Market meltdown 2?

5th Aug '20 by Martin C

34 comments 1559 reads

I find it very difficult to reconcile what's going on with the markets in comparison to what's happening in the real economy, and am becoming increasingly convinced that the markets are going to roll over again and that we're going to see another meltdown in the next month or 2 - maybe once the unemployment numbers start reflecting the true state of the US & UK economies.

Some factors that i'm looking at are....

S&P500 is on the verge of filling the gap from the late Feb covid crash, and is also within touching distance of an all time high (double top?)
The breadth of the rally (stocks rising vs falling) is dropping indicating that we are near a top
Volatility has dropped implying that there is little or no fear in the market
Gold & Silver hitting new highs indicates there are major problems ahead, and that smart money is looking for alternative means of making money, rather than stocks and bonds.

I've done extremely well riding the Gold/Silver price higher but have this week sold roughly a third of my holdings, whether they be ETF's and miners and will reduce again if I see the market turning. (Medium term these will all go much higher, but there will be major corrections if the markets go into meltdown again).

I've also sold 2/3rds of my regular shares, and have opened some shorts.

My SIPP is now roughly 40% cash, 40% gold/silver, 10 shares (long), 10% etf shorts

What do others think of where the markets stand at the moment? Bullish? Bearish? Neutral?

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Alphaflight

6th Aug '20

Hi Martin C,

Yes I completely agree with you. Very true, silver is indeed massively undervalued.

If you look at UK Gilts (see below), clearly they are moving further towards negative territory (despite what the BOE is telling us).

...and of course UK short term debt is negative right now anyway (red area below).

The case for equities and more importantly gold/silver is great in my opinion.

A 10 year UK bond is yielding a pitiful 0.114% p.a. so £1000 invested in a 10 years becomes circa 1000*(1.001140)^10 = £1,011. Not much of a return, the real rate of return on this would of course be negative in fact so you lose overall! These bonds aren't pricing in future inflation. It's all madness.

Anthony127

On the whole I would describe myself as slightly (and cautiously) bullish.

The article indicates that there is a disconnect between markets and the economy. Last Saturday's Economist magazine indicated that the FTSE 100 was down by 18.7% suggesting to me that there is at least some connection between the market and the economy. Similarly most of the worlds major stock markets are significantly down with the notable exceptions of China and US Tech.

However I don't think people should be too surprised by an apparent disconnect between the economy and the market. The economy expressed in GDP terms tells you what just happened whereas the Stock Market is a leading indicator which looks forward. My understanding is that it looks forward one year and estimates what the economy will look like then.

What will the economic situation look like in August 2021? A recent Bank of England report suggested that the economy will have returned to pre virus levels by the 2nd Quarter 2021. Recent news flow has suggested that there is likely to be multiple vaccines available by this time and at least some of us will have received the vaccine by then. I think that the Stock Market has already absorbed this information and that is probably why it is doing better than people expect at this stage. In August 2021 I believe the market will be assessing what the future looks like in August 2022 and on that basis it will be markedly different from today.

This suggests to me that the currently depressed British cyclical shares will do well over the next 12 months. To my mind the question is not whether to invest in them but deciding when it is best to do so.

Martin C

Hi Anthony, you are right that the FTSE and many global indexes are in negative territory, but as the old adage goes "when the US sneezes the rest of the world catches a cold!".

If you look at the US markets in general - not just tech - the valulations are at crazy levels. Doesn't mean that they can't stay crazy, just that the likelihood of another sharp plunge is greatly increased. And if that does happen you can bet the FTSE and other indices will plunge too.

dscollard

A cross-comparison of indices for some context below, performace 2020 YTD as of today: big tech has skewed the US indices suggesting either the new normal is fundamentally different than the relatively recent past or some reversion to the mean is due (whatever the mean means these days?). Negative rates and trillions of liquidity probably obviate any discussion of fundamentals: the recent slide in the USD may be a sign of trouble and is giving gold that additional boost it probably didn't need but is nice for as long as it lasts: Bitcoin has also awoken from its slumber, on a relative basis even the much maligned cryptos look favourable compared to infinite fiat with storage charges attached.

