As a Wealth Survival Strategy the Stock Market is a Death Trap

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Has anything important happened?

The Aussie market finished up Thursday with the 5th day of gains in a row. It’s a nice little run. But is it a bull market? If it is, it would contradict everything we’ve said about everything, and make us look very foolish (although not for the first time).

Here in the States everyone is keen to see the non-farm payrolls report. It comes out on Friday. Anecdotal evidence (what people say) suggests that the employment situation here is still pretty bad. But government statistics can say pretty much whatever you want them to say.

If you’re looking for the internals of the market, try breadth. That is, if you want to judge how intrinsically strong a rally is, look at how broad it is. Is it just concentrated to a few of the big stocks (banks and basic material, for example). Or are all stocks marching up in lock stop on higher earnings and higher valuations. Is the equity premium visible?

Take a look at the chart below. It’s the advance-decline index on the New York Stock Exchange from early 2007 unto today. The scale of the chart is less important than the trend. The index tracks the difference between advancing and declining issues on any given day. When there are more advancers than decliner, the index is bullish. When there are more decliners than advancers, it’s bearish.

NYSE A/D Ratio Looking Toppy

NYSE A/D Ratio Looking Toppy

If you’re trying to use the A/D ratio as a predictor of what’s next (and who isn’t?) then what does it really tell you? The chart above shows you that market breadth started to deteriorate months ahead of the actual high in the Dow Jones (which came later that year in October.) The June-July revelations that two Bear Stearns funds were in trouble accelerated the deterioration.

The March 2009 low in the A/D ratio more or less coincided with the low in the index. There wasn’t any advance warning from the index. That’s likely because the March lows were reversed by the active (and perhaps direct) support of the Federal Reserve via interest rates and a program of Treasury bond buying.

Whether the Fed worked a way, via its primary dealers, to get stocks moving too (another word is ‘manipulation’) is an interesting but ultimately unanswerable question. The important point here is that nothing in the fundamental mechanics of the market indicated a reversal. It was an external event.

And what about now? The A/D ratio is going up, up, and away. It could be that corporate cash positions are solid, the employment market won’t get worse, and that the end is in sight for the U.S. housing market. Some combination of these factors could explain the steady advance of stocks since last march. But maybe not.

Our guess is that this is simply evidence of the Fed’s Great Reflation (see Marc Faber’s March Gloom, Boom, and Doom Report). All the new money created by the Fed, and the new lines off credit made available to U.S. financial institutions, made its way into the stock market by force off habit. It was easy to borrow and there was only one sensible place to put it: stocks.

But is that still the best trade going now?

No.

Your best bet, as we’ve been saying all along, is to retire now. Gradually liquidate your stock portfolio and pare it down. People are buying stocks now because it’s what they’ve always done and what they’re still told to do. But as a wealth survival strategy, the stock market is a death trap.

You should, by our reckoning, own a small portfolio of stocks leveraged to positive Black Swans (low probability but high magnitude events that drive a share price higher…like the discovery of a new ore body or the development of a new drug). These are the sort entrepreneurial ventures that will create new wealth. A portfolio of these business experiments is like a call option on the world we’ll live in after governments have gone bankrupt and lost the ability to perpetuate the follies of the previous credit bubble.

But for now, the public sector campaign to bail out the plutocrats in the private sector is in full force. And in the meantime, the public sector in Europe is trying to save itself. Markets in Europe have reacted with contented indifference to the affair in Greece. Has anything important happened there?

Well, the Greek government presented a plan to cut spending by $6.8 billion. If effected, it will reduce the deficit-to-GDP ratio from 12.7% to 8.7% in the next year, which is pretty ambitious. The Greeks plan to do two things: raise revenue and cut spending.

The Greeks will raise taxes on fuel, tobacco, and sales taxes. And if the communist unions don’t derail the plan, bonus payments to public sector servants will be cut by 30% and wages will be frozen for civil servants.

If Greece is having a fiscal crisis, why is anyone in the government getting a bonus payment at all?

The Greeks have $20 billion in sovereign debt maturing in April and May of this year. The negotiations between the Greeks and the rest of Europe are trundling along. But to what end? The Germans refuse to pony up for a bail out. But will the EU sacrifice Greece to save the Euro as a currency?

