Why Australians Are Sleepwalking into a Nightmare

[Publisher’s note: We have published several books in the last year. None cover a more pressing issue than Vern Gowdie’s The End of Australia. It’s a strictly limited print run. So if you want to put your name to a copy and have it mailed to you, you need to let us know RIGHT NOW. You can do so here.

Why is this book more vital than any we have ever published? Because in it Vern deep-dives into the central issue facing Australian investors: What will happen — particularly in Australia — when the next big global financial hits? No other work that we know of has carried out such a detailed investigation. The facts Vern uncovers in ‘The End of Australia’ are pretty shocking. But the ‘plan for the worst/hope for the best’ wealth strategy he outlines is compelling. Every investor should be taking these five precautions now, says Vern.

Why? Because when the next global share market rout occurs, we will not have a mining boom to protect us. And we’ll get an idea, very quickly, of just how fragile our economy has been for some time now… What will that share market rout look like? And how close might we be to it? Read Vern’s sobering essay below for more…]

Why Australians Are Sleepwalking into a Nightmare

No one sees what we are seeing.

Are we blinded by our bias, or are they oblivious to what’s going on?

And so went a recent conversation with a good friend about the rise and rise of the US share market.

Are we missing something, or is it a case of being patient for the switch to be flicked from boom to bust?

To help rationalise this disconnect between what we think is a fait accompli and what the herd is doing, we draw inspiration from acclaimed psychologists, Kahneman & Tversky.

In their book On the Psychology of Prediction they wrote:

For if we can explain tomorrow what we cannot predict today, without any added information except the knowledge of the actual outcome, then this outcome must have been determined in advance and we should have been able to predict it.

The fact that we couldn’t, is taken as an indication of our limited intelligence rather than of the uncertainty that is in the world.

Based on the data we have, the outcome of this financially irresponsible experiment by a handful of central banker PhDs has been determined in advance. Record debt levels; downward wage pressures; historically high price to earning ratios; unfunded and unaffordable welfare promises; the sheer volume of boomer retirees; ultra-low interest rates; QE used to inflate asset prices; excessive corporate debt funding for buybacks and not for capital investment; too much supply and not enough demand.

The outcome is that the system will collapse.

As I show in my new book, The End of Australia, the lack of recognition of this actual outcome is an indication of limited intelligence…more specifically the fact that very few people possess financial intelligence.

When markets are running hot, how many people ask the question, ‘Why is this so?’

The majority simply accept that this is the way it is. Questions are rarely asked in boom times. No one wants to jinx the market.

The failure to recognise previous patterns of human nature is the reason history is doomed to repeat itself.

Those famous four words…‘this time is different’

It’s like most trends – at the beginning it’s driven by fundamentals; in the end, by speculation. It’s just like the old adage: “What the wise man does in the beginning, the fool does in the end.”

Warren Buffett

Actually, when people say ‘this time is different’ it proves it’s not different…because that’s what they always say to rationalise away the irrational behaviour of the mob.

The speculative end of the trend is evident in a recent article titled: ‘BAML Survey Of Asset Managers Says “Boom” Best Describes Market’.

Here’s an extract:

Major asset managers have been deploying cash. The BAML [Bank of America Merrill Lynch] Fund Manager Survey (FMS), released February 14 [2017], is a monthly survey of 200-250 primarily long-only investors.  The report showed that major asset managers have been deploying their dry powder, as cash holdings dipped to 4.9% from 5.1%.

The stock market is a buy, the BAML report noted, as cutting in cash holdings is supported by strong investor sentiment.

The ‘boom’ is supported bystrong investor sentiment’.

The following chart depicts the four stages of a bubble:

  1. Stealth: smart money buys in
  2. Awareness: the institutional money buys into the trend
  3. Mania: the public want a piece of the ‘easy money’ action
  4. Blow-off: watch out below.

Greed and delusion — which manifest themselves in ‘this time is different’ assertions — is where I think we are at today.

Source: Hofstra University, New York
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The predictability of human nature is what makes the phases of a bubble so easy to plot.

This is from the article that accompanied the above graph (emphasis mine):

Bubbles can be very damaging, especially for those who arrived late with the hope of getting something for nothing. Even if they are inflationary events, the outcome of a bubble’s blow off is very deflationary as large quantities of capital vanish in the wave of bankruptcies and financial defaults they trigger. Historically, they tended to be far in-between, but between 1995 and 2008 three bubbles took place back-to-back; the stock market (deflated in 2000), real estate (deflated in 2006) and commodities (deflated in 2008).

Tearing up large chunks of capital is deflationary for one simple reason…people have less to spend. Which is why the Fed and other central banks had to flood the markets with liquidity after 2008/09. They were trying to create Ben Bernanke’s theoretical ‘wealth effect’.

Given that the world is already wrestling with deflationary forces — cheap labour, excess productive capacity and the increasing uptake of automation — the next market crash could take us into a depression.

The article notes that, historically, bubbles tended to be few and far between.

Their tempo increased after 1995.

Greenspan, Bernanke and Yellen have proven to be serial bubble blowers. When confronted with the natural ebb and flow forces of a market, the Fed’s programmed response is to ‘prime the pumps’.

Giving rise to the next (bigger and more damaging) bubble.

Source: Quantitas Capital
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The reality is that asset prices cannot permanently outgrow underlying economic activity.

Facilitating easy access to an abundance of cheap money can and does cause a deviation from the economy. However, the deviation is temporary, not permanent.