AIM has bounced back the fastest having sold the most in the COVID crash: similar to the US , this is suggestive of a retail bid.. the shoe-shine boys of the 21C are the Twitterati and Robinhooders.

FTSE 250 off -25% , 100 about -20%, Europe and Asia faring better but none so outstanding as US tech. They are globally dominant players in a world that has had rapid transformation thrust upon it, maybe the multiples are justified and arguably could be stretched even more.

The stock market is not and never was the economy: I'm neither bull nor bear preferring to self-describe as a puma: predatory and alert.

5f2c40401eb152020-08-06_18_38_42-2020_lo

mojomogoz

7th Aug '20

There's bound to be some chop...what with the massive uncertainty and spectacularly out of sync with prior lived norm policies...however, the powers that be have already shown that they will not tolerate the bug causing a debt deflation depression....they will do anything, break any "rule" (there are no rules, just heuristics that date) to prevent it.

So the environment is going to be generally risk on. The dampener to that party is that some stocks got too giddy on the covid juice...looking at you Amazon, Zoom, general brave new world stocks. So risk on might have some index downside to it....but the median stock does well even if the averaged whole doesn't.

As for gold....you gold bugs crack me up....first its hugely under-appreciated in our broken corrupt fiat system and worth >>>>>>more than $1700....then its up 20% and the parties over. Gold miners don't even have their party dresses on yet so they aren't even at the party. Look at the early Noughties gold miner party for reference.

Strap in! Its all going to be rather bewildering.

Old ManFit

Hi All,

Really enjoyed reading the comments here.

Me I am 50% cash and 50% stocks that have proven to resist the Sars-Cov2 fallout, since mid-June after the peak.

I haven't a clue which way the markets will go, if I look at the fundamental’s things should be worse than they are in my opinion. If I use my Technical crystal ball skills on a weekly FSTE 100 chart I am believing a W recovery - so a fall coming.

So, I panicked in Mid-June and resorted to swing trades only since then - the "worry bear" that I am.

Though overall preservation of capital is king, so if I miss the recovery jump I am not bothered as markets will be in a more certain position, but if I go in now and it goes tits up; then it will be a while until I get back to where I am.

So anyway, I will make a prediction, a fall to 5600 in the FTSE100 by early September 2020.

Call me a plonker comments if I am wrong.

Macro

What risks do we see? How do we counter those risks? How do we construct our portfolios to address what we see as a mix of risks?

- Liquidity: The US Fed seems to be on top of this? They are presumably monitoring the markets in real time and prepared to intervene ahead of a market meltdown? Do we agree that the risk of a liquidity event has now be sufficiently addressed?

- Solvency: Many businesses are cutting jobs in an effort to protect balance sheets. So afre there have been relatively few instances of insolvency. With Stockopedia we are relatively well supported with information on balance sheet stress. Are we conciously picking sectors that we consider to be low risk? Or, are we optimistically selecting sectors that are high risk in the belief that a broad recovery is underway? Which sectors? Which stocks?

- Inflation / Deflation: The Gold/PM 'surge' suggests that many are positioning for future inflation. Similarly Miners (Industrial Metals) have made a significant move in advance of any signs of inflation or indeed increased demand? Which other sectors might be considered part of the 'inflation trade'? Which sectors might be able to apply pricing power over their customers? And conversely which ones might be in a poor position to do so? In general is 'Growth' as a factor more important in an inflationary period over 'Value'? And conversely in a deflationary period is a 'Value' or 'Quality' factor more important than 'Growth'?

- Secular Themes: Themes such as 'Ageing Poulation', 'Healthcare', 'AI-Robotics', 'Big Data', 'Cloud Computing' etc are often mentioned. Which ones will be most important to our new macro outlook?

