Red Flags are Flying

Friday, 29 February 2020
Gold Coast, Australia
By Vern Gowdie

  • What’s the lesson from history?
  • Confidence levels rise
  • A red flag of the utmost importance

Hi, Bernd Struben here.

My apologies in advance…but I’m off today so I’ve chosen to share an article with you from earlier this week.

Given the falls the markets are experiencing right now…what with the coronavirus causing all sorts of havoc…I thought I’d republish an essay Vern Gowdie wrote for his The Gowdie Letter subscribers on Monday, 24 February.

There have been many red flags throughout history and in recent history that governments and central banks should’ve taken notice of.

From Hitler’s Germany to the GFC in 2008, there have been warning signs pointing to a downturn.

Vern fears that we are wading dangerous waters, yet due to confidence levels being so high, people could once again be caught unawares.

Before we let Vern take over and explain his concerns, let’s take a look at the markets…


Overnight, the Dow Jones Industrial Average closed down 1,190.95 points, or 4.42%.

The S&P 500 closed down 137.63 points, or 4.42%.

In Europe the Euro Stoxx 50 index closed down 121.76 points, or 3.40%. Meanwhile, the FTSE 100 fell 3.49% and Germany’s DAX closed down 407.42 points, or 3.19%.

In Asian markets Japan’s Nikkei 225 was down 940.63 points, or 4.29%. China’s CSI 300 was down 3.44%.

In Australia, the S&P/ASX 200 is down 206.50, or 3.10%.

West Texas Intermediate crude oil is US$45.89 per barrel. Brent crude is US$51.01 per barrel.

Turning to gold, the yellow metal is trading for US$1,637.58 (AU$2,507.12) per troy ounce. Silver is US$17.52 (AU$26.82) per troy ounce.

One bitcoin is worth US$8,847.43.

The Aussie dollar is worth 65.64 US cents.

What’s the lesson from history?

Red flags can fly for a long time…but sadly few ever take notice of the warnings.

Central banks have been building a debt-funded economic growth machine for decades. Credit-fuelled consumption has created the illusion of prosperity.

The machine stalled — temporarily — in 2008/09 and it resulted in the worst economic downturn since the Great Depression.

Central bankers most definitely do not change their spots.

Since the GFC, central banks have mobilised their forces to inject a further US$110 trillion of debt into the system.

The wealth created (unless cashed in) is all fake. One prick of the asset bubble and we’ll see share and property values tumble.

Central banks have also promised so much. We’re hard wired for growth, growth and more growth.

There is no surrender or retreat on meeting this objective…even when the central bankers know the strategy of more and more debt is a proven failure.

They are locked in…irrespective of the damaged caused in the longer term. Small business closures. Retirements shattered. Homes foreclosed.

Here’s a few red flags that people are not noticing.

The official data on unemployment and GDP growth is an artificial construct.

These are not necessarily real indicators of what’s actually happening in an economy.

Here’s a screen shot from the Australian Bureau of Statistics website on the definition of employed…

Money Morning

Source: ABS

[Click to open in a new window]

Seriously, one hour paid or unpaid constitutes employment?

Pub test anyone?

Roy Morgan Research — based on a more realistic definition — undertake their own survey on the Australian employment landscape.

That data paints a different picture to the one presented by the ABS.

Money Morning

Source: Roy Morgan Research

[Click to open in a new window]

The ABS reports Unemployment at 5.3%. Roy Morgan has it at 9.7%…nearly double the official rate.

According to Roy Morgan, Australia’s ‘Un and Underemployed’ is estimated to be 18.4%.

And in the US, ShadowStats also publish alternative unemployment data…based on a more accurate definition of what constitutes employment.

Money Morning

Source: ShadowStats

[Click to open in a new window]

The ShadowStats ‘Un & Under-employed’ rate of 21% is a long way north of the US official U6 (un and underemployed) rate of 6.9%.

Defining people out of existence — those discouraged from looking for work or moving them off unemployment benefits onto disability/sickness welfare — is one way of lowering the numbers.

Another is making the definition of employment so broad that almost anyone qualifies.

