Why the Entire World Is Heading For Negative Interest Rates

The threat of Japanification spreads across the globe

Credit: Jase Bloor

In January 2016, the Central Bank of Japan made a remarkable decision: for the first time, the Japanese economy would feel the effects of a negative interest rate. After decades of low productivity and commerce, the central bank had no other option after running out of ideas on how to create economic growth.

Ever since the 1980s, Japan’s economy remains in limbo due to an aging population. As the ratio of workers to retirees keeps decreasing, Japan has hit a breaking point and continues to experience stagflation with little to no improvement in GDP growth. A Goldilocks state: not too hot and not too cold.

Originating from The Lost Decade: a prolonged period of slow economic growth in the Japanese economy, “Japanification” is the latest phrase to describe the ongoing problem of stagnation we see across the world. As economies globally experience little to no prosperity under the current fiat monetary system, many are starting to undergo the process themselves.

Following Japan’s population peak in 2008, there are clear signs of Japanification in other parts of the world. Countries with low birth rates such as Sweden, Denmark, and Switzerland, are already following in the footsteps of Japan having introduced negative deposit rates in their interbank markets— the overnight lending market between banks.

If the global trend of Japanification continues, the next economy to experience its full effect is China with its population set to peak in 2029 — mainly due to the one-child policy launched by the Chinese government in the 1970s. And while the European Central Bank (ECB) is predicting Europe’s population will peak in 2044, the biggest economy in the world, the U.S, has the slowest rate of population growth since 1937 during the midst of the Great Depression — now that’s food for thought.

Recent political and monetary concerns around the world have exposed the fragility of economies with slowing population growth: Trade war tariffs, a crisis in money markets, and Brexit uncertainty caused the majority of central banks to stop raising interest rates and reverse the process trying to counteract any damage done.

As the most influential financial institution, The Federal Reserve, cuts rates from 2.5% to 1.75%, along with other major central banks like the Reserve Bank of Australia, clearly there’s something very wrong with the global financial system as it fails to stabilize in an environment of rising borrowing costs. Monetary stimulus is the screw missing from the global economic engine and without it, consumers — who have little to no savings — can’t borrow money on the cheap, causing the system to fall apart.

Therefore, central banks will do, in the words of Mario Draghi, “whatever it takes,” to maintain stability within the financial system even if that’s by introducing negative rates. Many central bankers around the globe are open to the idea with former Federal Reserve chair, Janet Yellenconsidering them in 2016, and recently the new head of the ECB, Christine Lagarde, saying, “in the absence of the unconventional monetary policy adopted by the ECB — including the introduction of negative interest rates — euro area citizens would be, overall, worse off.”

But while central bankers are hinting at the possibility of going or staying below zero, the consensus within the finance community is it’s unlikely to become part of central bank policy in major economies like the U.S, United Kingdom, and Australia. Jim Cramer, the Mad Money host, says, “It’s a sign of weakness,” and Wall Street veteran, Milton Ezrati, remarks, “Not any time soon,” showing distinct signs of a confidence bubble in central banks being able to save economies in the developed world without implementing negative rates.

But here’s the status quo: every major economy is echoing Japan’s issues: the declining demographics, the central bank stimulus, and the excessive printing of money — problems that aren’t going away any time soon.

As the entire world follows the same economic model and design, it’s almost a certainty that we’ll voluntarily or involuntarily embark on one of the riskiest monetary experiments of our time: a globally synchronized world of negative interest rates.

Why Bitcoin Isn’t Digital Gold

Real money is subjective no matter how you look at it. Whether you are a crypto nut or a gold bug there’s always someone who’s going to disagree with you on what the best form of money is. Money is anything that the vast majority of people believe in and can be used as a medium of exchange for goods and services.

Money, therefore, is confidence. But confidence is fragile: it’s easy to lose and almost impossible to win back. Throughout history, countless things have been accepted as a medium of exchange: feathersshellsbeads, you name it. Before being replaced by successors, all these commodities were once the monetary standard of civilizations, governments, and ancient tribes.

Gold is the latest commodity to be used as money and many perceive it to be the ultimate form — especially by Austrian Economists while not so much by Keynesians. There’s speculation within the financial community that the failure of the current fiat system is approaching, and many expect the precious metal to play a major role in the next monetary standard whatever that may look like. The main contender to gold’s revival is Bitcoin which continues to rise in popularity due to mainstream coverage fueling one of the biggest speculative bubbles in history — before it burst in late December 2018.

Recently, Bitcoin has been given the moniker “digital gold” by many crypto companies and evangelists who are marketing it as an alternative to the shiny metal. But does it hold up to scrutiny? As it turns out, the popular cryptocurrency has some work to do before it lives up to that title.

Is Bitcoin a Safe Haven?

Throughout history, gold has been the ultimate safe haven: a place of refuge and security for vast sums of money. Produced during the collision of neutron stars its invulnerability provides a perfect store of value. Bitcoin, however, has a few flaws.

Due to its digital nature, it’s destructible. Once your wallet is wiped, hacked, lost, or stolen, there’s no guarantee you’re getting your money back. And it’s even possible to be the victim of a victimless crime: ask James Howell who lost a small fortune forfeiting over $80 million by forgetting his password.

The most important property of a safe haven is its ability to protect your wealth during financial crises such as the bursting of the tech and subprime bubbles. Because everyone is too optimistic, safe havens are cheap by the time things start to turn bad causing them to appreciate dramatically in a crisis-style environment.