The orange line (US GDP) eventually exerts a gravitational pull on asset prices (blue line).

When the bubble cycle makes a full rotation, those who hoped to get something for nothing will find out the hard way that this time is not different.

Why America matters

My new book, The End of Australia, drills down to what the next big financial crisis will look like at ground level in this country. And it focuses on some steps you can take right now to protect yourself. (If you’d like a hard copy while we’re still mailing them, you’ll need to be quick. I’m told just 10,000 copies have been printed. You can reserve one here.)

But why, in a book about Australia, do I spend quite a bit of time looking at the US markets and economy?

My approach to investing is more macro than micro. I am a lousy stock picker — as are a lot of professional fund managers. But at least I admit it.

If we can get the big trends reasonably right, then we can participate in the wave up and avoid the inevitable crash.

You’ll never pick the bottom or the top. The aim is to invest somewhere in the ‘Stealth’ phase and exit in the ‘Mania’ phase.

It’s a given that you’ll enter a little late and leave too early, but no one ever went broke taking a profit.

Successful investing is about making a considered risk versus reward assessment.

When markets are in the ‘stealth’ phase they represent a low risk/high reward proposition. In the ‘mania’ phase there is a distinct and fundamentally important reversal in market characteristics — high risk/low reward. As the ‘mania’ phase continues, the market dynamics become extremely high risk/negative reward.

Yet, the majority read the signs differently. In their mind the market is signalling ‘no risk/really high reward’ in the mania phase and ‘high risk/no return’ in the stealth phase.

Identifying trends and making judgement calls is how I manage my money.

The following graphic on who’s who in the global economic zoo, shows you why we have to take notice of the 600-pound gorilla on the other side of the Pacific Ocean.

If you look closely, on the bottom right (around four o’clock on the chart) you’ll see Australia…at 1.8% of the global economy.

In the scheme of things, we do not matter.

Source: Visual Capitalist
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If something goes awry in the US, China or one of the big four in Europe, we’re caught in the downdraft.

Given the interconnectivity resulting from globalisation, it’s not hard to see why dominoes falling in one part of the world will eventually reach our shores.

The Western world and China dominate the global economy.

Each one of these major players is grappling with the same problems, to varying degrees.

Massive debt overhang; demographic issues (less births, more retirees); low wage growth; youth unemployment, and rising levels of lower and middle class unrest.

The global economy is more fragile than most people think.

All it takes is for one significant piece of this economic puzzle to experience a contraction, and we have a world of trouble.

Watching what’s happening beyond our shores is like an over-the-horizon radar…hoping to spot a problem in advance and take the necessary precautions to protect our capital.

When the US share market falls 50, 60 or 70%, the All Ords will play follow the leader.

Why deflation is so persistent

The US economy is 70% consumption.

With average US household income stuck in a time warp — not buying any more than it did in the 1970s — the fight for the US consumer dollar is intense.

The rise and rise of Amazon, at the expense of traditional retailers, is evident in the following graphic.

The American consumer (as well as the Aussie, UK and European consumer) is looking to make their dollar/pound/euro stretch further by turning to online suppliers.

The destruction in shareholder value of the major retailers over the past decade is breathtaking. Sears is down 96%. JC Penney is down 86%.

A decade ago these were not penny dreadful stocks. They were retailing institutions.

Even the giant Walmart has only managed to stay static.

Source: Visual Capitalist
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Amazon is coming to Australia, and the same level of creative destruction is likely to happen to our major retailers. There will be a knock on effect to yields from Real Estate Investment Trusts (REITs) with large exposures to shopping centres.

The deflationary trend of online consumption is only going to embed itself into the system, as the negative loop of retail closures, staff lay-offs, the reduction in penalty rates and lower yields on REITs force more and more people to seek more ‘bang for their buck’.

Mix in the deflationary effect of an asset bubble bursting, and we have the very real potential to experience a Greater Depression.

To quote another famous Buffett truism, ‘Be fearful when others are greedy and greedy when others are fearful.

I fear that most people are completely unaware of the unsustainable pressures building within the global economy.

Thanks to history, we know the outcome — the ‘wealth effect’ asset bubble will burst. The economic fallout will be far worse than 2008/09, and social unrest will escalate.

Now is a time to be fearful. Remain cautious. And unlike the US investment institutions, keep your powder dry.

Vern Gowdie

[Publisher’s note: Hard copies of Vern’s new book The End of Australia: The True Story of Australia’s Coming Economic Collapse and How to Survive It started mailing yesterday. Just 10,000 have been printed, and I’m told 500 were reserved in just the first few hours. This mailing campaign won’t last long. To reserve your copy click here.]

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Vern is a contributing editor to Money Morning — Australia’s biggest circulation daily financial email. (To have Money Morning delivered straight to your inbox you can subscribe for free here).

Vern has been involved in financial planning since 1986. In 1999, Personal Investor magazine ranked Vern as one of Australia's Top 50 financial planners. His previous firm, Gowdie Financial Planning, was recognized in 2004, 2005, 2006 & 2007, by Independent Financial Adviser (IFA) magazine as one of the top 5 financial planning firms in Australia.

Vern has been writing his 'Big Picture' column for regional newspapers since 2005 and has been a commentator on financial matters for Prime Radio talkback. His contrarian views often place him at odds with the financial planning profession. In his leisure time Vern remains active with triathlons and pilates.

Money Morning Australia