Why You Must Stop Living in Your Head

In today’s Money Morning…the bull market still climbing a wall of worry…the conditions for a real crash just don’t exist right now…and more…

While everyone was wringing their hands about property yesterday, the stock market just got on with it. The ASX 200 jumped 50 points to above 5,900. It’s now at its highest point since May 2015.

This bull market is climbing the traditional wall of worry. That doesn’t mean it’s not going to correct from time to time. It will. Guaranteed. We just don’t know when, or by how much.

But chances are any future correction will be just that — a correction. Not a crash. A crash happens when everyone has bought into the market and liquidity is tightening. That’s not happening.

There are still many people sitting on the sidelines waiting for the crash to happen. It doesn’t work that way. We’ve got a long way to go before we get another credit crunch-type crash. I’ll explain why in a moment.

But first, let’s look at what might be getting the market excited…

China!

The Middle Kingdom is set to release its first quarter GDP numbers today…just 11 days after the quarter ended. That’s some feat of statistical gathering. The expectation is for an annualised growth rate of 6.8%, which is higher than the government’s latest growth target of 6.5%.

That’s thanks to good old infrastructure related stimulus spending, which is the tried and true way for China to tweak its growth rate. The only problem is that this growth model comes with rising debt. But who cares about that, right? Everyone is doing it.

And besides, it’s government debt, so it doesn’t really matter. They owe it to themselves!

That’s all fine until it’s not. But no one knows when that ‘not fine’ moment will hit. So in the meantime, everyone pretends it never will. Isn’t 21st century finance great?

As I’ve pointed out previously, if you want to track China’s 21st century growth model, just follow the iron ore price. That’s recently corrected more than 20% from its peak, which suggests that China is slowing down again, albeit marginally.

But for how long? They seem to have an unending stream of projects to call upon. As the Wall Street Journal reports:

Faced with a slowing economy, the central government early this month announced an ambitious plan to build a new economic center located between the capital and port city of Tianjin. State media have compared the Xiongan New Area in Hebei province with the creation of similar zones in Shenzhen in the 1980s and Shanghai’s Pudong in the 1990s.

Will this be enough to support the iron ore price, or will it continue to fall and return to the dark days of the 2012–15 bear market?

Monitoring Fortescue Metals [ASX:FMG] share price will help to answer that question. It’s a pure iron ore producer, and sends nearly its entire production to China.

As you can see in the chart below, the share price has corrected sideways for a few months now. But it looks like it could be heading lower. A move below $5.50 will suggest the trend is turning and that the iron ore price could struggle for some time. Let’s see what happens…


Source: Bigcharts
Click to enlarge

No credit crunch in sight

Did you read the sad story about the apparent suicide of New York fund manager Charles Murphy? He was wealthy and successful, but happiness eluded him. He suffered from depression and worried about things that others simply couldn’t see.

His boss, hedge fund billionaire John Paulson, spoke at his funeral, as reported in the Wall Street Journal:

“The mind can play tricks with oneself, distorting reality,” Mr. Paulson said. “No matter how much those close to him tried to help, and no one tried more than Annabella, Charles could not see a path forward…his mind created a trap from which he couldn’t escape.”

I don’t mean to trivialise depression and its devastating effects. But we all live life in our mind. Or rather, our mind creates the narrative by which we live life. Sometimes that narrative is a dark one.

Or sometimes, it’s just driven by fear. Like fear of another stock market crash.

But, to overcome fears, or to see if they’re warranted, you need to deal in facts. Right now, the facts don’t support the ‘crash thesis’. Let me explain why…

A 2008 style credit crunch and stock market crash occurs when liquidity evaporates. That’s why it’s called a crunch. At some point, and all at once, market participants want to get out of all risk-based assets (like stocks, commodities, corporate bonds etc.) and into cash or cash-like instruments, such as US treasuries.

But in a crunch, there is never enough cash to satisfy the demand for it, and so stocks keep falling to balance out supply and demand. That is, stocks fall to become so cheap that owners no longer want to sell for cash.

In a credit crunch, the relative value of cash increases sharply, while the relative value of stocks plummets. Because of the fear of loss, people are willing to hold very expensive cash and dump very cheap equities.

To correct this imbalance and end the panic, central banks inject huge amounts of cash into the system. They do this by lowering interest rates or, when interest rates can’t go lower, they buy government bonds with newly created cash.

Soon enough, there is plenty of cash around and then, when people regain their senses, they see that stocks relative to cash are cheap, and they begin buying. Stocks recover.

The things is, even nine years after the crash, there is still plenty of cash in the system. Europe and Japan are still on the QE bus. The US Federal Reserve has only just started taking excess cash out of the system by increasing interest rates.

If another panic unfolds for whatever reason, there is plenty of cash still sloshing around to satisfy the demand for it. That’s why I said earlier that any correction will be just that. It won’t be a full on crash.

The time to worry about these things and get defensive is when all the ingredients are there for it to happen. Right now, that’s just not the case.

There is always an emotional argument for a crash. It’s still vivid in our memories. But our memories are in our head, and they’re in the past. It’s time to live in the now, and see what’s really going on.

Our fellow Money Morning Editor, Sam Volkering, isn’t letting anxiety about an unlikely crash stop him from hunting down the best small-cap stocks for his readers. Sam has found an opportunity in a small Aussie biotech stock that he believes could be on the cusp of a massive growth stage. You can find out more here.

Regards,
Greg

From the Port Phillip Publishing Library

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Greg Canavan is a Feature Editor at Money Morning and Head of Research at Port Phillip Publishing.

He likes to promote a seemingly weird investment philosophy based on the old adage that ‘ignorance is bliss’.

That is, investing in the Information Age means you have all the information you need at your fingertips. But how useful is this information? Much of it is noise and serves to confuse, rather than inform, investors.

And, through the process of confirmation bias, you tend to read what you already agree with. As a result, you often only think you know that you know what is going on. But, the fact is, you really don’t know. No one does. The world is far too complex to understand.

When you accept this, your newfound ignorance becomes a formidable investment weapon. That’s because you’re not a slave to your emotions and biases.

Greg puts this philosophy into action as the Editor of Crisis & Opportunity. As the name suggests, Greg sees opportunity in a crisis. To find the opportunities, he uses a process called the ‘Fusion Method’, which combines traditional valuation techniques with charting analysis.

Read correctly, a chart contains all the information you need. It contains no opinions or emotion. Combine that with traditional stock analysis and you have a robust stock-selection strategy.

With Greg’s help, you can implement a long-term wealth-building strategy into your financial planning, be better prepared for the financial challenges ahead, and stop making the basic, costly mistakes that most private investors do every time they buy a stock.

To find out more about Greg’s investing style and his financial worldview, take out a free subscription to Money Morning here.

And to discover more about Greg’s ‘ignorance is bliss’ investment strategy and the Fusion Method of investing, take out a 30-day trial to his value investing service Crisis & Opportunity here.

Official websites and financial e-letters Greg writes for:


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