But Bitcoin is already expensive costing $7,000 per coin while gold only costs $1,500 per (troy) ounce. Why overpay by almost five times to protect your wealth while you also know that gold performs well during periods of financial difficulty? This is the question that highlights a problem with the “digital gold” moniker: it’s clear that Bitcoin, in its current state, isn’t a safe-haven while gold ticks all the boxes.

The Issue of Evolution

What makes gold an incredible store of value is there’s only one type in the entire universe, so for Bitcoin to become gold’s digital counterpart there can only be one cryptocurrency.

Except with around 5,000 cryptocurrencies now in circulation, it’s only a matter of time before a competitor overtakes Bitcoin’s dominance. As the successive cryptocurrency gains the biggest market share, it will slowly cause Bitcoin to weaken and eventually become a novelty currency like the Zimbabwean dollar. But the vicious cycle of evolution will continue as another cryptocurrency is likely to supplant Bitcoin’s successor.

Gold, on the other hand, can’t be replicated, modified, or destroyed and has been used as money successfully multiple times throughout millennia. The reason why the precious metal isn’t used today isn’t due to its fundamentals but the poor monetary policy decisions and interventionism we see in modern monetary theory that, over history, has resulted in the fall of several civilizations — including the Roman Empire.

Because there’s no successor to gold but thousands of potential replacements for Bitcoin, we can’t really count that as a positive for the cryptocurrency being named digital gold.

The Lack of Usability

Imagine you’re at the checkout and your shopping basket has $50 worth of essentials for the week ahead. You open your Bitcoin wallet and try to pay but the payment processor declines your payment. The reason why wasn’t because you lacked the funds, it was because during the 10-second transaction a big swing in the price of Bitcoin caused the value of your money to depreciate enough so you couldn’t complete the payment. With significant price moves being a daily occurrence in Bitcoin markets, the cryptocurrency fails to gain usability outside the crypto world.

Meanwhile, gold’s value is tied to the physical supply that increases on average 2% each year resulting in a stable price. In the past, there have also been big moves in the price of gold — such as Nixon decoupling the precious metal from the U.S dollar — but they’re a rarity, allowing gold to be utilized as a money-backed currency.

It’s uncommon knowledge nowadays that gold is one of the most commonly used metals. It’s used in jewelry to increase the overall value and rarity of a particular piece. In the electronics industry, every sophisticated device including several parts of a computer contains tiny fragments acting as a reliable conductor of electricity, and it’s even used to treat medical conditions such as rheumatoid arthritis.

Unfortunately, the same can’t be said for Bitcoin. Although it’s the best medium of exchange out there, it has no other use at this time.

The Bullish Case for Bitcoin

In the future, crypto fans are hoping for Bitcoin to become the new global reserve currency replacing the U.S dollar. Regardless of the negative fundamentals, there’s speculation that the price of cryptocurrencies will skyrocket in a financial crisis as they are denominated in fiat currency terms. The theory states that investors will rush to exchange their fiat currencies into Bitcoin causing a huge price rise as governments begin to utilize them around the world.

But they are forgetting one thing: in such an event fiat currencies lose all their value and become worthless. As confidence shatters there’s nothing of real value backing the currency as insolvency of a government isn’t a viable medium of exchange. The very thing you are trying to convert your profits into will have no value.

Recently, a particular type of altcoin has been establishing itself: crypto-currencies backed by gold. Bitcoin may be a great medium of exchange but it’s yet to be a great currency and let alone money in its current form. So for the world’s most popular cryptocurrency to earn the prestigious title of digital gold, it has to combine the revolutionary elements: distributed ledger, accessibility, and connectedness with the backing of the precious metal itself — an unstoppable force that will change the monetary world forever.

Adam Neumann: The First Billion Dollar Redundancy

How WeWork’s founder walked away with a fortune

Credit: Eloise Ambursley

Love him or hate him, Adam Neumann, the founder of WeWork, has walked away with a whopping 1.7 billion dollar severance package, smashing the previous record of $417 million held by Jack Welch — the former CEO of General Electric.

As for WeWork, the company’s valuation continues to decline losing 80 percent over the last few months, causing the most important shareholder, Softbank, to enter full cost-cutting mode: the New York Times reported the company plans to lay off 30% to 50% of WeWork’s workforce —up to 6,000 employees — by the end of 2019.

WeWork’s valuation got ahead of itself because we’ve entered the euphoric stage of the business cycle, which creates an abundance of cheap money, and where there’s cheap money, you’ll find malinvestments.

The market is starting to expose crazy valuations and companies that only have the aim of “going public.” A phenomenon where you no longer need to build a successful, profitable business but instead create enough hype for investors to keep buying into your idea. To get rich quick in a market based on loose monetary policy, all you have to do is IPO your company, offload your stock when the lockup period expires, and run for the nearest exit — dealing with any backlash later.

At a glance, it may be confusing as to why any business, let alone WeWork, would pay out such an enormous amount of money to an ejected CEO, and especially to one who tried and failed to go public. Your initial judgments are probably along the lines of fairness, equality, and ethics: why are they handing out huge sums to ex-employees over current employees? But as outsiders in this scenario, it’s easy for us to rush to the conclusion that they are rewarding poor management instead of rewarding faithful employees.

In reality, severance packages are anything but a bonus or a way of saying thanks for all the hard work. They are, in fact, a damage control tool: a bribe to brush over the range of complex issues created by firing a high ranking employee.

