Sunday, November 13, 2016

You’re bearish… but there is no euphoric stock market!

Have you heard about the investor who has been short selling for the last 5 years or longer and losing his shirt? He may be right (in the end) but the market can keep on going up longer than he (or you) has money left.
But still we’re now quickly approaching another bull market anniversary – eight years since the lows of 2009? Eh… 2010, 2011, 2012, … We never had such a long-lasting bull market!  Even if you start counting from 2011 - the depth of the European debt crisis - we still have a market that gets quite old and tired.  Wow that is some business cycle and like we have said earlier investor sentiment is not exactly bullish or euphoric, so why be concerned?
Yes, stock market investors are not exactly bullish but you don’t have to go far looking for extreme market bubbles!  Yeah, the bond market! These days, in Germany and Switzerland, the bank pays you for borrowing its money (negative mortgage rates). Can you believe it?  So people pay you to borrow money! That means that money, I am talking Cash here, is a liability if you believe the banks and central banks!  No wonder, people buy real estate with money they get paid to borrow and drive up prices in the large cities of the world such as London, New York and here at home in Vancouver and Toronto!  If that is not a distorted market, then what is?  Central banks have been supporting the bull market in all kinds of assets with this low interest or better this negative interest rate policy.  They are printing money from thin air; buying bonds and forcing retirees to put their money in riskier and riskier investments so that aforementioned retirees may still earn an income.
This is a market extreme; an enormous market bubble! And don’t tell me that nobody is seeing this coming?  A lot of people hope that the central banks will keep on lowering interest rates at every whiff of slowing economic growth and stock market weakness. But it has become like pushing on a rubber string with the tool becoming less effective. And if the central banks are no longer printing money out of thin air who is going to lend money at negative rates to companies that are already over-leveraged.  Still, market volatility indexes like the Vix are near all-time lows, i.e. nobody believes that anything can go wrong. Now there is your euphoria!  If nobody believes in a market crash as indicated by the Vix, likely the opposite is to happen!
As explained in the previous post, you may consider yourself an INVESTOR but even for good assets the returns may be falling during a new credit crisis or recession! For several years now, we have promoted to build up your cash. Now we’re saying start protecting yourself even more actively. We have seen credit defaults in the U.S. on the rise. Defaults of triple BBB rated debt (called investment grade) has increased from typically 1 to now 5%. This is the type of debt banks and insurance companies tend to invest in and you know that in-spite of their improved balance sheets the leverage is still many times their own equity.  Having loans default at 5% may trigger higher defaults as happened in the past. Some analysts consider a 5% loan failure rate as the trigger for the start of the default phase of a credit cycle. If the bond market collapses, interest rates will go up if not sky-rocket and guess what THAT will do to the stock market?  Dividend paying stocks, anyone?

Rising interest rates due to a stronger economy is good but if interest rates rise because of increased credit risk that is another story entirely. So, prepare yourself for tougher times ahead. We’re on the edge of a new boom because of the millennium demographics but we may first have to clean-up the mess of a severe phase of credit defaults in the credit cycle.

Apparently, I am SPECULATING that we are close to a recession and/or market crash which makes me more cautious and I am assuming that my investments will throw off less earnings than previously anticipated. That in turn, especially in an environment of rising interest rates may drive stock prices significantly lower.

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