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It is the simple emotion of greed that tends to lead to devastating losses

By David Scott | Monday 9 January 2017


 


The US government has worked tirelessly to manipulate statistics to falsely reflect an overall recovery. The stock market is much easier to manipulate than the fundamentals, so, the fundamentals must be misrepresented.  While some numbers slipping  through issues of true supply and demand continue, the vast majority of the populace has little clue that the collapse of 2008 never actually stopped, it was just shifted into a state of slow motion which is peaking again.
 
The Fed’s low interest rates,  has allowed the economy to sputter along for eight years, and has greatly enriched the top .01% in the process, whilst the middle classes have been decimated  creating a massive social device.. But now, the strategy has to change because the problem is that debt stimulus has a shelf life, and while certain stats can be skewed and the stock market can be inflated for a time, eventually, consequences must be accepted in the real economy for attempting to defy gravity for so long.

 For example, real GDP is probably  -2 percent, not +2 percent as Is claimed, when one calculates for distortions such as government spending, which is counted towards GDP even though government does not actually produce anything. Due to high healthcare, energy and education costs most people's personal inflation over the last few years is at least double if not treble the official number. When talking about the good unemployment level common ratios  refuse to bring up the fact that over 95 MILLION Americans are no longer counted as unemployed by the Bureau of Labor Statistics because they have been jobless for so long they do not qualify to be included on the rolls. 

This lie of reduced unemployment has been pervasive through the entirety of the Obama Administration and the newly created jobs have been generally of very poor quality. The improving housing market is also a myth. Currently pending home sales are plummeting and home ownership rates in the U.S. are so low that you have to go back to 1965 to match them.   The majority of the boost in home sales during Obama’s two terms was due to corporations like Blackstone buying up distressed mortgages and turning the homes into rentals. The housing market is not being supported by individuals and families seeking home ownership, but corporations searching for yield. Wall Street is now America's landlord.
 
I thought there was a good chance that the Italian bank crisis would come to a head in 2016, but yet again The Italians seem to have again delayed the inevitable. But the basic Reality hasn’t fundamentally changed, though. Monte dei Paschi and the other troubled institutions are not going to get better on their own, nor is the new government going to miraculously gain public confidence. Monte dei Paschi has at least 36% of its loan portfolio in the nonperforming category. The Italians have raised €20 billion for a bank bailout fund, but there is serious doubt that will be enough to cover Monte dei Paschi alone. Goldman Sachs estimates that successful recapitalization would require €38 billion, while others it might be closer to €52 billion that is just one bank! Saving Italian banks will take hundreds of billions of euros, which Italy does not have, nor do they technically even have the legal right to unilaterally bail these banks out. They would have to utilize an ECB facility that does not now exist to get that much money, and such a measure would require German approval.

In addition individual Italian investors and savers have invested at least $200 billion in junior, subordinated debt that paid a higher yield than bank savings accounts did and they were told the investment was safe. Think about what would happen if $1 trillion disappeared from the savings of retirees in the US, and then double that number and you’ll be getting close to what the equivalent impact would be.
 
With both retail and institutional investors fully committed to equity ownership, it is not surprising to see margin debt (borrowed money to play the market’s) at record levels and I have two important points to make about leverage. First, there is a view that record margin debt is not a problem, but this is true only during rising markets. Margin debt is a huge problem when equities begin to fall. It is worth noting that when net credit balances move to extremes this tends to occur at the time of a major directional change. The reality is that leverage of the current magnitude is gasoline waiting on a match and when the event eventually occurs, this creates a rush to sell in the markets.

Then the decline in prices will reach a point that triggers an initial round of margin calls (debt being called in). Since margin debt is a function of the value of the underlying collateral, the forced sale of assets will reduce the value of the collateral further triggering further margin calls. Those margin calls will trigger more selling forcing more margin calls, a vicious circle is therefore unleashed. Most worrying to me is that margin debt is still rising as the fear of missing out on potential upside in the market is trumping logic. However, this has always been the case with investors, as they generally chase returns which eventually leads to buying tops and selling bottoms. If history is any guide, this time will turn out to be no different.
 
The ramifications of the US dollar losing its status as the world’s premier reserve currency are difficult to overstate. It will likely be the tipping point at which the US government becomes sufficiently desperate to implement official restrictions on the movement of people and their money, and other forms of overt wealth confiscation. Don't forget for a large part of the twentieth century it was illegal for Americans to own gold. In just the past 100 years, the international monetary system has collapsed three times: in 1914, in 1939, and in 1971 when Nixon severed the dollar’s last ties to gold and with China’s rise and ambitions it appears we are soon due for another major reshuffle of the current dollar-centric international monetary order. Nobody knows the exact date on which the US dollar will lose its prized status, though it is objectively clear that we’re moving in that direction.

The majority of international trade is conducted in US dollars. This means that most countries that wish to engage in trade need to first buy US dollars on the FX market. This creates demand for the dollars, in many cases that would not otherwise exist, which translates into value for the dollar. Therefore Global demand for the dollar is enormous. It has allowed the US government and citizens to live way beyond their means for decades. It also gives the US government immense geopolitical leverage. They can pick and choose who they want to cut off from the US-dollar-based financial system and by extension the vast majority of international trade. Iran & Russia are two recent examples of major global economies frozen out of the global economy by the US.
 
All of these unique benefits, which have been taken for granted for decades, will disappear when the dollar loses its dominant status. That is when the US government is likely to be desperate enough to enact restrictive measures, remember they made it illegal for Americans to own Gold in the past. Once the dollar eventually loses its status as the world’s premier currency, your options to take protective action will likely have significantly narrowed, if not disappeared altogether.
 
My job as an investment manager and adviser is not only to make money for my clients, but also to preserve their gains, and investment capital, as much as possible. This is why, although I am currently considered a bear, I focus on the risks that prevail. Understanding, and analysing, both sets of arguments is crucially important to navigating the markets successfully over time. The very real risk to investors is not missing out on a further rise in the markets, but missing out on the inevitable fall that will wipe out most of the gains from the previous advance or advances.
 
Debt has continued to erode the underlying ability for economic growth to accelerate and with US money market interest rates rising sharply in the last few weeks, the negative feedback loop will likely manifest itself sooner than most expect. However, in the meantime, the promise of a continued bull market is very enticing. But it is important for investors to remember that the aim is to Buy Low/Sell High. This is a simple rule that is often forgotten, as greed replaces logic.  It is also the simple emotion of greed that tends to lead to devastating losses. 
 
Therefore, if your pension (so ultimately your retirement) and investment portfolio, are dependent upon the thesis of a continued bull market, you should be asking yourself how tired this Bull market, the answer is "very".

David Scott works for investment Manager Andrews Gwynne


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