Nobody knows. But our main point today is that you should not think Greece has gone away. It’s true that since February, the cost of insuring sovereign governments against default has fallen. According to the folks at Bespoke Investment Group, only Vietnam, Argentina, and Egypt have seen wider credit default swap spreads in the last two months.

So we have a pause in the crisis-think. Markets rally on reflationary monetary and fiscal policy. But the underlying structure of the fiscal welfare/warfare state is badly damaged. This is still an excellent time to reduce your exposure to stocks and add, on the dips, your exposure to precious metals and precious metals equities (in full knowledge that even gold stocks are going to decline on another general decline in stocks).

It’s probably not just stocks you should re-think, though. Last week we mentioned that fund manager Colonial First State (owned by the Commonwealth Bank) has told investors in its Mortgage Income Fund that it could be as long as four years before they get their money back. The average age of the 17,000 investors in the fund is 74 years old.

Redemptions in the $850 million fund were frozen not long after the Federal government guaranteed bank deposits. High-yield mortgage trusts are not bank accounts. Investors and pensioners who treated them like high-yield bank accounts – because that’s how they were sold – were suddenly not generating needed income on precious savings. And now the savings are locked up.

But it wasn’t just the government guarantee that pummeled the mortgage and property funds. It was the underlying securities. On February 9th, Colonial announced it would wind down the Mortgage Income Fund because the bad debts on some of the underlying property loans were, “too big to manage.” It has another $1 billion of pensioner savings locked up in similar funds.

Now without knowing the composition of assets in the other funds, it would be hasty to say that mortgage funds in general are lousy investments. However we’re inclined to think just that. But more importantly, there’s a point here about having your money locked up in large pools of capital these days.

These large pools of capital – mortgage funds, property funds, super funds, 401(k) plans in the States – are extremely attractive to people who need capital. Call it “captive capital.” Banks covet it because it keeps them cashed up when facing declining asset values in commercial and residential property.

Governments covet the capital even more. It’s a ready source of funding for government deficits. If you can compel banks to buy government bonds (via credit requirements), or if you can compel savers to own government bonds for “safety” and “annuity” reasons, then you can force people to fund your deficits. That means you may not have to cut spending so deeply that you lose an election because of it.

So what should you expect and what should you prepare for? Higher taxes are a given. “Nutter expected to tax sugary drinks, set trash fee,” reports a Philadelphia newspaper. The Nutter in this case, quite appropriately, refers to the Mayor. He’s taxing fizzy drinks and garbage to raise extra money for the city. At the city and state level, you can expect a lot more of these creative ways to finance spending – along with cuts in services.

This is part and parcel of the over-reach of the Welfare state. If the U.S. Warfare State has over-reached in Iraq and Afghanistan, it’s been over-reaching domestically for years with programs paid for out of an empty pocket. The same is true in Europe, Japan, and increasingly, in Australia.

Some places are better off than others. Australia has a relatively smaller public sector debt burden. But the country overall, if you look at the net foreign debt, owes its prosperity to foreign lenders. You can expect the strain on public sector finances to only increase in the coming years.

All of that suggests, to us anyway, that you should re-think your reliance on traditional income and savings vehicles. Look for changes to be made that make it harder for you to get at your money. Or, if you can withdraw it from certain accounts and schemes, you will do so at a massive penalty. Governments need capital. And when they can’t compel you to use yours to finance their spending, they are going to get at least a pound of flesh if you choose to remove your money from the system.

What should you do instead?

As we said above, a small portfolio of stocks – business projects leveraged to very high returns – is nearly the only good reason to stay in stocks. The other good reason is that as governments monetize debts and confidence in paper money fails, stocks may beat inflation a lot better than cash. The rally of the last year is evidence of that.

Next week, when we get back to Australia, we’ll take on the main objection to all of this: deflation. That argument is simple. As the global debt burden becomes too heavy, it will crush asset values, leading to falling asset prices across the board, including precious metals. We have too many objections to this to list here. But stay tuned next week. Until then!

