When do you head for the lifeboats?

Thursday, 3 August 2017
Melbourne, Australia
By Bernd Struben

Over the course of this week we’ve been running the Crash Market Investor interview series. Kris Sayce has been in the hot seat. If you missed any of the first three instalments, you can find them on the Port Phillip Insider website here.

You’ll get the most out of the series if you read them in order.

Yesterday we left off discussing ‘melt-up’ stocks. That is, stocks that may run hard and fast in the weeks or months preceding the next market crash.

Today we’ll find out which types of stocks could hold their value, even as the broader market tumbles. And, importantly, how you might know when the market really is at, or at least near, the bottom.

Of course, the market isn’t crashing yet. And though there are plenty of warning signs, some of which I touched on over the past three days, the ASX 200 is still up 1.24% for the calendar year. And 4.94% over the past 12 months.

These aren’t stellar returns. But they are gains nonetheless. And the gains over the months ahead could be significantly higher. Though caution and some portfolio reshuffling may be in order, that’s not something you entirely want to miss out on.

A friend of mine brought this up over the weekend. And, as I’m wont to do, I dove into an analogy.

Imagine you’re on a cruise ship in the middle of the Pacific, I told her. And imagine you’re enjoying it, I was forced to add after some initial protestations.

It’s beautiful weather out on the sundeck by the pool, where you can get a relaxing massage. There’s the all-you-can-eat gourmet buffet and the open bar. One of your favourite musicians plays regularly in the ship’s nightclub. Your room is airconditioned and comfortable. Oh, and don’t forget the shuffleboard!

Now you know the ship is destined for serious trouble. But you’re still months away from port — it’s a slow ship — and you don’t know when it will begin to take on water.

You could leap into a lifeboat now. But you may find yourself bobbing around in the sea eating stale emergency rations, while your fellow passengers continue to enjoy all the benefits of the cruise liner for weeks or months yet.

On the other hand, if you wait for the ship to start listing, everyone aboard will know it’s going down. The mad rush for the lifeboats will be on. The expression, after all, is ‘man the lifeboats’. It won’t be women and children — or, in the case of the markets, poorly-informed investors — first.

When ships start to sink, they can go down fast. Markets are no different.

So how do you know when it’s time for an orderly withdrawal to the financial lifeboats?

That’s one of the things Kris and his team of analysts at Crash Market Investor are keeping a very close eye on.

More on that, after a look at the markets.


Overnight, the Dow Jones Industrial Average gained 53.32 points, or 0.24%. 

The S&P 500 gained 1.22 points, or 0.05%.

In Europe, the Euro Stoxx 50 index closed down 18.07 points, or 0.52%. Meanwhile, the FTSE 100 lost 0.16%, and Germany’s DAX index fell 0.57%.

In Asian markets, Japan’s Nikkei 225 index is down 41.25 points, or 0.21%. China’s CSI 300 is down 0.52%.

In Australia, the S&P/ASX 200 is down 18.80 points, or 0.33%.

On the commodities markets, West Texas Intermediate crude oil is US$49.45 per barrel. Brent crude is US$52.20 per barrel.

Gold is trading for US$1,262.93 (AU$1,591.19) per troy ounce. Silver is US$16.53 (AU$20.82) per troy ounce.

The Aussie dollar is worth 79.37 US cents.

Warning signs

Without further ado, we’ll get straight into the final instalment of the Crash Market Investor interviews.

Bernd: You wrote about your ‘magic number’ in Port Phillip Insider a few times back in July. After teasing it for a while, I might add!

From everything I’ve seen, it really is a good indicator of pending downturns. Can you give readers who may not be familiar with it a quick recap of what the magic number is all about?

Kris: Well, Bernd, you and I are on the same page when it comes to technical analysis. Neither of us can abide it. The lines, the squiggles…the hindsight! [Laughs]

But, once you peel away all the junk and the mumbo-jumbo, and if you keep it super simple, there are elements of technical analysis worth looking at.

In particular, I discovered what I call a ‘magic number’ indicator. And that, when the magic number turns negative, it more often than not — in certain circumstances — indicates further falls are ahead.

I noticed this trend specifically with the Dow Jones Transportation Average, a much overlooked index. I noticed that 34 out of something like 36 times over the past five years, when the magic number turned negative, the Dow Transportation index continued to fall in subsequent days.