With a public company like Softbank facing so much scrutiny, $1.7 billion will be a small price to pay to protect the company’s reputation and image as opposed to what would happen if Neumann remained as CEO. Despite the rapid devaluation of WeWork, it remains a solid part of Softbank’s Vision Fund portfolio, and if a CEO is costing the company millions — or in WeWork’s case billions — then paying them a small fortune for a quick dismissal is a sound business strategy.

Severance packages offered by companies in crisis create a bizarre dynamic: the more damage a CEO does, the more they get paid.

If there’s one thing Hollywood gets right, it’s severance negotiation in the boardroom. When a corporation is in full damage control and an employee has access to potentially damming inside information, such as dodgy filings or financial accounts, the company can literally offer hush money in exchange for a nondisclosure. So when you compile the speculation from journalists and insiders about WeWork’s questionable figures, it makes sense why many believe Neumann has signed nondisclosures that would contribute to the size of his severance package.

Employment law is another major threat to a company: If a CEO feels at all hard done by then there’s a chance of an impending lawsuit, and it could take weeks, maybe months, to resolve with the CEO still in their position. This could cost a company millions not just because of litigation costs but generally what the CEO is doing to make a company unprofitable. Whether that’s due to a failing business strategy or a loss of confidence from shareholders, a potential lawsuit is a nightmare scenario for any board, especially for companies like WeWork, creating a big incentive to offer a significant payout.

In the end, it’s not about equality, fairness, and ethics: it’s all about damage limitation at whatever the moral cost. When the health of a company like WeWork is under stress the board is only thinking about one thing: the financial ramifications of keeping the CEO in their position. Neumann’s gigantic payout shows just how crazy the world of venture capital is right now as severance packages offered by companies in crisis create a bizarre dynamic: the more damage a CEO does to a company, the more that CEO gets paid.

How to Survive a Black Swan Event

Credit: Negative Space

Market risk happens slowly then all at once

19th October 1987, also known as Black Monday, was the day investors never thought possible: a 22.2% fall in the U.S stock market. It was perhaps the most mysterious black swan event in history as nobody knew for sure why it was happening.

It was a day that most investors want to forget as they witnessed the full force of a global stock market selloff, and how fear sparked more fear creating a self-fulfilling loop of panic selling. Markets reacted instantly and there was no way to get out, unless, of course, you were willing to accept a heavily discounted price for your holdings.

Yet it was just another day at the office for a few smart investors who knew to protect themselves in advance. Like everyone else, they already had a fancy broker and a diverse portfolio of stocks, foreign currencies, bonds, and commodities. But what gave them an edge was their ability to withstand the most contagious psychological force in finance that many investors succumbed to leading up to the events on that fateful day: extreme greed.

When times are good, extreme greed forces even the most rational of thinkers to avoid paying for protection: the failure to sacrifice a few gains to secure profits. Greed turns us into irrational beings so we think we can predict the unpredictable and assume the unassumable, but, in reality, anything can happen at any time, at any pace.

Surviving a black swan compels us to overcome this greed, shielding our investments from any event of any magnitude, whether that’s the U.S subprime market collapsing, a European sovereign debt crisis, or an event that’s yet to occur. But you don’t need to be an expert in math, science or psychology. Protecting your investments doesn’t require complex arithmetic or the latest computer algorithms from Wall Street’s Intelligencia. Instead, it comes down to two approaches: the passive approach and the active approach.

The Passive Approach

The passive approach is for passive investors. For people who live busy lives managing their jobs, side hustles, and kids. Whether you have a pension, a brokerage account, or even a Vanguard fund, all these financial products have exposure to the stock market, and if the stock market falls dramatically — say 22.2% or more — it’s going to impact your investments.

With events like Black Monday occurring every so often, we need to be preemptive so we can sleep well at night knowing we are protected. The passive approach is to utilize long term Options which provide a simple, passive shield against black swan events.

As options are maximum risk instruments, the price you pay for the option is the most you can lose meaning you don’t have to worry about your insurance blowing up as well. For example, let’s say you start with a hypothetical $100,000 portfolio of stocks and the market is up 30% over a year and a half. Now you are looking to preserve your $130,000 for the latter half of year two so you decide to use around 5% ($6,500) of the portfolio as insurance against a market you believe to be overvalued. You obtain $SPY put options that expire in six months, which — at current prices — are a bit over budget at $7,050.

A few days later, and it’s Monday morning. You wake up and turn on the T.V, but unfortunately, another Black Monday is wreaking havoc in the stock market which falls 22.2% over the trading session. This is what happens to your portfolio, with and without protective puts:

Black Monday Without Options Protection

Portfolio Value Before Market Open: $130,000*
Portfolio Value After Market Close: $101,400

Black Monday With Options Protection

Portfolio Value Before Market Open: $130,000*
Portfolio Value After Market Close: $127,727

* Not $122,950 because the option has yet to lose any value.

When the market drops 22.2% your $130,000 becomes $101,400 without protection. But if you bought a put option it’s now worth $27,485 saving you over $21,550 ($130,000-$101,400-$7,050) worth of losses from the crash.

But remember this is just Black Monday. We have yet to see a 50% down day or more in U.S stock markets and that’s when having protection really pays off. This scenario happens more often than you think: recently Argentina’s stock market halved overnight due to the surprise election victory of Alberto Fernandez.

