Good news?

  • Not much balance
  • Risky Venezuela?
  • Gold
  • New podcast episode

Good news from Bloomberg.

Australia’s trade surplus stands at $1.24 billion, against an estimated deficit of $550 million.

Exports are up 8% from the previous month.

No change on the imports front.

Elsewhere, Australian government debt now stands at $464.79 billion.

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Source: Australian Office of Financial Management
Click to enlarge

Roll on half a trillion dollars of debt. It’s within sight.

Is there no end to the [ahem] ‘good’ news?


Overnight, the Dow Jones Industrial Average fell 42.87 points, or 0.21%.

The S&P 500 fell 1.75 points, or 0.08%.

In Europe, the Euro Stoxx 50 index fell 1.05 points, for a 0.03% fall. Meanwhile, the FTSE 100 added 0.08%, and Germany’s DAX index gained 0.01%.

In Asian markets, Japan’s Nikkei 225 index is down 90.91 points, or 0.47%. China’s CSI 300 index is down 0.41%.

In Australia, the S&P/ASX 200 is up 2.30 points, or 0.04%.

On the commodities markets, West Texas Intermediate crude oil is US$53.70 per barrel. Brent crude is US$56.84 per barrel.

Gold is trading for US$1,176.16 (AU$1,607.35) per troy ounce. Silver is US$16.41 (AU$22.43) per troy ounce.

The Aussie dollar is worth 73.2 US cents.

Not much balance

Watch that crash warning. It’s still flickering on red.

We can’t take our eyes off it.

Therefore, we don’t know for sure if the crash warnings we see are real, or whether we’re seeing what we’re seeing because we’re looking for it. If you get our drift.

Put simply, we’re talking about ‘confirmation bias’.

So, bear that in mind as you read our commentary and analysis. We’re the first to admit that when we get an idea into our head, it’s hard for us to shake it.

For the better part of two years, we’ve worried about a crash. We first flicked the switch to a heightened state of warning in mid-2014.

That was just before markets worldwide went into a tailspin…before recovering.

Over that time, we’ve been proven right…and wrong…about an impending crash.

However, since issuing that warning, it’s worth pointing out that the S&P/ASX 200 is only up a paltry 2.19%. That’s an annualised gain since August 2014 of just 0.91%.

chart image

Source: Bloomberg
Click to enlarge

If you add in dividends, you naturally get a better result — 5.64% annualised. But, still, as our old buddy Vern Gowdie says, is the prospect of a 5% gain worth the risk of a 50% or more loss of capital?

You could probably argue that until the cows come home. But as much as we love stocks and stock investing, even we believe that Vern has a point.

And we certainly wouldn’t have more than 40% (maximum) of our wealth invested in stocks. (On a point of disclosure, we noticed last week that our family self-managed super fund had more than a 40% exposure to stocks, so we sold some to get below that level.)

Yet many folks continue to have most of their wealth invested in the risky stock market. Even so-called balanced investment funds have big exposures to stocks.

Take the Morningstar Balanced ETF Asset Allocation Portfolio fund. As of the end of November last year, it had 58% of its assets in stocks. 20% was in corporate debt. Just over 17% was in government debt.

Just 1.74% of its assets were categorised as ‘Cash and Other’.

Now, it may be fair to argue that government bonds are as good as, or even better than, cash in the bank. That’s reasonable, given the low interest rates in the US market.

Even so, with everything that has happened in sovereign debt markets over the past few years, it’s hard to say which poses the greatest risk: a sovereign debt collapse or a bank collapse.

Perhaps that’s why we still favour gold. More on that later.

Another reason to question the allocation of 58% of assets in stocks is the current valuations of those stocks.

The Morningstar fund in question discloses that its stock holdings have an average price-to-earnings (PE) ratio of 26.2-times earnings.

Again, amazingly for a ‘balanced’ fund, this average PE far exceeds the current PE ratio for the S&P 500 index, which stands at 21.2-times earnings.

That in itself is a high number — the highest it has been since 2009. You can see this in the chart below:

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Source: Bloomberg
Click to enlarge

As you can also see, the S&P 500 PE ratio is well above the 19-times earnings level it hit in 2008. So if the current level doesn’t shout ‘risk’, we don’t know what does.

One thing to note: Ignore the big spike in 2009. Those numbers are irrelevant. After the crash, companies shoved as much bad news as they could into their income statements. That pushed earnings down even further, causing the PE ratio to spike.

The point is, the market is already expensive, past the level it was at the previous peak in 2007 and 2008. Yet investors are now supposed to believe that a new bull market is about to begin.