- Currency Risk: The GBP has had a period of relative strenght (against the USD, at least). But history tells us to brace for Sterling weakness. Indeed Governor Bailey had mentioned negative interest rates in public interviews - almost signaling a lower pound? How do you see the balance of currency risks for a GB resident investor?

- Strategic Competition: While the USA-China tension may not result in physical fisticuffs (conventional or nuclear) it does seem that they are set to 'compete'. Will they seek to destroy each other economically, or will they find separation and co-exist? How do we feel about China based investments while this back-drop develops? Sanginue, or concerned?

- Brexit: Who do we think the winners and losers might be? Are there any that have not yet been sufficiently priced into the market? Can this area of risk now be discounted, or not?

- Pandemic: Golman Sachs pointed out the other day that if a vaccine were to be suffenly announced as approved it may create a significant market 'jolt'. A bond sell-off? A technology sector sell-off? A rapid rotation into previously bearish sectors? Given that ~150 teams are working on a vaccine what are the risks that a sudden explosion of good news results in bad news for our portfolios? This reminds me of the 'bar bell' approach - i.e. deliberately selecting some really bad investments that suddenly come back into the money. Realistic, or not?

- Technical Sell-Off: Not necessarily connected to any of the above. But the market just has a 'hissy-fit' and crashes 20%! Could be triggered by a 'fat finger trade', or an over-crowded trade in derivatives, or perhaps the credit markets. Do you think sudden shock-type events such as '87 are worth mitigating for, or not?

mojomogoz,

Absolutely correct.

As for gold, well here is a chart just to remind everybody why holding gold/silver is wise when fiat currencies look like they might fail:

john652

8th Aug '20

Hi Martin,

Interesting post.

‘’My SIPP is now roughly 40% cash, 40% gold/silver, 10 shares (long), 10% etf shorts’’

I’d say that a very high conviction position, i have 10% in gold & think will go a lot higher but to have 40% id have to be very very sure as at that size its not really an investment more or of a trade. Also, what are you short, my problem is i was shorting the s&p in march/april until it dawned on me that the s&p was really a tech index at heart!

10% short, if leveraged etf’s is also quite a high conviction trade.

As mentioned, Ruffer Investment (LON:RICA) is well worth a look as they effectively have a fund that is very defensive with growth equities. as close to a Ray Diallio all weather fund as youll find ,that or Troy Trojan fund. This fits well with the Taleb/barbell approach of one big chunk of safety and then specific higher risk trades- for me this has started to make more sense over the last two years. Ruffer Investment (LON:RICA) has 10% credit protection, ie derivatives positioned for big drops and i take the view they will be far better at hedging, and have access to products, than me.

So for me, ruffer & troy & gold & short term gov bonds one side - other side of barbell is small caps, one lets me sleep, other keeps me occupied, and hopefully solvent!

Hi Alpha flight,

Excellent chart , no wonder the Germans are cautious!

9th Aug '20

Interesting day Friday just past. Russell 2000 value index up near 2.5% ie the "crud" of US market. Tech negative. Russell 2000 growth index 1.5% behind value. All in a good day for the median US stock but a bad one for the most loved.

One day doesn't make a trend or a narrative of course

10th Aug '20

Hi john652,

Thank you. The USD has seen a 99% decline in value of the dollar Vs gold. Other currencies such as the British pound and Japanese yen have done even worse. The yen for example has lost 99.98% of its value against gold in 100 years. Note, the chart below has a log scale.

Because of its immutable properties gold sustained its role as the sun in our monetary cosmos after the gold standard was abandoned in 1971.

Central banks around the world kept holding on to their gold, despite its price reaching all-time highs such as now. This is due to Gresham’s law, which states “bad money drives out good.” If the price of gold rises central banks are more inclined to hoard gold (good money) and spend currency that declines in value (bad money).

