In late July, the small cap stocks in the US did not follow their larger brethren to new highs, which is called divergence. Divergence along with overvaluation and bullish enthusiasm are signals of a potential sell off. Is that happening now?
Was last week's sell-off the first sign of a bubble deflating or just a temporary pull back? There is no way to really tell with certainty. There is reason to worry though, even the Chairman of the US Federal Reserve has noted, that certain sectors of the equities market are “over stretched”. Meanwhile, the financial press in the US and the UK have their own bubble of writing about bubbles. They have been writing more stories that include the word “bubble”, over the past 18 months than ever before. And there is certainly a lot to write about.
Let's start with equities. During the dotcom boom, the boom was largely localized in dotcoms, hence the name. But in the US today, the entire market has high valuations. The cyclically adjusted price/earnings ratio (CAPE) is 60% above its 130 year average. The Q ratio (Tobin’s Q) one of the most accurate means of valuing equities markets has been higher only in 1929 and 1999. The percentage of profits of US GDP always reverts to mean. As of now, it is at levels seen after the second world war. Not just the US, but almost every other market everywhere, is close to or already at highs, despite some slowing growth. Brazil’s market is only 5% off its all time high, but growth has been slowing since 2010.
Then, there are the bonds, really almost too many to mention. There are junk bonds, which have been at record low yields. Then there are the bonds of peripheral Europe. For example, Spain received bailouts and has a credit rating, which is 7 levels below the US, but pays the same interest. The rest, including Ireland, Italy, and Portugal also pay relatively low yields.
Don’t forget emerging market sovereign debt. Argentina is really not worth mentioning, but there are ten other countries including Greece, Ukraine, Pakistan, Ecuador, Venezuela, Belize, Egypt, Cuba, Cyprus, and Jamaica with credit ratings below Moody’s 'Caa' rating, which is considered to be either highly speculative or with extreme risks. Other lending to emerging markets is also at a record high. Corporate debt in emerging markets has expanded far more than any other asset class, 500% since 2008.
It is not just corporations and governments that have gone deeply into debt. There may not be as many subprime home mortgages these days, but there are quite a few subprime auto loans. Sales of subprime auto loans in the US are the highest since 2007. About a third of new car sales are subprime and so are two thirds of used car loans. Like the mortgages before them, these loans are securitised and sold on to insurance companies, mutual funds and pension funds. Spending on cars is extremely important in the US. If you discount car sales, retail consumer sales would have contracted in the first half of the year.
Consumer debt is not just an American problem. Consumer debt burdens in Asia are up to 30% higher than in the US. The countries affected include India, Indonesia, Thailand, South Korea, China and Malaysia. There are also potential real estate bubbles in London, China, Hong Kong, Sydney Australia, Canada, and Brazil.
But the problem with bubbles is that it is a matter of personal taste. One person’s bubble is another person’s healthy exuberance. According to legendary investment sage, Jeremy Grantham, a bubble is when prices are two standard deviations above norm. Large bubbles that fit that definition occur once every 31 years. The US market does not quite fit this definition, but Mr Grantham also identified 330 minor bubbles. Only 30 of these did not burst, at least so far, and all were in obscure assets. However if you look at corporate profits alone, the situation right now, easily falls within the definition.
Recently, the chief economist of the Bank for International Settlements (BIS), also known as the central bankers’ central bank, issued a warning. He said that there were dangerous imbalances building up in the financial system. Of course his predecessor had said the same thing in 2003. Although he was right, it took another five years before the bubble burst. The level of debt compared to 2003 is exponentially higher as is almost every asset class.
Janet Yellen, Chairperson of the Fed, believes that interest rates should not be used to control bubbles. She feels that she can use regulations or “macro-prudential policy” to ensure there is no crash. The BIS is appropriately sceptical about this as well. We must remember that Ben Bernanke, the creator of the present massive bond buying program QE, told us before the crash that the subprime mortgage loan problem was “contained”. It wasn’t.
There is one thing about the present market that we do know, at least for the moment. The US Federal Reserve’s program called quantitative easing is ending. So the era of unlimited cheap money will eventually come to an end. Recently, junk bonds have started to sell off. They have been rising for nine consecutive months breaking a record set in 2007. This time a sell off will likely be more of a problem due to the lower liquidity.
There is also something else, which is troubling. The small cap stocks in the US did not follow their larger brethren to new highs in late July. This is known as divergence. Divergence along with overvaluation and levels of bullish enthusiasm are signals of a potential sell off. Is that happening now? We shall see, but we do know that it will happen.
is president of Emerging Market Strategies. An international lawyer and economist, he developed his theories beginning with his first-hand experience and business dealings in the Russia starting in 1993. Mr Gamble holds two graduate law degrees. He was educated at Institute D'Etudes Politique, Trinity College, University of Miami School of Law, and University of Virginia Darden Graduate School of Business Administration. He was a member of the bar in three states, over four different federal courts and speaks four languages.)