As we’ve noted before, we just don’t buy it.

And despite what the commentators and analysts may say, underneath, the market doesn’t necessarily believe a bull market is about to begin either.

As the Wall Street Journal reports:

The historic relationship between Wall Street’s fear gauge and U.S. equities faltered last month — a sign that investors are demanding protection against wild swings in stocks as the market flirts with all-time highs.

The CBOE Volatility Index, or VIX, is derived from the prices of S&P 500 index options and is a barometer of expectations for stock-market turbulence. The correlation between the VIX and the benchmark S&P 500 typically is negative, meaning when stocks slide, the VIX tends to rise and vice versa.

But in December, the VIX and S&P 500 rose together for six days, or 50% of the days that stocks climbed during the month, according to Russell Rhoads, director of education at the CBOE Options Institute. That is higher than the historical average of about 20%, he said.

The simultaneous gains by the VIX and stocks signal investors are hedging more, even amid rallies in equities, said Stewart Warther, BNP Paribas SA’s U.S. equity and derivatives strategist.

Looking at the long-term chart of the VIX below, you can see it has been much more volatile since the 2008 crash than it was beforehand:

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Source: Bloomberg
Click to enlarge

You can look at that and think two things. First, that volatility is the proverbial ‘new normal’; or, you can look at it as we do and think that the market has become, and will become, even more complacent about volatility.

Investors will look at the recent past and conclude that volatility will be modest, stocks will fall just a bit, and then the rally will continue.

Beware the dreaded phrase: ‘Buy on the dips’. That’s complacency about the risks. Once the distraction of the Donald Trump inauguration is over, our bet is that volatility will begin to rise again.

Risky Venezuela?

It’s not just stocks where trouble looms. From Bloomberg:

Watch out for the unexpected in commodities markets in 2017. Barclays said raw materials markets from energy to metals face the high likelihood of disruptions, giving a laundry list of possible threats including a default by Venezuela, riots in Chile and a trade war with China.

“The new politics of populism and protectionist trade policies have the potential to disrupt global supply and demand assumptions for various commodities,” analysts including Michael Cohen and Dane Davis wrote in a report published on Thursday. “We see risks skewed to the upside in 2017, based on a high likelihood of disruption risk.”

According to Bloomberg, Venezuela’s two-year government bonds are yielding 32% (the chart below contains limited data from 2015 through 2016):

chart image

Source: Bloomberg
Click to enlarge

As one of OPEC’s biggest oil producers, the collapse in the oil price through 2014 and 2015 took a toll on Venezuela’s economy.

That made it hard for the country to repay its US-dollar-denominated debt. A collapse in the Venezuelan bolivar didn’t help, either. It has fallen from 4.29 to the US dollar to nearly 10 to the US dollar.

The lower bolivar makes it more expensive for Venezuela to convert its currency into US dollars in order to cover any US-dollar debt repayments — especially if US-dollar oil revenues don’t match the debt obligations.

So, would a Venezuelan debt default lead to a worldwide crash?

Possibly. Although we find it hard to believe that will be the trigger. Venezuela does have a big pile of outstanding debt.

According to Bloomberg, its total debt stands at 922 billion Venezuelan bolivars. That’s around US$92 billion, or roughly 50% of the country’s GDP.

But when you consider that other debt crises, such as Ireland, Spain, and Italy, have failed to cause a widespread collapse, what makes Venezuela so different? A bailout by other OPEC members perhaps.

Or maybe this is the complacency we mentioned above. Maybe we’re guilty of thinking that, just because other debt crises have gone off with a whimper rather than a bang, it will be the same for Venezuela.

Who knows? What we do know is that it’s one more reason to keep that crash warning sign on high alert.


We’ve been quiet on gold in recent weeks. That’s because we’ve kept our head in the sand, denying that the price is falling.

Now that the price is on the rise again, we’re happy to cheer for it.

After sinking to around US$1,125 (AU$1,525) per troy ounce, it has recovered to around US$1,179 (AU$1,608) per troy ounce.

But, whatever the price, we only ever have one piece of advice on the yellow metal: Buy it.

New podcast episode

Yesterday, we recorded the latest episode of our Financial Anarchists podcast. If you don’t yet subscribe to the free podcast, you can do so on iTunes or Stitcher.

Just search for ‘Financial Anarchists’, and then subscribe to the podcast feed. That way, when we release a new episode, it will download automatically to your mobile device.

Look out for the next episode. It will be available from around 10:00am AEDT on Saturday morning.