In the chart below you can see that gold's purchasing power is remarkably stable. As the gold price rises through time it mainly compensates for fiat currencies being devalued versus goods and services. In other words, the price of gold goes up by the same amount that consumer prices rise. Gold even shows a tendency of increasing in purchasing power, which might reveal inflation numbers published by governments are too low. Another theory is that sound money, like gold, should rise in purchasing power as technological development makes goods increasingly cheaper to produce.

12th Aug '20

Well looks like I got really lucky selling a big chunk of my gold/silver position just before the 10 and 20% corrections!

Still believe there's a market top forming in the wider stock markets, but the gold/silver drops are providing a good opportunity to get back in. Taking my % of gold/sliver back up to 60% in my SIPP, reducing cash to 20%.

Lots of good points there Macro!

I also think there's a high chance that a major vaccine breakthrough will herald the top of the market, causing one final major spike upwards, before the selloff begins.

I don't think anyone is saying the gold/silver party is over - far from it, I believe it has a long way to go!

But nothing goes up in a straight line and there will be corrections along the way, so if you feel that prices are stretched then it makes sense to take some profits and hopefully get a better entry point, as I have just done - the timing was pure luck, but I was expecting a correction.

Hi John,

Yes, my positions are high conviction. There's a perfect storm brewing for the USD which is one reason why I'm so bullish on gold & silver.

Re the 10% short via ETFs, I'm currently just shorting Boost European Banks which is 3x leverage, and Boost S&P VIX index, which is 2.25 leverage.

When I say 10% short, my actual cash positions are roughly 4% in the above. I'm using the leverage to turn it into a quasi 10% short to balance out the 10% that I hold in general equities.

Greig

My outlook is long-term Martin (10 years plus), and I regard a period of stagflation as the most likely outcome for at-least short to medium term.

Lessons from the last financial crisis would suggest that the banks are too big to fail, but I can't help feeling that a run on the banks poses a serious threat to those with large cash holdings. This year's QE measures (and the possibility of negative interest rates) will undoubtedly serve to erode cash as a store of value, (even if deposits are secure).

At the risk of sounding like an economist, 'on the other hand' - the advantage of cash holdings are that they enable you to play the market volatility that is likely to be with us for the short to medium term.

As an alternative to cash holdings, I regard holding some investments in precious metal related stocks as a useful insurance policy against further sharp falls in the market.

I agree with you that watching the S&P returning to all time highs is hard to fathom. I guess that the world's financiers feel that there is nowhere else to place all the money that has been generated from thin air.

Notwithstanding the damage done by Brexit, for UK investors I think that many FTSE 100 companies are under-valued at the moment, and offer reasonable long-term prospects (and protection from inflation) - providing you are prepared to ride the bumps.

I agree with most of what you say. The only bit i'd differ is that I don't think its the financiers who are piling into the market and fuelling the bubble, - I think its the robinhooders and young professionals, the type who've never lived through a real bust, such as the dotcom bubble and GFC.

I'm 49 later this year so was invested through both of those. My hope is to retire in 6-7 years time, leading me to target a return of circa 15% a year.

I realise this can sound heartless given the human tole, but the current covid-inspired scenario of mass-printing money does appear to present a massive (once in a generation?) opportunity to turbo-charge ones wealth through holding gold/silver.

You are absolutely right. Central banks never stopped printing money after 2007/8. QE was meant to be a temporary measure. They said they would normalize interest rates but they did not.

Negative interest rates at retail banks are coming next. Actually we have them already in the UK for some of the Euro accounts (€75,000 - €999,999 charged at -0.5% p.a.). Note that the short end of the UK GILT yield curve is already negative anyway, the 10 year will go negative too within the next 6 months I predict.

Bank bail-ins are now written into law so they can do this if necessary a la Cyprus. Perhaps they will force us to buy government debt if we hold >>£85k in a retail bank.

Once you realise that the central banks will never normalize interest rates (because they can't, it would collapse the sovereign bond market), Gold/Silver suddenly start making a lot of sense and as you say "looks like the opportunity of a lifetime". I'll continue buying on the dips.

Market meltdown 2?

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Martin C

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