As if on cue, that has played out with the Transportation Average over the past week or so. In fact, since I pointed out this phenomenon, the index has fallen around 3%. If you had money on that trade, it would be looking pretty good right now.

Bernd: Does it work on other indices, or even stocks?

Kris: Yes but, naturally, with varying degrees of success and strike rate. I’m looking at its performance on other indices right now, including the Aussie and Japanese markets.

Plus, it just so happens that a magic number trade triggered on a major US stock this week. I issued a short sell. If this trade pays off, it could be the big one. We’ll see how it plays out.

Bernd: OK. I’ll watch with interest. And by the way, I just saw that one of your other short recommendations is already showing a 5.1% profit. While one of your long tips is up 19%. And that’s just since 21 July.

But moving on, what other warning signs are you and your team on the lookout for to get a jump on the masses heading for the lifeboats when things turn south?

Kris: I look for a lot of things. But to be honest, I tend not to look at the things the mainstream follows. Most of the mainstream focuses on GDP. That’s gross domestic product, a measure of a nation’s economic output.

That figure is fine, but it’s backwards-looking. Often, too far backwards-looking. By that I mean, it’s telling you what the economy did last month or last quarter. Plus, as far as I’m concerned, it’s too easily manipulated by the government and its statisticians.

So instead of GDP, I prefer to look at more specific business data.

Bernd: For example?

Kris: I don’t think you’ll have enough space in Port Phillip Insider for me to go into detail on each one, so I’ll give you a rough outline.

I like looking at the Baker-Hughes drilling rig numbers. It’s a weekly round-up of the number of active drilling rigs in various locations. It was a great pointer for the collapse in the oil price in 2014.

I recently came across the Drewry East-West Air Freight index. It shows you the cost of sending freight from one side of the US to the other. Historically, freight costs are low when the economy is weak, and high when the economy is strong. That’s logical.

As it happens, the freight index is near the level it was in 2008/09, when the world’s economy was in the depths of recession. To me, that’s interesting.

What else do I look at? Well, there’s merger and acquisition activity. Here, you tend to see M&A peak near the top of the market. That’s because companies find it hard to achieve organic growth at the market peak.

So companies will try to ‘manufacture’ growth by taking over another business. Often, as you’d expect, at the top of the market prices are expensive. Companies overextend and borrow too much. That’s when the problems really begin.

There’s so much I look at. Oh, of course, there are earnings forecasts. Earnings have improved for US companies over the past year. But they’re still well short of where earnings need to be a year from now, in order to meet analyst expectations.

To get there, companies would have to achieve earnings growth at a rate you don’t normally see this late in a bull market. For that reason, I just don’t buy the idea that this bull market has much further to run.

Bernd: Speaking of your team, Crash Market Investor wasn’t born overnight. It’s a premium service you’ve been pouring time and energy into for almost a year now. Atop your existing network, you also decided to bring two new analysts into the service. Can you tell us who they are and what they offer to the service?

Kris: One of the analysts I’ve brought in is someone many Port Phillip Insider readers will be familiar with, Selva Freigedo.

Selva has been a great addition to our team here in Albert Park. She has a fascinating background, growing up in Argentina, and living in Brazil, Spain, and the US.

Selva writes the popular Port Phillip Insider EXTRA e-letter. But she’s also joined us in Crash Market Investor. There, Selva focuses on macroeconomic trends and insights, using her global contacts from within the Agora network of financial publishers.

Selva has a direct line to top analysts in Brazil, Argentina, France, and the UK — among other locations. I believe having access to this network will be key when it comes to recognising the beginnings of the next bear market.

While it’s possible that the bear market will start in Australia, it’s more likely it will start overseas.

Also, I hired a gun stock analyst. His name is Ryan Dinse. This guy is going to be a star in our business in the years to come. You can quote me on that.

Ryan cut his teeth as a financial planner for a major Australian financial services group. After spending over six years there, he realised that not only was the financial planning business not for him, but that it shouldn’t be for most Aussie investors either.

His conclusion was that the big financial planning firms are more interested in taking care of their own bottom line than they are with helping investors grow their wealth. So he got out, traded for himself, and has now joined our team to show Aussie investors the successful trading strategies he’s used for his own account.

As I say, keep your eye on Ryan. He’s going to be a star.

