Three signs governments are not confident about the future

Wednesday, 2 August 2017
Melbourne, Australia
By Bernd Struben

Today we bring you part three of our four-part interview series with publisher Kris Sayce.

As promised, we’ll move away from the gloomier aspects of the pending market crash. And we’ll take a closer look at how you can potentially profit from some hidden opportunities before, during, and after share prices collapse. Which, of course, is a primary focus of Kris’ new premium service, Crash Market Investor.

If you missed part one or two of this series, you can find them on the Port Phillip Insider website here. I recommend reading them in order.

Before we get to that, though, a quick — and yes, gloomy — look at global governments. Why? Because officials in Europe, the US and Australia have all recently signalled their lack of confidence in the future.

Over in Europe, bureaucrats continue to stress about the growing likelihood of more bank runs. And they’re looking at ways to keep people from accessing their deposits in times of financial turmoil. Customers could see their accounts suspended for up to 20 days ‘in exceptional circumstances’.

As Reuters reports,

European Union states are considering measures which would allow them to temporarily stop people withdrawing money from their accounts to prevent bank runs, an EU document reviewed by Reuters revealed.

The move is aimed at helping rescue lenders that are deemed failing or likely to fail, but critics say it could hit confidence and might even hasten withdrawals at the first rumors of a bank being in trouble.

The proposal, which has been in the works since the beginning of this year, comes less than two months after a run on deposits at Banco Popular contributed to the collapse of the Spanish lender.

Meanwhile, the largest US bank, JPMorgan Chase, has fallen further in line with the global war on cash.

We won’t get into the details of this war today. But, in essence, the elimination of cash will allow central banks to implement their much dreamed about negative interest rates. And, of course, make any future bank runs impossible. Neither of which should be a concern in a healthy, growing economy.

From Newsmax

A firestorm of speculative commentary has been ignited by reports that JPMorgan Chase has ceased to accept cash for payments on credit cards, mortgages, auto loans, lines of credit and so on.

JPMorgan Chase has also banned the storage of ‘any cash or coins’ in its safety deposit boxes.

Over here in Australia, the Reserve Bank of Australia (RBA) gave its own not-so-subtle thumbs down on its outlook for the future. Yesterday, as you likely know, the RBA kept interest rates at the record low 1.5%.

RBA Governor Philip Lowe stood by the bank’s forecast that the Aussie economy should grow by 3% annually for the next few years. But he cited low real wage growth and high household debt as two major concerns for the Australian economy going forward.

We couldn’t agree more.


Overnight, the Dow Jones Industrial Average gained 72.80 points, or 0.33%.

The S&P 500 gained 6.05 points, or 0.24%.

In Europe, the Euro Stoxx 50 index closed up 28.03 points, or 0.81%. Meanwhile, the FTSE 100 gained 0.70%, and Germany’s DAX index rose 1.10%.

In Asian markets, Japan’s Nikkei 225 index is up 114.68 points, or 0.57%. China’s CSI 300 is down 0.02%.

In Australia, the S&P/ASX 200 is down 21.60 points, or 0.37%.

On the commodities markets, West Texas Intermediate crude oil is US$48.74 per barrel. Brent crude is US$51.36 per barrel.

Gold is trading for US$1,265.69 (AU$1,592.26) per troy ounce. Silver is US$16.63 (AU$20.92) per troy ounce.

The Aussie dollar is worth 79.49 US cents.

Stock market ‘melt-up’ ahead?

And now, on with the interview…

Bernd: The volatility index (VIX) is often referred to as the fear index. When it’s low, it infers investors are confident. In recent months, the VIX has been trending at multi-year lows.

Shouldn’t we draw confidence when the fear index is running this low?

Kris: I like how you say that with a smile Bernd. You are, of course, right. When the VIX is low, it generally means investors are content. It means there isn’t a lot of volatility, and investors don’t expect a lot of volatility.

I won’t go into details on how they calculate the VIX but, in simple terms, it’s derived from the price of call and put options over the US S&P 500 index.

But here’s the important thing. While it’s certainly fine for the index to run at a low level, that in itself signals that trouble could soon be on the way. Look, let me pull up this chart of the VIX. I’ll send you a copy to show your readers.

chart image

Source: Bloomberg
Click to enlarge

What do you notice about the chart when the VIX stays low for a significantly long time, or even when it falls to a significantly low level?

Bernd: It shoots back up. Pretty quickly too.

Kris: Spot on. This stuff isn’t rocket science. [Laughs] This is just looking at history, and asking, ‘If that happened in the past, could it happen in the future?’ In terms of the VIX spiking higher after staying low, there can only be one answer — yes.

It then just comes down to how savage that spike will be. Will it just be a short-term spike higher for now, followed by another spell of calm, or will the next spike be the major and catastrophic crash that I believe will happen within the next two years?

So, in short, no, investors shouldn’t feel confident about the VIX being low. Ultimately, they should be worried.

Bernd: OK, moving on a little. We know that excessive debt is a major concern in developed and developing nations alike. And Australia is certainly no exception.

Expanding our debt pile has allowed us to live comfortably beyond our means. Yet the power of debt is waning. In fact, it’s now taking four or five dollars’ worth of debt to get one dollar of GDP growth. Why are we getting ever less bang for our borrowed dollars? And what does this mean for investors?

Kris: Look, I’m no macroeconomic expert. And I’m certainly not a monetary theorist. I’m sure if you ask them, they’ll tell you about the ‘velocity of money’, or some other economic theory.