If, however, the world is in a better place six months from now then you’ve sacrificed $7,050, but now you know it’s a sacrifice worth making.

The Active Approach

The active approach, also known as the long-short approach, is the defacto strategy that professionals use to manage risk at financial institutions such as hedge funds and investment banks.

There are only two types of real-world portfolios: long-only and long-short. While with a long-only portfolio you buy and hold stocks, with long-short portfolios you buy, hold and short-sell them. The typical long-short portfolio of a professional money manager consists of around 20 stocks: 10 stocks long: betting that a stock will go up, and 10 stocks sold short: betting that a stock will go down.

Now let’s compare the two styles and see how they fare in a Black Monday scenario. We have a long-only portfolio consisting of 5 stocks, and a 10 stock long-short portfolio consisting of five longs and five shorts. Both portfolios total $100,000 in value.

As you can imagine, each portfolio performed slightly differently on Black Monday. In the examples below, note that we adjust stock moves by their volatility using Beta: a measure of how stocks move relative to the market as a whole. For instance, if a stock moves 20% more than the market on an average day then the stock has a beta value of 1.2. So when the market drops 20% we adjust the value of the stock which, in this example, will lose an additional $640 on top of the market loss of $2,000. Therefore, our $10,000 worth of stock becomes $7,360 instead of $8,000.

A Long-Only Portfolio Example on Black Monday

Ford: ($20,000-(($20,000 * 1.2) * 0.22) = $14,720
Caterpillar: ($20,000-(($20,000 * 1.4) * 0.22) = $13,840
Wingstop: ($20,000-(($20,000 * 1.1) * 0.22) = $15,160
Amazon: ($20,000-(($20,000 * 1.2) * 0.22) = $14,720
Facebook: ($20,000-(($20,000 * 1.1) * 0.22) = $15,160
Total Before Market Open: $100,000 
Total After Market Close: $73,150

A Long-Short Portfolio Example on Black Monday

Ford: ($10,000-((10000 * 1.2) * 0.22) = $7,360
Caterpillar: ($10,000-(($10,000 * 1.4) * 0.22) = $6,920
Wingstop: ($10,000-(($10,000 * 1.1) * 0.22) = $7,580
Amazon: ($10,000-(($10,000 * 1.2) * 0.22) = $7,360
Facebook: ($10,000-(($10,000 * 1.1) * 0.22) = $7,360
Macy’s: ($10,000+((10000 * 1.2) * 0.22) = $12,640
Netflix: ($10,000+((10000 * 1.3) * 0.22) = $12,860
Gap: ($10,000+((10000 * 1.0) * 0.22) = $12,200
Shakeshack: ($10,000+((10000 * 1.2) * 0.22) = $12,640
Walmart: ($10,000+((10000 * 0.8) * 0.22) = $11,760
Total Before Market Open: $100,000
Total After Market Close: $98,680

As you can see, a long-short portfolio is the best antidote to a black swan event like Black Monday with only a small drawdown compared to a five-figure loss by being long-only.

But, of course, having the time to learn how to trade profitably using the strategy is an art that only a small percentage of professional investors get to master — and a bigger drawdown is the price the rest of us have to pay.

The Takeaway

Implementing just one of these two strategies will help you sleep at night knowing that whatever the market does, you’ll be able to survive the next black swan event. No matter how big or how small and whatever it may look like, both passive and active approaches provide certainty and stability even against a zero situation.

But before we get to implement them, a major hurdle we face is identifying and overcoming extreme greed which, in other words, is the bizarre fear of not wanting to protect ourselves from a financial disaster — the reason why most investors fail to meet their investment goals over a long period of time.

If we can’t eliminate this habit then we can’t implement protective measures that help us manage risk in markets; a risk that could increase at any time in the morning, afternoon, or at night. The period before Black Monday is a testament to this: a nonvolatile, quintessential calm before the storm.

A Storm Is Brewing In Technology Stocks

Photo by Usukhbayar Gankhuyag on Unsplash

US/China Multifaceted Wars

If you thought the tariff war between China & US would cause some meltdown in tech stocks you would be correct but only in the eastern hemisphere. China has resorted to sacrificing it’s stock market for as long as possible by deleveraging debt and devaluating it’s currency as an offset to Trump’s tariffs. All the Chinese have to do is devalue the yuan to the percentage that offsets the latest round of tariffs imposed by President Trump therefore having no effect on the cost of exporting goods to the US.

The current mood towards the stock market in China is completely indifferent to that of the US. China will happily tank their stock market if required to maintain their political status quo. Under a communist rule by the Communist Party of China social mobility and cohesion ranks higher than profits and gains driven in the Shanghai Composite.

As investors start to see that China is on the brink of stock market meltdown and the EM debt crisis causing flatlining stock prices, the US tech sector has gained an artificial safe haven status alongside defensive sectors and the US dollar. Investors are flocking into the dollar as a safe haven trade and US equities have outperformed other world stock markets in 2018 dramatically.

Tech Earnings Growth Has Peaked Dramatically

What the EPS estimates show is something to behold. Analysts are currently estimating that stocks such as NVDA and INTC have negative next year EPS YoY growth estimates of around 80%~ compared to the previous year yet stocks have continued to rise even after Q2 earnings releases. The hilarity ensues as analysts are still maintaining strong buys on the stock even though the growth potential for next year’s earnings has dwindled to single digit figures. Current earnings estimates tend to only matter until the second quarter earnings releases and after that next year’s earnings start to matter a lot more on Wall Street.

