Bubbles, Busts and Income Stocks

Businessman analyzing investment charts at his workplace

Last week was a strong one for global financial markets. Stocks had their biggest rally in nearly two years. On Friday, the Dow and S&P 500 put on nearly 1%. Our market was off to a good start early in today’s session, with the ASX 200 aiming for its first close above 6,000 since 2008.

But this level looks like an important one for the market and will offer a bit of resistance. It might take a little while to clear. Once prices do breach 6,000 points for a few days or a week, there’s a good chance you’ll see record new highs in the following months.

The US Federal Reserve was behind last week’s market rally. In a sign of just how ‘dovish’ the Fed is, the market assumed that interest rate tightening would begin sooner rather than later. It’s not often the market overestimates the Fed’s willingness to tighten.

But the Fed’s statement and press conference assured them that wouldn’t be the case. And a rate rise in the US will be later rather than sooner.

The Fed has moved the goalposts on a number of occasions in its desire to ‘normalise’ interest rates. This normalisation process has been going on for years. I remember the Fed first started talking about it back in 2010…that was before QE round two and three and ‘Operation Twist’!

And back in 2013, the then Governor, Ben Bernanke, discussed the process of normalisation from years of QE. Here we are two years later, still waiting.

The Fed initially targeted the unemployment rate as its guide to know when to lift interest rates. But now that employment growth is strong, the Fed has moved its focus to inflation. Of course, thanks to crashing oil prices and general deflationary conditions, inflation is not a concern right now.

With inflation not a worry, the market realises it’s got much longer to speculate than it previously thought.

Last week showed you that there will always be a reason for the Fed not to tighten. Low inflation…a strong dollar…economic growth not robust enough.

Needless to say, history will not look kindly on the US central bank. Slowly but surely, it’s sending the world down the path to another 2008 type crisis. It’s encouraging speculation and debt accumulation on a scale never before seen in history.

When the next crisis hits, it will be much, much worse than in 2008. Governments will have no ammunition to get us out of trouble. They’ve spent the past seven years firing it.

The problem is, no one knows when the next crisis will hit. All I can say is that at the moment, there is no immediate sign of it. Certainly not in Australia…

On Friday, two top bureaucrats stoked the fires of future financial instability in this country.

RBA boss Glenn Stevens indicated that interest rates might fall further. At the same time, APRA (the bank regulator) head Wayne Byers voiced concern about the effect of low interest rates on house prices…but he still isn’t too keen to do anything about it.

Well, he did write a letter to the banks in December telling them to go easy on the lending. That’s had zero effect. His next weapon is imposing stricter capital requirements on individual banks if he thinks their lending practises are getting out of hand.

But that may or may not happen and even if it does, no one will know about it because Byers’ policy is to not publicly disclose that a bank has been overdoing it and needs disciplining.

Apparently, such disclosure (of the truth, I might add) could undermine the integrity of the financial system! Are these guys serious? You’ve got Stevens’ in one corner blowing bubbles in Sydney and Melbourne real estate markets and Byers in another saying it’s all good…and even if it’s not, no one should know about it.

This type of regulatory neglect beggars belief.

Unlike the Fed, maintaining financial stability is one of the RBA’s mandates. Surely then it can see that it’s contributing to a massive amount of long term financial instability with its current policies?

House price booms always end in busts. It’s just a matter of time, and Australia is no different. However, our recent experience is different from most other nations.

That is, we’ve had the benefit of a long secular decline in interest rates from a peak of around 17% in the early 1990s to 2.25% (and heading lower) now.

At the same time, we had two massive terms of trade booms. The first one lasted from 2002 until 2008. The second one was shorter but bigger, lasting from 2009 to 2011. These provided a massive injection of money into the economy, money that we gratefully borrowed against to speculate on real estate.

The result of all this is a massive house price boom, now narrowly concentrated in the main markets of Sydney and Melbourne. There’s no reason why it can’t keep going for another couple of years either.

While ever Stevens keeps pushing the interest rates buzzer, Byers looks the other way and the government refuses to address the tax distortions that encourage capital to pour into property, prices will march higher.

But the gains will only accrue to speculators or those who have been in the market for years. It’s these players who can leverage up their increased housing equity to push prices up even further.

There’s nothing wrong with this at an individual level. People are just responding to price signals. But at an aggregate level, it’s disastrous. Apart from creating a huge boom that will turn to a bust when the stimulus runs out, it’s also creating increased social tensions as Australian society fractures between the haves and have nots.

And when the bust hits, that’s when those tensions will boil over. It’s all well and good to have a boom and economic ‘good times’. But when it’s a boom created out of easy money, the ‘good times’ never last.

Despite history teaching this lesson over and over again, we appear doomed to ignore it. Human hubris knows no bounds.

So what can you do to survive?

The first thing to do is acknowledge it. Know what’s coming down the pipeline so you’re at least partly mentally prepared for it. Most wont be.

Second, realise that it will probably be slow to materialise. That gives you time. So if you want to join in and take advantage of the Fed’s and the RBA’s insanity (while occasionally despairing at it), do it now.

One thing is for sure: interest rates are staying low for some time. If you want income generating ideas in such an environment, keep an eye out for a new income product we’re launching this weekend called Total Income.

I’ve asked Total Income editor Mat Hibbard to contribute to The Daily Reckoning this week and introduce you to some of his income generating ideas.

Greg Canavan,
for The Daily Reckoning Australia

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Greg Canavan
Greg Canavan is the Managing Editor of The Daily Reckoning and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to The Daily Reckoning for free here. If you’re already a Daily Reckoning subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Daily Reckoning emails. For more on Greg go here.

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4 Comments on "Bubbles, Busts and Income Stocks"

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slewie the pi-rat
slewie the pi-rat
1 year 6 months ago

FED Chair Dammit Janet Yellen as Disney archetype:


slewie the pi-rat
slewie the pi-rat
1 year 6 months ago
slewie the pi-rat
slewie the pi-rat
1 year 6 months ago

http://ts1.mm.bing.net/th?id=HN.608044915813844984&pid=15.1&P=0 [“after” shot of Cinderella Economy]

how about a documentary: “The Deep State as Pinocchio”?
this could feature rare footage of Ms. Gemini Crickette’s: “When You Wish Upon A Star-Note”.

1 year 6 months ago

Sit tight dear Niarchos. We may have 2 more years of this bubble insanity Then however there will be the biggest financial crisis of all time. China, US, EUrope BRICs all together deleveraging. THen wait, dear investor, spread that money in 10 different bank accounts, watch, wait, withdraw, crash, pounce.

Worth the wait.

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