For those who have come to know my approach to investing and trading, you will be aware that I am not in the game of predicting the markets. It’s just not a successful method for consistency in returns. My approach is that you need to be able to read the information that is available to you, form an opinion, adopt a strategy that suits, and execute.
But the state of the current environment has me worried. Very worried!
Like many of you, I have joyously ridden this stock market boom and want to see it continuing for much longer. There is no easier way to make money than to sit at a screen, check positions for action, and then just watch the balance increasing.
It was like that in 2006 when I was a Private Portfolio Manager. At the time, we had experienced a Bullish market from 2004, which ended in 2007 as the GFC (Global Financial Crisis) unfolded. During that time, the S&P500 index had risen more than 40% in a 3-year time frame.
The current bull market started after the GFC in early 2009. Aside from a period in late 2016/early 2017 when the markets consolidated in a 10% range, this Boom has seen an increase of more than 260% from the low point in 2009 to this weeks new all time market high. That’s an average of nearly 30% per annum, which is 3 times greater than the long-term average stock market return.
Even if we consider the most recent bullish trend starting from late 2016 to now, the S&P500 index has risen 30% (nearly 35% from low to high), in a little over a year.
This rate of return is not sustainable!
Bitcoin, and for that fact Cryptocurrencies, have been the main headline grabber in recent months. Its’ spectacular rise and subsequent fall (down 50% from highs at time of writing), have highlighted to me that we need to be vigilant with the current state of the Stock Market. Now is the time to be concerned!
In the current US environment, Everything is booming!
- Stock Markets have reached all time highs
- Property prices (based on the Case-Shiller Composite home price index) are almost back to 2007 highs
- Bitcoin has made 10’s of thousands of new millionaires. How many held onto that wealth is another question!
- Unemployment is at 4.1%, the lowest since 2001
- Consumer Sentiment is at long-term highs, at the same level as 2006
The US economic environment doesn’t provide the same glorious picture however.
- GDP is at 3.2%; Inflation is at 2.1%; therefore the Real rate of GDP is a mere 1.1%
- Government Debt (to GDP) is the highest it has been since the early 1980’s, and only short of the post World War 2 debt levels
- Wage Growth is low, and about 15% of where it was at in the late 1970’s.
When I put this altogether, my opinion is that I don’t think the rate of return we have in the markets, is sustainable. Investor Sentiment is high, euphoric almost. But there are some real underlying problems in that the Economic Growth is just not there, and Debt is about as high as it has ever been.
Economist Hyman P. Minsky developed the 5 stages of a Bubble, in his book “Stabilizing an Unstable Economy” (1986). These are:
- Displacement – where there is a technological development that triggers a new era, such as Cryptocurrencies, the Internet, Transportation, extremely low Interest Rates.
- Boom – during this stage more and more investors participate although price movements can be slow at first.
- Euphoria – As price momentum increases, Fear Of Missing Out (FOMO) attracts more media attention. Prices skyrocket and investors buy at any cost
- Financial Distress – Is when prices start to drop. There is exhausted buying behavior and just like a game of Musical Chairs, people are left standing holding the asset with no-one to sell to. The “Smart Money” has already exited, but price falls are seen as an opportunity to enter for the late comers.
- Revulsion/Panic – prices fall quicker than they rose. Those who borrowed money to invest lose everything, whereas others become “long-term investors”, only to never realize the return they had seen on paper during the Boom.
Joe Kennedy, father to US President John F. Kennedy, sold all his stocks days before the crash in what turned out to be the Greatest Depression of all time. He is quoted as stating:
“You know it’s time to sell when the shoeshine boys give you stock tips. This bull market is over”.
How many people are talking about Bitcoin? About booming stock markets?
I believe we are in the Euphoria stage of Minsky’s 5 Stages of a Bubble. We are now at a point where we need a trigger. Something fundamentally based that will result in the Financial Stress.
For the GFC, it was defaulting home loans. For the Tech Crunch in 2000, it was over-inflated prices in Technology companies. And every other Crash/Mania/Recession has had its own trigger. Whether that was the Oil Crisis of 1973, the Great Depression, Tulipmania, or the South Seas Bubble.
Run for the Hills! What am I to do?
Ok, so there’s no point driving the fear of a crash into you without providing a solution.
First and foremost, I am a trend trader. Having been a Dow Theorist since I started in the markets 20 years ago, my investment and trading decisions have an underlying approach of trend trading.
Right now, the trend is up. Yes, I believe we are at the Euphoria stage, but this could last months, or even into 2019. Again, I don’t get into the game of predicting – I analyze the information I have now and implement strategy to suit.
That means I need to have in place alerts, or triggers, to tell me this trend is over. Identify the trend is over, you identify the next market movement.
My opinion is that 2018 will have corrections. The year still has a strong probability of finishing higher, albeit at a slower rate of return. Again, an average 30% per annum is just not sustainable.
The Fundamental Trigger isn’t yet presenting itself. Could it be Cryptocurrencies; US Politics; Government Debt; a new Middle East Crisis; a major global Cyberattack; War between the US and North Korea?
When the Fundamental story starts to unfold, and then influences the change in market behavior to end the current trend, only then will it be time to act.
But if you don’t know what to look for, you will be the one left in financial distress when the Everything Boom comes to an end.