80%~ Drop Year on Year EPS Growth In Major Tech Stocks (Source: Zacks Investment Research)

We have seen this kind of false optimism occur many times before. Every analyst had a Buy or Strong Buy rating on Apple stock in 2011 however 12 months later it was trading at a 50% discount to the sector and retail investors who had made money on the way up in the previous year ended up breaking even. This shows that tech stocks are in classic bubble territory where investors are loaded up on fake optimism and no one is really looking at the actual numbers.

FIRRMA Effects Are Being Underestimated

If you think the US tech sector has weathered the perfect storm you would be mistaken, this is just the beginning of the multifaceted war between China and the US. President Trump has another powerful weapon up his sleeve to create even more market uncertainty in the future; introducing The Foreign Investment Risk Review Modernization Act (FIRRMA).

“A close-up of the dome of Capitol Hill in Washington D.C.” by Jomar on Unsplash

The act is part of reform enacted by the The Committee on Foreign Investment in the United States and was signed into law recently on August 13th, 2018. The bill essentially grants Trump greater powers over Chinese business influence in the US such as prohibiting company takeovers and the transfer of new technologies. As China continues to steal technology from US through various channels Trump has a new trick in his playbook and can cause a cataclysmic effect on tech stocks by limiting Chinese investment not just in the technology sector but also in telecommunications and defensives.

“Shutting off the second biggest market in the world (China) to technology related investments will cause a major correction and revaluation of technology stocks in the US market.”

Once Trump starts to use this weapon it is likely to cause severe pain for the tech sector as a whole but the most pain will be seen in extremely high beta stocks such as chip makers and testers that operate research and development facilities in both the US and Asia regions.

A Missile Pointed At Chip Stocks

FIRRMA has the potential to kill the rapid growth in any company who sells or licenses technology developed in America to non-U.S. customers. For AMD this is particularly worrying since they carry out research in facilities located in both the US and China.

We see the same risk factors in every chip stocks’ annual report:

Uncertain global economic conditions have in the past and may in the future adversely impact AMD’s business, including, without limitation, a slowdown in the Chinese economy, one of the largest global markets for desktop and notebook PCs.

We conduct product and system research and development activities for our products in the United States with additional design and development engineering teams located in Australia, China, Canada, India, Singapore and Taiwan.

AMD Annual Report 2017

So what happens when AMD’s Chinese facilities make a breakthrough? The Chinese can easily issue countermeasures to seize technological advances before it ever reaches the US mainland. Chip companies rely on providing technological breakthroughs hence it allows them to beat their competitors in gaining contracts with important clients further up the value chain. This could have disastrous effects on the bottom line of chip making companies like AMD as governments seize their means of production.

China’s Likely Response: Technological War

China retaliates in a copycat fashion and expect nothing but the same from The Communist Party. Anything the US has done to hurt China, China has replicated. So imagine how the market will react when both sides start to engage in technological armageddon. The result inevitably is a major correction in the tech sector which has the potential to push major US indexes down sharply due to the highly cyclical nature of tech stocks.

ISM Report on Business Is Flatlining

The main indicator for economic health indicator the ISM Report on Business has rebounded from it’s yearly lows in February 2018 where world markets plunged 10% the month earlier however its beginning to look like a downtrend in growth is occurring. What we could be seeing is the topping out in the US which would only add to the decline in stock markets worldwide. So what does this mean for tech stocks?

The Warning Signs Are There

Taxes kill growth and the victims are the technology, telecommunications and defence companies. An exit strategy to get out of tech stocks at the right time is hard but looking at the headwinds in the future and understanding what the effects of FIRRMA could be on the global tech industry is a no brainer. Reducing tech allocations in stock portfolios will likely to be a big theme in the near future as the reality strikes home.

What matters is how the media reacts to FIRRMA in the coming months and Trump’s weaponisation of the new legislation in order to give the US a temporary edge in the multifaceted war which in turn will have the Chinese respond with similar countermeasures. I will be keeping an eye out on the ISM reading for August if it continues trending downwards we could be seeing a massive downward move in technology stocks that is long overdue.

The trick is to get out before it’s too late.

The Potential Chilean Crisis

Emerging market uncertainty has finally hit Chile.

The Chinese Economy Owns Chile

Emerging market turmoil has finally hit the mainstream and financial media can’t get enough. Coverage of the crisis you are witnessing in Turkey & Argentina didn’t happen overnight but developed slowly ever since the financial crisis in 2007/08. Other emerging market economies such as South Africa & Ukraine have also reached crisis levels but nobody seems to be talking about Chile.

What connects an Asian superpower and a relatively small South American country? The answer is globalism and primary metal commodities. In a globalized world, China’s thirst for growth has led to a rapid increase in the demand for copper and iron ore which coincidentally are Chile’s top two export markets totaling 40%. This spells trouble in the future…

Source: OCED Data.

Primary metals demand has been a boon for the Chilean economy however for expansion to continue the Chinese and their insatiable demand for copper needs to grow at a similar pace. This was true until early 2018 due to the US/China multifaceted war and ballooning debt levels causing major problems in China’s financial infrastructure. The tariff countermeasures placed on the US by China have barely had any effect since the US stock market is still pricing in Trump’s tax cuts.