To me, it’s simple. People have spent as much as they can afford to spend. All the debt taken out and issued over the past eight years has to be repaid. Not in full of course, but in regular instalments — such as a mortgage or car loan.

When incomes haven’t really grown in recent years, there’s a limit to how much extra debt people can take on, even with super low interest rates.

Remember, debt isn’t some magical thing to boost the economy forever. Debt involves bringing purchases forward. If you take out debt to buy something today, rather than saving to buy it in the future, it means the purchase happens today, and not in the future.

If we take ourselves back five years, for example, people borrowed then to buy something then. Now they’re still paying off whatever they bought. So what can they buy now? In many cases, nothing. They’re all spent out. They’ve got all the debt they can handle.

Furthermore, the expansion of debt is just as likely to be debt that’s being used to repay old debt. In other words, debt refinancing. That explains why there’s more debt taken out, but it’s not contributing to economic growth.

Does that make sense?

Bernd: Sure. It sounds like a bit of a ‘debt hamster wheel’. You keep running and running, but you’re not really getting anywhere.

But now let’s flip this around. Yesterday I promised readers that we’d move away from all the all doom and gloom. Because in Crash Market Investor you’re actually looking to make investors money before, during and after the crash. Is that right?

Kris: Yes. Well, my primary focus right now is trying to help investors not screw up. I believe a major economic and stock market crash is on the cards. But after eight years of mostly rising stock markets, I have this niggling feeling that investors are becoming complacent.

The chart I showed you before of the VIX index is evidence of that. Investors think that nothing can go wrong. Or if something does go wrong, then the government and central banks will step in and fix things up. First, I wouldn’t be so sure that will happen. And even if they do, you should seriously question whether it will be effective.

So, helping investors avoid the worst of the next crash is the main objective. But I’m also aware of a couple of other things. First, even though I believe that a crash will happen within two years, I don’t know for sure when it will happen.

And second, I can’t ignore the possibility that, before the crash, we could see a ‘melt-up’ in stock prices. A ‘melt-up’ describes the period immediately preceding a market crash, when stock prices go higher. Sometimes, spectacularly higher.

One of the best examples of all time is in recent history. From 1998 to the end of 1999, the NASDAQ index gained 200%. That was in around 18 months. An extraordinary gain.

If that happens again, whether it happens to stock prices here in Australia or in the US, we’d love to be able to help investors make the most of that.

Bernd: While we’re on the concept of a stock market ‘melt-up’ before the crash… Is this something that precedes most crashes?

Kris: It goes without saying that stock prices rise before a crash. But do they always ‘melt-up’ first? Not always. I just mentioned the NASDAQ index. The NASDAQ is full of tech stocks.

But if you look at the price action of the Dow Jones Industrial Average or the S&P 500 prior to the dot-com bust, it’s fair to say that non-tech stocks didn’t go through a ‘melt-up’ phase.

Then again, if you look at the 2008 crash, and the Aussie S&P/ASX 200 in particular, I think you could say the period from late 2006 through to late 2007 — just over a year — was a ‘melt-up’. The index gained around 40%.

That’s a big gain. Much more than you’d normally expect from the market.

Bernd: In that case, are there certain types of stocks, certain sectors even, that are more likely to ‘melt up’ than others?

Kris: That’s a tough one. I’m not so sure that it’s necessarily certain sectors. But yes, there are certain types of stocks that are more likely to ‘melt-up’ than others.

Those stocks are most likely to be hot, high-growth stocks. Stocks where investors almost literally seem to believe that the ‘sky is the limit’ for growth stocks.

That was so in 2000 with the dot-com boom. Those were growth stocks. Many of them had little or no revenue, no profits and, in hindsight, few genuine prospects for real growth. Those stocks happened to be in the tech and internet sectors.

In 2007, the ‘melt-up’ stocks in Australia were resources stocks. They were growth stocks. Many of them had little or no revenue, no profits and, in hindsight, few genuine prospects for real growth.

Do you see a pattern there? [Laughs]

My point is, it’s not necessarily so that it’s the same sector and same stocks that are the ‘melt-up’ stocks. In 2000 it was dot-com stocks. In 2007 it was resources stocks.

So, what could be the ‘melt-up’ stocks this time? Companies that have borrowed a bunch of cash perhaps. Those with no or low profits. Maybe those without any genuine revenue, or with outsized expectations of growth.

Where should we look? Personally, I don’t think it would be a crazy idea to look at the NASDAQ again. The NASDAQ is up around 50% in 18 months. It’s up 30% in just over 12 months.

Already, the NASDAQ is in ‘melt-up’ territory. And there are plenty of stocks in the NASDAQ that meet the criteria of ‘melt-up’ plays. If I had to put my money anywhere, in any market, to bet on a ‘melt-up’ situation, and a subsequent crash, it would be the NASDAQ.

Bernd: Thanks Kris. I can see you’ve got at least three people waiting outside your door now. And they’re looking restless. So we’ll wrap this up tomorrow.

Kris: Perfect. I look forward to it.

Be sure to tune back in tomorrow

I hope you’ve enjoyed the first three instalments of the Crash Market Investor interview series. More than that, I hope you’ve learned something.

In our wrap-up tomorrow, we’ll find out which types of stocks you might consider holding onto even as the market tumbles ever lower. And, importantly, how you might know when the market really is at, or at least near, the bottom.

After all, that’s where the really big gains can be made.

In the meantime, you can check out the full service here.