Dan Denning
for The Daily Reckoning Australia

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.
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25 Comments on "As a Wealth Survival Strategy the Stock Market is a Death Trap"

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annie
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Good article Dan. What I really want to know though, is, when do I take my cash and hide it under the mattress? It’s not safe in stocks or property…….. eeekkk!!!!

Justin
Guest

If the funds are ‘locked up’ it’s reasonable to assume that they are not there.

Interesting that mortgage funds are in trouble despite the ‘resilient’ real estate market. Bad debts “too big to manage” doesn’t sound good at all.

John
Guest

Annie, one idea I’ve seen expressed a few times here is that you don’t trade gold for fiat currency at all. Things as we know them will be unimaginable. Gold’s true value will be in trading it for staple, gluten-based products.
Certainly these carbohydrate foods should be secreted in secure areas.
Is under your mattress really the ideal place for perishable goods?

Jimmy
Guest

wtf thats not funny

Biker Pete
Guest
Trading ingots for smaller bread units is feasible, Annie. Chris Isherwood’s poem comes to mind: “But what these unobservant birds Have never noticed is that herds Of wandering _bears_ may come with _buns_ And steal the bags to hold the crumbs.”
Lachlan
Guest
IMO stocks of everything including gold miners have looked and still look like they are in a bear market rally since no new highs have been made post double top (yet) and considering the dubious way in which the bear rally has progressed thus far. If gold stocks are buffered against failure through increasing gold prices then they may as a group fail less often during the next few years. But just because they or any other group are profiting does not mean their share price will increase. If credit is destroyed (the money supply reduced) then even good stocks… Read more »
annie
Guest
I agree Lachlan, I’m a bit queezy on gold too. But then again I am very conservative about investing in anything at the moment. I get the feeling things are going to topple over. Instead of trading gold for perishables, I still am leaning towards trying to grow my own things and learning to tin and preserve as much as possible. I brought up two kids on my own on the smell of a oily rag, sent them to private schools, went without new clothes for 5 years, but still managed to get through ok. I think those of us… Read more »
annie
Guest

I like that poem Biker. I seem to be reminded of that old indian poem about when the last tree has gone (can’t remember most of it but I’m sure most will know that one I’m referring to) the last river is poisoned, we will realise we can’t eat money.

Ned S
Guest

“Only when the last tree has been cut down; Only when the last river has been poisoned; Only when the last fish has been caught; Only then will you find that money cannot be eaten.”

???

Greg Atkinson
Guest
Well I won’t be popular but I reckon there is little doubt that gold is already in a bubble. That does not mean prices won’t go up further but I will be quite clear in saying that I don’t see them getting near $2000 USD an ounce. There are so many people talking up gold now that even taxi drivers are talking about how gold will make you rich. So maybe the gold bubble really is about the burst? http://www.shareswatch.com.au/blog/commodities/is-the-gold-bubble-about-to-burst/ I think the smart players know gold will not make it to $2000 an ounce but hope all the hype… Read more »
K
Guest

More important than numbers on a piece of paper you get from the bank every month, the yellow metal that won’t corrode, or the printed paper that our governments distribute, is the strength in your arms, your legs, and your back to plant seeds in a field, swing a hammer, or teach.

Justin
Guest

How do we know that you’re not short sighted Greg? suffering tunnel vision? glaucoma maybe?

Firebug
Guest
Hi Greg, I really don’t understand a smart man like you couldn’t see the bleeding obvious, not necessairly on gold, but for that you don’t seem to fully appreciate the dire state the Western world’s economies are in… Gold is not your everyday commodity, holding gold is a hedge against the failing of governments and the lack of confidence in the fiat money systems… It is an investment for unusual times, like we’re in the process of going into now. Gold is not in a bubble again this time around yet, it is still in the early days. It will… Read more »
Biker Pete
Guest

Greg: “…there is little doubt that gold is already in a bubble…”

Well, as we know, Soros himself identified gold as a bubble… then quietly bought up. More interesting than knowing _when_ Soros will sell, would be knowing _why_. It’s likely he has identified some PIs which, when lined-up, will trigger a sell.

I figure we may all learn something from the post mortem. If his sell is well-publicised it will be interesting to watch the global effects…. ;)

Biker Pete
Guest

OK… I now see you’ve already addressed the ‘sell’ repercussions online, Greg:

“The reason this is so interesting is because he has made his views so widely known, which means when he sells people will take it as a sign (wrongly or rightly) that gold prices will crash.”