However, the opposite is true for China who still rely solely on massive US consumption. The charts below demonstrate the declining growth as shown by the correlation between Chinese business sentiment and the Shanghai Composite, a stock index composed of the top 50 Chinese companies.

China Caixin Manufacturing PMI YTD Correlation w/ Shanghai Composite

The Asian superpower is on the brink of negative GDP growth and the pain is already being felt in third world economies. As history has shown time and time again the weaker links in the chain will break before the contagion reaches mainland China. The global economic rout has already started in EM countries like Argentina & Turkey and fear is spreading to China’s more stable neighbors like Japan, Hong Kong & South Korea.

The cracks are now starting to show in Chilean data. Chile’s balance of trade has turned negative requiring them to dig into reserves in order to pay for imports. Graph 2 shows something even more concerning, if the economy of any major trade partner collapses Chile is vulnerable, they can only afford to pay for five months of imports before they run out of reserves. In the event of an economic recession, Chile would require immediate financial assistance to avoid defaulting on its debt.

Chile’s Ballooning Private Debt

After the financial crisis, the world’s central banks pumped trillions of fiat money into the system to temporarily keep their economies from completely collapsing. Artificially low interest rates, a side effect of money printing, allowed Chile to borrow cheap money from the US in dollar-denominated debt. As China began to expand once again the uptick in trade boosted Chilean exports hence optimistic business sentiment and employment. Citizens have been on a domestic credit-fuelled binge ever since resulting in private debt almost reaching 200% of GDP.

Years later we are in a higher interest rate environment and Chile’s addiction to cheap money has backfired as it’s cheap money no longer. Now the Chilean economy is contracting at a rapid pace, unemployment is ticking up and default rates are set to increase as citizens will find it harder to finance their credit-fuelled lifestyles.

If China continues to contract, commercial banks like Banco De Chile are in for a rough ride as default rates will skyrocket causing profits and revenue to plummet. A gun is also pointed at the Chilean Peso. The central bank of Chile may be forced into action and print excessive amounts of currency to rescue the banks resulting in a large percentage currency devaluation and capital flight.

It all depends on the severity and duration of China’s economic rout and rate hikes from the Fed. Chile will pay the price for not taking into account that trade globalization has unexpected and unforeseen circumstances. Once you rely on a foreign entity to produce a large percentage of your gross domestic product you better have a Plan B. Chile doesn’t seem to have that up their sleeve.

The Truth About Trumponomics

Why presidents manipulate asset prices for political gain

Trump has been aware of the mess also known as US economy for a while now. The subject became part of his presidential campaign as he spoke openly about the current economic situation in America. The president has been a recent critic of the Fed expressing his opinion about their decision to hike interest rates, despite the rest of the world and especially emerging markets being under immense pressure as a result. Trump knows that if these markets collapse, “contagion” will likely spread to the United States a lot faster than expected.

Potus is now in a tough situation, he could drop his pride, accept reality and let the economy tank or totally backfire on the criticisms he made about the financial system before he became President. Unfortunately, he has taken the latter option in the form of tax cuts. Trump wants to take credit for the so-called booming economy by selling the idea to businesses and corporations who understand that cutting taxes would grow the economy. In reality, it is not that simple…

The Trump Administration didn’t tell you the tax cuts will add just over $2 trillion to the national debt.

The tax cuts were only possible because of this! Effects of the stimulus package are only temporary. The White House has only widened deficit spending and raised the debt ceiling yet again. The more the President props up the stock market and real estate asset bubbles the bigger they will burst next time round. As long as the economy grows and inflation keeps ticking up they will take on as much debt as possible to achieve that before the whole system comes crashing down. The Fed knows the debt ceiling is now a red herring, it is completely meaningless and no one in government takes it seriously.

Trump has no intention of giving in either. He will happily try and keep the ball rolling, especially now in early fall when the midterms are just around the corner. The last thing a President wants is the economy tanking a month or two before midterm elections, this is a death sentence politically. The tax cuts are now showing positive effects for GDP growth and Trump couldn’t be happier. Conveniently for him, their effects on the economy are likely to last for years…

The tax cuts allowed Trump to inflate the economy in order to maintain a red state through the midterms and possibly achieve a second term.

The economic madness we are witnessing in the present day didn’t start with Trump or Obama, it started with the Bush Administration. This is not the first time a president has manipulated the stock market for political gain. In recent history, George Bush Jr. refused to let the Tech Bubble play out under his first term and looked to seek a second term.

The former president lobbied Alan Greenspan, then chairman of the Fed, to issue a huge stimulus package temporarily delaying the effects of the looming recession and created an asset bubble in real estate which eventually morphed into the subprime crisis seven years later. Market optimism witnessed at this time boggled the mind of professional economists who saw through the bullshit. Tech startups who proclaimed to be the next big thing and had only operated for a single business quarter, were supposedly worth the entire GDP of New Zealand when in reality all they had on their balance sheet was an NYC rental office and a copy of Microsoft 2000.

If Bush didn’t issue financial aid to support the economy, there was zero chance he would ever be re-elected mainly as the aftermath of the tech bubble could have resulted in disastrous consequences matching that of the Great Depression. This is exactly what Trump is trying to avoid, delaying the inevitable recession long enough so he can seek another term. This reveals something quite sinister…

Presidents have no choice but to inflate the bubble further because politically they don’t want to be held responsible for causing the next Great Depression.