James Rickards-Financial Collapse and Massive Shortages in Gold Coming
By Greg Hunter On May 26, 2014 In Media 141 Comments
4By Greg Hunter’s USAWatchdog.com
Financial expert and best-selling author James Rickards’ latest book predicts “the coming collapse of the international monetary system.” One of the sign posts is countries like Russia declaring it will shed the U.S. Dollar as reserve currency in international trade. Rickards explains, “Putin said he envisions a Eurasian economic zone involving Eastern Europe, central Asia and Russia. The Russian Ruble is nowhere near ready to be a global reserve currency, but it could be a regional reserve currency.”
Rickards’ latest best-selling book, “The Death of Money,” was released in April. Even Rickards is surprised at how fast the economic situation is unfolding. Rickards says, “If you ask me what has happened since you finished writing the book that comes as a surprise, I would say a lot of the things I talk about in my book are happening faster than I would have expected. Things that I thought would happen in the 2015 or 2016 time frame seems to be happening now in some ways. If anything, the tempo of events is faster than expected. Therefore, some of these catastrophic outcomes may come sooner than I wrote about.”
Rickards goes on to say, “Right now, we are on the precipice now. When you are on the precipice, it doesn’t mean you fall off immediately, but you are going to fall off because you can see the forces in play. What I tell clients and investors is it’s not as if we are going to make some mistakes and some bad things are going to happen. The mistakes have already been made. The instability is already in the system. We’re just waiting for that catalyst that I call the snowflake that starts the avalanche. You don’t worry about the snowflakes; you worry about the snow and that it’s unstable and it’s just waiting to collapse. That’s what the system is right now; we are just waiting for a catalyst. People ask me all the time, what could it be? Technically, my answer is it doesn’t matter because it will be something. It could be a failure to deliver physical gold. It could be an MF Global financial failure. It could be a natural disaster. It could be a lot of things. The thing investors need to understand is the catalyst doesn’t matter. It’s coming because the instability is already there.”
On gold manipulation and when it will end, Rickards says, “It will end when the physical shortage gets to the point that someone fails to deliver; which, at that point, there will be a buying panic. There could be a buying panic or what some people call a demand shock. One of the things I said about gold manipulation is if I was the manipulator, I would be embarrassed at this point. The manipulation is obvious. The evidence is coming in from all directions. . . . The manipulation is clear. When will it end? It will end when there is a physical shortage that pops up somewhere, or it will end with a short squeeze.”
Rickards goes on to say, “We are going to get a very large demand shock coming from China and India. Let me explain those two cases. We have a brand new government in India, and they are going to repeal the import tax on gold. We also have the wedding season coming up. . . . So, India is set up for a very large surge in demand in the fourth quarter. Now, over to China, this is one of the things that it’s happening faster than I originally thought. The credit collapse story is happening in real time. I said (in my book) this might be a 2015 event, but it looks like it is happening now. Defaults are piling up. We are seeing money rise. We’re seeing people march down to the banks . . . trying to get their money back. . . . So, if they can’t buy foreign stocks, domestic stocks, don’t want to put their money in the bank and are getting out of real estate, then what’s left? The answer is gold. . . . I see a demand shock coming from China. . . . You could see a scramble to buy gold. It is going on anyway, but you could see it accelerate. That will take down the manipulation. Once the markets prevail over the manipulators, then watch out.”
Rickards says the collapse will happen, but he is not sure of when it will come. Rickards explains, “It is the thing you won’t see coming that will take the system down. Things happen much more quickly than what investors expect.” Rickards adds, “What will happen in gold is that it will chug along and then all of a sudden–boom. It will be up $100 an ounce, and then the next day it will be up another $200 an ounce. Then everyone will be on TV saying it’s a bubble—boom. It’s up $300 an ounce, and before you know it, it will be up $1,000 per ounce. Then people will say gee, I better get some gold, and they’ll find out they can’t get it because the big guy will get it. You know, like central banks and sovereign wealth funds will be able to get the gold. The typical investor will run down to the coin shop and they will be sold out, and the U.S. Mint will say sorry, we’re not shipping. You’re going to find out you can’t get it because the whole thing is set up for massive shortages in supply.”
Join Greg Hunter as he goes One-on-One with James Rickards, author of the best-selling new book called “The Death of Money.”