Bernd: You’ve mentioned that some stocks will be more resilient to the impacts of the coming market crash. I know you can’t give away specific stock tips here. But can you give us a better idea of what kind of stocks you’re talking about?

Kris: You’ll have to ask Ryan about that. He’s the one who’s picked them [laughs]. Seriously, I’m looking at this project from the short side. I’m convinced a major and potentially catastrophic crash could hit the Aussie and world’s markets within the next two years.

That said, getting back to your question about resilient stocks. It’s hard to give anything away without giving away too much.

So I’ll just say that one of Ryan’s resilient stocks could be termed a ‘vice’ stock. I leave it to your readers’ not-too-vivid imagination to guess what stock that could be.

Another one of Ryan’s resilient stocks could, erm, also be termed a ‘vice’ stock. Seems to be a trend here, right? [Laughs]

And a third resilient stock is a…healthcare stock. But not any old healthcare stock. It’s a stock that Ryan claims could grab a slice of a $100 billion industry. That would be neat.

Bernd: The time where the really big money can be made is obviously after the market bottoms. But if the stock market loses 40% of its value, many investors will fear it could fall further. And, of course, it could. How will you and your team at Crash Market Investor know when it’s hit the bottom…or at least near it?

Kris: Let me bring up this chart to show you Bernd. It’s of the Aussie S&P/ASX 200 index going back to 2006. I’ve circled a specific point for your readers.

chart image

Source: Bloomberg
Click to enlarge

At this point, in early 2008, many investors thought that the ‘crash’ was over. The index had fallen 25% from the peak. That’s a big move. A fall of that size hadn’t happened in years.

You can see how the market rebounded sharply over the following weeks. Yet, the rebound didn’t last. Soon after, the market gave back all of those gains, and much more. Those who bought at what they thought was the bottom of the market would have lost 38% of their investments if they had held on until the real bottom around a year later.

So, how will we know that the market has hit rock bottom? The truth is that we won’t know for sure. But what we can do is position investments, and help investors to position their investments, to try to protect against the worst.

The magic number trades I mentioned earlier are a good example. Over the coming weeks and months, we’ll keep looking for opportunities to get in on magic number trades, mostly on indices.

We’ll get in on the short side as the index is falling and, if it continues to fall, we should rack up gains. In many instances, investors will use that as a way of hedging their portfolio. They won’t necessarily sell all their stocks, but they may place a few strategic magic number trades to partly protect their portfolio in the event of a crash.

And of course, if stocks don’t crash, but instead bounce back, well, that’s where we have a risk-management system in place to reduce losses on hedging trades.

This is all about making money, and not losing money. It’s an important approach. Unfortunately, most investors only tend to think about one of those things at any one time. In reality, they should think about both at the same time.

Bernd: When push comes to shove, we’re all looking to make money. That’s undoubtedly an important reason for any investor taking out a subscription to Crash Market Investor. And obviously you’re looking to run a profitable service. But there are a lot of potentially profitable new services you could have launched. Why this one? And why now?

Kris: That’s right Bernd. There are any number of services we could launch. Folks are always coming to me wanting to launch a new small-cap service. They clearly know I have a soft spot for small-cap stocks. [Laughs]

But while small-cap stocks are great, and offer a lot of potentially profitable situations, it’s important investors consider their entire portfolio and wealth. We have had a lot of new subscribers come to us since 2008, telling us that their financial planner ‘helped’ them to lose a lot of money during that crash.

With stocks going up, and investors becoming complacent — remember the VIX index chart I showed you — I fear that many investors will end up doing to their own portfolios during the next crash what their financial planners did to them last time.

Hopefully, the Crash Market Investor service can prevent that from happening. It’s a long shot, because I’m certain most investors will just ignore our warnings and advice. If so, fine. That’s on them. That’s their responsibility.

But I don’t want any of them coming to me two years from now, claiming that we never warned them about a crash. I’m warning them about it now. It’s up to them whether they take notice.

Proceed with caution

That brings our Crash Market Investor interview series to an end. I hope you’ve found it useful. And I hope you do take notice of Kris and his team’s warning.

As he’s made clear, the market meltdown he’s convinced is coming could be only weeks away, or it could be as long as two years. That’s why the intent of this new service is to get you in the right position to make big gains before, during, and after the coming crash.

So what are you waiting for? Go here now.