So where are we now? The truth is the US hasn’t recovered and there are so many signs that point to this. Just because house and stock market prices are rising doesn’t mean the economy is booming. A politicians urge to stay relevant results in them intervening with the free market and as a result creating artificial bubbles of economic growth.

Stock market prices are artificially high due to stock buybacks that are financed by the tax breaks which conveniently push up stock prices. Mortgages are being financed and backed by the government! Anything state-sponsored Wall Street touches goes up in price and they haven’t learnt anything since the Subprime crisis. They are aware that if they go under, there is a high probability that the government will attempt to bail them out.

Velocity of the M2 money stock is the frequency at which the average same unit of currency is used to purchase newly domestically-produced goods and services within a given time period. The fact money is changing hands at a slower rate as time goes by indicates that ever since 2001 the economy hasn’t recovered but actually contracted. The chart shows that even after the Subprime Crisis was “officially over”, velocity didn’t pick up as it should do. This is why many economists don’t believe we are in a recovery because using logic and reason velocity would be through the roof in a booming economy by now.

If we look further afield, it’s even scarier what the rest of the world is doing. Every economic superpower under the false pretense that the US dollar has any sort of reserve currency status, followed the same destructive economic policy! Instead of decoupling from the US central banks have played copycat due to the fact the global economy still relies heavily on American consumers.

Central bank balance sheets are now completely out of the control. In order to decrease them governments need to sell the bonds they own into the money markets. This will cause a decrease in money supply, resulting in higher interest rates and tightening of credit which is the last thing Trump wants right now. The president wants inflation, inflation and more inflation which is the ideal environment for a real estate tycoon and a president seeking economic growth.

We are in the longest bull market in history. The Fed have tried everything to keep biggest bubble in America’s history from bursting. This is the reality. When you repeat a lie such as “the economy is better than its ever been”, over and over again it starts to become truth, it’s the oldest trick in the book.

We need a president who will let the bubble burst and let an actual recession take it’s proper course. This will destroy the US economy temporarily but another Great Depression allows America to pay off their national debt and become a net creditor once again. We might even start to produce more than we consume. Whether you are a supporter or not of the current president, you have to acknowledge the possibility that there is no real recovery. All that the Trump administration is hoping for is that the effects of his tax policies subsequently wear off after re-election.

Predicting The Housing Market Is Easier Than You Think

Wouldn’t it be great if you could predict future house prices? If possible then you’re a step ahead of the market; while everyone else is in a state of euphoria piling their money into real estate, you’ll be able to sell your assets before the inevitable market crash.

The housing market doesn’t collapse overnight, crashes materialize over months rather than hours. Property is extremely illiquid when compared to stocks — there are limited buyers and sellers for each unit — hence creating enough time to recognize when things are starting to go right and wrong.

This framework will allow you to identify and take positions in the market; benefiting from housing euphorias, booms and busts, months before the mainstream start reacting. You’ll effectively become a housing market insider, using solid housing fundamentals and leading indicators to predict the future market.

Once you have a solid foundation in place, you will have the confidence to start investing — or taking advantage of doom and gloom — in the housing and real estate markets even without owning anything physical, but more on that later…

Step 1: Identify powerful leading indicators

Identifying the housing markets’ leading indicators is the key to predicting future price movements. The big three; building permitshousing starts, and new homes sales are the most reliable for predicting housing market health in the U.S. Released once every month respectively, the data associated with the indicators can be freely downloaded from the internet.

At the start of each month, building permits predict the number of new housing starts; new housing starts predict the amount of new homes sales and the cycle starts over. It’s a feedback loop that is missed by many traders in the financial markets. Combining all the indicators on one chart, we get a great indication of what drives house prices up and down.

If you’re not located in the United States, you can find indicators for your home country with a simple Google search.

As you can see from the chart above, the three indicators allow you to predict future house price movements. The red line shows the U.S. house price index lagging all three indicators. Once housing related indicators start to trend one way over an extended period, house prices stall and then reverse in the opposite direction.

The Subprime Crisis of 07′ started to occur when house prices peaked; at this time consumer’s main income was house price appreciation. If you knew these indicators existed, you could’ve sold your real estate investments at their highs long before the crisis occurred.

The cycle is identifiable over history: The leading indicators peak, starting to report contraction as house prices begin to increase at a slower pace. They eventually decrease as supply overcomes demand and real estate valuations plummet. Once the global economy starts to recover, so does demand for housing, confirmed — once again — by rising building permits.

Step 2: Use the stock market as an indicator

In the U.S., the S&P500 index is the main barometer of the economic health, composed of the top 500 U.S. blue-chip companies — some housing related. Investors use global stock markets to express their view on the real estate and housing sectors. For example, if investors think the U.S.’s housing bubble is about to burst they will start to sell or short stocks related to the American real estate and housing market.

The S&P500 index versus US housing indicators

As the chart above demonstrates the S&P500 trended downwards during the Tech Boom and Oil Crash of 2015 while building permits continued to trend higher. Therefore, it’s a powerful indication of a potential housing bust or boom when the S&P500 starts trending along with the building permits indicator — look closely at August 2007.

If the housing market performs poorly, that doesn’t mean the S&P500 moves in tandem with our indicators, in fact, housing stocks also tend not to follow the index either; they follow our leading indicators instead.

Homebuilding stocks follow building permits, housing starts, and new home sales

Diving deeper into the market we can find stocks that follow and lag our leading indicators.

$XHB is an exchange-traded fund (ETF) tracking the stock prices of home-building companies within the U.S.