Since 2010, US ‘un and under-employment’ has remained stubbornly high. Yet, the US economy is booming.

How is that possible?

The old ‘US$3 debt for $1 growth’ swap.

Inject US$20 trillion of debt to generate US$6 trillion of GDP.

Money Morning

Source: Federal Reserve Economic Data

[Click to open in a new window]

Versions of Germany’s 1930’s ‘miracle’ economy have appeared over the decades…Japan, Spain, Iceland and Ireland come to mind.

In due course, Australia will also be added to that infamous list.

They all track the same pattern…debt, more debt, even more debt and finally, POP.

Some ‘miracles’ last longer than others, but they all meet the same fate…a severe recession/depression.

That’s what happens when people are lulled into a false sense of security.

They are told to believe one thing, when in reality, they should be making preparations for an entirely different outcome.

Confidence levels rise

The longer the period of uninterrupted success, the more confident people become.

They believe ‘it is peace for our time.

But in reality, the more peaceful we think it is, the closer we are to turmoil.

The US Consumer Confidence Index chart shows a clear pattern of rising confidence (blue line) being closely followed by the grey bars (recession).

Money Morning

Source: Advisor Perspectives

[Click to open in a new window]

The current consumer confidence reading is the second-highest since 1977…only pipped by the euphoric peak of the dotcom boom.

Note the green bars on the bottom of the chart…annual GDP growth.

You’ll see there’s a red arrow, tagged ‘Regression’, that runs slightly down from left to right.

That’s the long-term downward trend in US economic growth. Yet, against this trend you have the US share market hitting all-time highs.

A red flag of the utmost importance

Deciding whether to include the following chart in this week’s update was a real struggle for me.

It’s a great chart. But it is very complicated.

There’s so much data going on here, that it’s more confusing than clarifying.

The firm that produces charts like this do excellent technical work, but trying to convey that in an easy narrative is not easy.

Anyway, I decided it was too important not to share with you.

Think of this chart as past US market battles waged…going back to 1920.

There are times when the US market makes no real advancement — Secular Bear (the yellow shaded areas).

And, there are times when the market marches forward — Secular Bull (the green shaded areas).

Money Morning

Source: Real Investment Advice

[Click to open in a new window]

Like all military campaigns, fatigue sets in.

After an extended period, the forces of the Secular Bull or Bear surrender and another trend begins.

Since 1920, there has been a tremendous amount of data gathered from these battles.

The extent of the advancements of previous Secular Bulls (the green peaks above the 70 line) and how far the Secular Bears have retreated (the jagged lines below the 70 line).

Over the past century intelligence has been gathered on the emotional energy that pushes the market higher or lower.

The MACD (Moving Average Convergence/Divergence) is a technical indicator designed to identify the strength, direction, momentum and duration of a trend.

The MACD is the chart right at the bottom…with the arrow comparing the present bubble with the one that existed in 2000.

With that background, I’ll hand it over to the good folks at Real Investments to distil down the messages in this chart.

They start with…

…this chart is not about short-term trading but the long-term management of risks in portfolios. This is a quarterly chart of the market going back to 1920.

And that’s what we’re about long-term management of risks.

Here’s the first red flag (emphasis added):

Note the market has, only on a few rare occasions, been as overbought as it is currently. The recent advance has pushed the market into 3-standard deviations above the 3-year moving average. In every single case, the reversion was not kind to investors.’

Followed by this one…

Secondly, in the bottom panel, the market has never been this overbought and extended in history.

These are very dangerous times, yet, judging by confidence levels, people do not see the warning signs.

The final commentary accompanying the chart was this:

As an investor it is important to keep some perspective about where we are in the current cycle, there is every bit of evidence that a major mean reverting event will occur.

Don’t get lost in the mainstream media. This is a very important chart.

There are numerous red flags flying.

The forces of the Secular Bear are being marshalled.

I believe that all the ground gained in recent years (and more) will be surrendered to these forces.

The best way an investor can have peace in these times and get a nice quiet sleep is to be invested in cash.

Vern Gowdie