It’s likely to have a great deal more impact than Steve Keen selling his house to herald the GPC!~ ;)

Lachlan
Guest

Interesting that because a man tells people to sell, they do. Its at least possible Soros statement may not have that much impact anyhow. The bankers have been active of late with there shorting/price suppression games. They managed a 16.2% (USD$183) discount for a brief moment in time but the tenacious longs just wouldn’t give in. There will be no giving in from the longs while debt/derivatives keep piling up toward global insolvency and inevitable new currency.

wasabu
Guest
My revelationary moment was when I realised that everything rises and falls AGAINST Gold, not the other way around. It is the elite store of value that cannot be printed and is highly resistant to manipulation because of the massively decentralised holdings. The ETF (paper gold) schemes were an attempt at final deception away from the real thing, into centralised hegemonic structures. Firebug is on the right track. The enemy of Keynsian manipulators is indeed Gold, and will react in lock-step to falling economies. So far as history is concerned, Gold is poised for the biggest bubble in history and… Read more »
Ross
Guest
Per below it may become fashionable to seek to own “real assets” with an ROI not born of a “hollow economy” (as opposed in the inflationist past of wanting only nominal ownership and clipping the ticket in the past). With assets & rents inflating less acutely than their fiat currency depreciates …. the bodgy once inflationist accommodating CPI basket turns horned beast! following from a poster on zerohedge quote How Currency Devaluation Destroys Wealth By Henry C K Liu In today’s financial world, a liquidity boom produces rising nominal or face value in return on investment (ROI) with an increasingly… Read more »
Biker Pete
Guest
Lachlan: “Interesting that because a man tells people to sell, they do. Its at least possible Soros statement may not have that much impact anyhow.” Earlier this year Soros called gold “the ultimate asset bubble,” but he neglected to announce that his hedge fund had been quietly buying it. I doubt that Soros will tell anyone to sell. Just as quietly as he bought, he’ll sell. There’ll be none of Steve Keen’s media statements, TV appearances, vidclips, silly bets, for instance. One day Soros will own gold, the next he won’t. Weeks or months later, he may respond to questions… Read more »
Ross
Guest
Reports on Chinese metals exports / re-exports have been around for many months now. http://www.forbes.com/2010/03/05/shipping-rates-precious-metals-personal-finance-containers.html?partner=alerts Disregard the the narrative in the above hopping from the Baltic to container no.s and pricing, the bulk vs container markets are largely independent. The Baltic is tracking metals on a logarithmic basis and is chasing oil, the BDI is currently rating at about the middle of boom and bust in norties terms. Recent months has it ratcheting up but in an uncertain fashion. The Forbes story here though is about metals in containers being exported from China, empty ships creates more opportunity for bulk… Read more »
Firebug
Guest
Agree with you Wasabu There will indeed be massive volatility in gold prices and the gold miners. This is certainly not the investment for the faint hearted! However, the overall trend should be up. Gold is certainly not an investment that one can buy and hold. If one bought in 1980 would still be in the red. As fortune seems to go around in cycles, gold seems to be still in the early days of the next cycle / bubble. My prediction is that the gold bubble will pop some time later in this decade. One would certainly want to… Read more »
Coffee Addict
Guest
Dans stated: “At the city and state level, you can expect a lot more of these creative ways to finance spending – along with cuts in services” I wonder if the “negative” stimulous impact has been factored into the neo-Keynsian models? While J.M.Keynes himself would most certainly have factored this in to determine the likely short, medium and long term results (or otherwise) of stimulous policy, his successors don’t appear to have done so. My guestimate is that Keynes would have supported the “initial” shot in the arm AND argued against the economic addiction and resource misallocation of the current… Read more »
Biker Pete
Guest

Greg, I see we’ve moved into your predicted range, 4800+, today… ! :)

Mick
Guest

After reading Dans article ..wealth survival stategy….I had an overwhelming feeling the sky will fall!I must now grab my longboard and live the life of a hippie besides the sea. Dan has just sparked the revival of the hippie movement!!! Peace Dan

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