium Services Group Ltd [ASX:MIL], and Zicom Group Ltd [ASX:ZGL].

Note: The stocks listed above are stocks that hit an intra-day 52-week high or low during today’s trading. The stocks didn’t necessarily close at the 52-week high or low.