Today, we’re going to revisit yesterday’s subject – something so surprising and counterintuitive that almost no one expects it or is prepared for it.
We’re talking about a sudden disappearance of dollars.
For a brief time – perhaps three days… maybe three months – Americans will wonder what happened to their money. The greenback will become more precious than gold… perhaps even a matter of life and death.
But we’ll come to that in a moment…
First, a dear reader wrote to ask about our new “Trade of the Decade.”
The trade in question is not based on any forecast. We simply take a look at what has gone up the most in the last 10 years and sell it (or “go short,” as they say on Wall Street). On the other side, we look for what has gone down the most and buy it.
We let mean reversion do the rest…
(In statistics, “mean reversion” describes the phenomenon whereby extreme variables – such as stock and bond prices – tend to move back toward their average over time.)
At the beginning of this decade, the best trade we saw was to buy Japanese stocks, which had gone nowhere but down for the preceding 20 years, and to sell Japanese bonds, which had gone nowhere but up.
The trade had a not-so-hidden logic, too.
Japan was clearly borrowing itself into bankruptcy. At some point, people would realize that Japanese government debt was not worth what they had thought it was worth. They’d sell their Japanese government bonds (JGBs).
But what would they do with the money?
They would have to buy Japanese stocks.
So, how are we doing so far?
The Nikkei 225 – Japan’s equivalent of the Dow – has gone up from 10,654 to 18,703 points. In yen terms, that’s a gain of 75% since the start of 2010.
JGBs, on the other hand, have not gone down as expected – yet. They’re still going up in price (with yields falling). The price of the 10-year JGB has risen from 139 to 147, in yen terms – or about 6%.
That leaves us with a net gain of about 69% in yen terms.
Not too bad. But if we are keeping score in dollars, we have to adjust for the drop in the yen. This takes our net dollar gain down to about 30% so far. (Remember, this is a trade of the decade; we still have another five years to go.)
Still, we’re happy with that. And we’re going to be a lot happier when investors finally wake up and realize their JGBs are worthless.
There’s still a lot of juice in this trade…. especially because Japanese stocks are still relatively inexpensive.
As colleague Steve Sjuggerud put it in his new True Wealth Market Intelligence service, “The best value in developed markets this month is Japan.”
Now, let’s return to the line of thinking we took up yesterday.
We remind readers that we live in such a topsy-turvy financial world that it is hard to tell up from down and backward from forward.
Central banks and central governments issue more and more debt. But the price of debt goes up… so that the yield on $2 trillion of developed-world sovereign debt is now negative!
In other words, lenders pay borrowers to take their money. Go figure.
Meanwhile, the world economy is slowing. US corporate profits are falling. And US stock prices are so high relative to the earnings they produce that it would take a miracle to give investors a decent rate of return over the next 10 years.
Former Value Line equity analyst, and our go-to guy on stock market valuations, Stephen Jones tells us that the rate of US stock market gains is slowing.
There aren’t many examples from the past, says Stephen, but they suggest that gains will go lower and lower, until they become negative:
On October 3, when I last wrote the note, stocks were up 17.2% from one year earlier. Today, March 5, stocks are up 12.2% from a year earlier.
Forecasts are always tough, and there is not a lot of precedence at these high valuation levels. But this slowdown appears likely to continue, and thus position us with 0% year-over-year returns sometime over the coming year.
Again, precedents are few, but they have resulted in roughly 50% market declines.
Whether that 50% collapse happens next week or five years from now, we don’t know.
But when it happens it is likely to set in motion an alarming series of events that will lead to a temporary, but violent, monetary shock…
People will go to their banks to get cash. But the banks won’t have any cash. The ATMs will run dry.
There will be a “run on the banks,” to use the old-fashioned term. People will line up, desperate to get cash. Not because they fear the bank will fail… but because they need cash to pay for the necessities.
“Wait a minute,” says French colleague Simone Wapler (or words to that effect).
“Governments are already trying to stop people from using cash. In France, transactions of more than €3,000 [$3,292] in cash are forbidden.”
In the US, too, cash is suspect.
Ask your bank for “too much” cash… and the bank is obliged to report you to the feds. And if the police stop you and find a lot of cash, they are likely to confiscate it.
“You must be doing something illegal,” they’ll say.
(In fact, the Justice Department recently revealed that US police departments seized more than $6 million from citizens in roadside stops in the recent fiscal year – despite not pursuing any criminal charges against their “suspects.” It’s all part of the Justice Department’s “Civil Asset Forfeiture” program.)
So, what would cause cash to come back into style… suddenly and overwhelmingly?
What would cause a panic into dollars?
The “Buffett Indicator” Flashes a Warning
|by Chris Hunter, Editor-in-Chief, Bonner & Partners|
Take your pick of valuation ratios. They’re all at or near extremes.
But today, let’s look at Warren Buffett’s favorite – the total value of the stock market relative to GDP.
In 2001, Buffett told Fortune magazine that market cap to GDP was “probably the best single measure of where valuations stand at any given moment.”
That’s bad news for investors. Because the US stock market is the most expensive it’s been relative to GDP in the last 100 years… bar an eight-month period in 1999 and 2000 at the peak of the dot-com boom.
And you know what happened next…
Add in the contraction in US corporate profits in 2015… and the picture becomes even bleaker.
According to Bloomberg, profits for S&P 500 companies are expected to come in at 2.3% for 2015 versus 5% last year.
So, what’s keeping this market afloat?
One big tailwind for stocks, as we mentioned on Wednesday, is the record level of share buybacks. (Remember, when companies buy back their shares, they cancel them. This means each outstanding share represents a higher percentage of earnings, which makes them more valuable.)
Bloomberg reports that the biggest source of funds going into the US stock market is companies buying their own shares.
They’re outspending speculators and exchange-traded funds by a 6-to-1 margin.
P.S. Are you prepared for the next downturn? Make sure to check out Braden Copeland’s latest research report. Braden reveals the simple steps you can take now to protect your savings… and how you can even profit in the next panic. Read on here for full details.