Stocks that make up the ETF follow our housing indicators with an almost one-to-one correlation; prices begin to rise and fall when there is a demand/supply shock in the market.

Homebuilders started to struggle and contract in 2007, long before the S&P500 tumbled. The doom and gloomers — who turned out to be right — began taking positions in credit default swaps on mortgage bonds just before the subprime crisis occurred, using stocks as an indication of decreasing sentiment within real estate and housing sectors.

What we’ve learned is the stock market can predict a housing crisis long before the crash occurs! It’s also important to remember that real estate and housing stocks follow the leading indicators we’ve utilized and not the stock market as a whole because the former is the most accurate barometer of housing sector health!

Step 3: Assessing the market’s liquidity

US Government Bond Yield Spread — also known as the Yield Curve

Interest rates and credit spreads play a considerable role in the availability of credit to build houses. Most consumers and businesses don’t just buy a plot of land upfront with capital; mainly because the average joe doesn’t have $500,000 in cash to blow on real estate. They finance the cost using credit borrowed from the banks and other financial institutions like Fannie Mae and Freddie Mac.

These institutions make a profit by borrowing short-term paper usually in the form of government bonds (U.S. Treasuries) while lending it out to customers over the long-term at a higher rate. The difference between the short and long-term interest rate — net interest margin — allows the banks to make their money. If the difference in the interest rate of short and long money becomes flat — or even worse negative — then it is almost impossible for banks to stay profitable.

Net interest margin matters to the housing sector because if banks can’t lend to clients and other banks in the interbank money markets, the availability of credit reduces rapidly — the supply of loans therefore affects how many houses can be constructed.

House prices are starting to correlate inversely against the Yield Curve

An inverted yield curve is not necessarily a panacea for a market crash, but it should make you aware of the potential problems that lie ahead in the future for the housing market.

Ever since the Dot-com bust in 00′, house prices move inversely to the yield curve, indicating that the housing market will be the next bubble to burst eventually. We can come to this conclusion as the only thing keeping house prices propped is the availability of credit within the system — this will be tested when the Yield Curve inverts.

House prices are 30% higher than when the last housing bubble burst in 2007, indicating that even more credit has been pumped into the system than ever before; when the next crash occurs the effects could cause a severe decline in house prices.

Step 4: Analyse housing-related commodity prices

An indicator lagging all others is the commodity price of lumber. When the price of lumber crashes — like in July 2018 — it usual coincides with a peak in house prices. This makes sense: if there’s a decrease in construction demand, prices have to fall to counteract the excess supply.

There may be temporary noise in the media, but the only real factor that affects the price of lumber is supply and demand. If there is no demand for wood products, it’s a clear indication that there is a severe demand shock ahead for the market. You can be confident the smart money is watching.

Lumber prices have crashed, declining over 50% since July 2018

As the chart above shows, lumber prices precede housing stock prices. A significant crash in the lumber price is followed by stagnant house price growth. Wood products are created at the manufacturing stage in the supply chain and therefore takes time for the lack of demand to reach the manufacturer. You’ll witness this effect in every industry — if you research technology retailers vs. semiconductors, this is a prime example.

When the lumber price crash occurs it is the nail in the coffin for the housing market — something is significantly wrong.

Step 5: Predicting the future housing market

When analyzing the information gathered over the preceding steps we can come to the following conclusion: looking at the fundamentals, it’s pretty apparent there’s pain ahead for the housing market. Prices are starting to peak, and we are witnessing a slowdown in growth similar to December 05′.

Yield Curve: Approaching Inversion: Negative Outlook.Homebuilder Stocks: Down 29.78% since Jan 2018: Negative Outlook.REITs: Down ~20% or more since Jan 2018: Negative Outlook.Lumber Prices: Crash of over 40% in July 2018: Negative Outlook.

It’s too early to know for sure whether the decline will become a long-term trend but if we observe the current state of homebuilders, real estate, lumber prices, and the Yield Curve, the “smart money” has already priced in a crash. It looks like the stagnant U.S. economy is having an effect on the housing market and we may be entering a period of deflation in house prices.

Step 6: Speculate without owning physical assets

If you are looking to invest or speculate on sentiment within the housing sector, REITs (real estate investment trusts) allow you invest without owning anything physical; they are traded on stock exchanges around the world.

If you don’t have time to endure the stresses of taking out a mortgage, renovating a property and paying for upkeep and maintenance costs, then you can consider using REITs to express your view.

Real estate investment trusts are required by law to pay back 90% of their profits to shareholders. Therefore, REITs have some of the highest dividend payouts in the stock market ranging for 3–12%. If house prices don’t appreciate you still receive the annual dividend interest!

The REIT market is global: if you live in the U.S. but would like to invest in Singaporean real estate, you can simply log in to your brokerage account and buy or sell the stock in Singapore. Due to being traded on stock exchanges, you can also short them if you feel like the market is going to crash — this also applies to homebuilders and other housing-related stocks.

Last Word

Patience is critical in investing. Therefore, you might have wait for over a year to see how the market pans out before you consider profiting solely from house price appreciation. If you’re feeling brave you can also speculate by shorting housing-related stocks if building permits, housing starts, and new home sales continue to decline over the coming months.

I wish you the best of luck when entering the property market and hope the upcoming market crash doesn’t hurt you too badly. Looking at the analysis, anyone who says it’s not going to happen, is in for a big surprise.