The Financial System is Primed For a Crisis Worse Than 2008
Over the last 30 years, the US has built up record debts on a personal, state, and national level. Consumers thought they were financially stable so long as they could cover the interest payments on their credit cards, states created program after program few if any of which they could afford, and the Federal Government issued $30-50 trillion in debt and liabilities (counting Social Security and Medicare).
This all came to a screeching halt when the housing bubble (arguably the biggest debt bubble in history) imploded in 2007. Since that time, stocks have staged one of their worst years on record (2008), one in five us mortgages has fallen underwater (meaning the mortgage loan is worth more than the home itself), and some trillions in US household wealth has evaporated.
These issues seem to be distinct, but in reality they all stem from a debt problem. And as you know, there is only one legitimate way to deal with a debt problem:
Pay it off.
However, instead of doing this, the Feds (the Federal Reserve, Treasury Dept, etc.) have been producing EVEN MORE DEBT. Here’s a brief recap of their moves thus far:
- The Federal Reserve cuts interest rates from 5.25-0.25% (Sept ’07-today)
- The Bear Stearns deal/ Fed buys $30 billion in junk mortgages (March ’08)
- The Fed opens various lending windows to investment banks (March ’08)
- The SEC proposes banning short-selling on financial stocks (July ’08)
- The Treasury buys Fannie/Freddie for $400 billion (Sept ’08)
- The Fed takes over AIG for $85 billion (Sept ’08)
- The Fed doles out $25 billion for the auto makers (Sept ’08)
- The Feds’ $700 billion Troubled Assets Relief Program (TARP) (Oct ’08)
- The Fed buys commercial paper (non-bank debt) from non-financials (Oct ’08)
- The Fed offers $540 billion to backstop money market funds (Oct ’08)
- The Feds backstops up to $280 billion of Citigroup’s liabilities (Oct ’08).
- Another $40 billion to AIG (Nov ’08)
- The Fed backstops up $140 billion of Bank of America’s liabilities (Jan ’09)
- Obama’s $787 Billion Stimulus (Jan ’09)
- The Fed’s $300 billion Quantitative Easing Program (Mar ’09)
- The Fed buying $1.25 trillion in agency mortgage backed securities (Mar ’09-’10)
- The Fed buying $200 billion in agency debt (Mar ’09-’10)
- QE lite buys $200-300 billion of Treasuries and mortgage debt (Aug ’10)
- QE 2 buys $600 billion in Treasuries (Nov ’10)
- Operation Twist reshuffles $400 billion of the Fed’s portfolio (Oct ’11)
- QE 3 buys $40 billion of Mortgage Backed Securities monthly (Sept ‘12)
- QE 4 buys $45 billion worth of Treasuries monthly (Dec ’12
And that’s a BRIEF recap (I’m sure I left something out).
In a nutshell, The Feds have tried to combat a debt problem by ISSUING MORE DEBT. They’re pumping trillions of dollars into the financial system, trying to prop Wall Street and the stock market. They’ve managed to kick off a rally in stocks…
But they HAVE NOT ADDRESSED THE FUNDAMENTAL ISSUES PLAGUING THE FINANCIAL MARKET.
Stocks are headed for another Crash, possibly as bad as the one we saw in October-November 2008. As you know, that Crash wiped out $11 trillion in household wealth in a matter of weeks. There’s no telling the damage this Second Round will cause.
The Feds have thrown everything they’ve got (including the kitchen sink) at the financial crisis… and things are fundamentally no better than they were before: most major banks are insolvent, one in five US mortgages is underwater, and the stock market is being largely propped up by in-house trading from a few key players (Goldman Sachs, UBS, etc).
Regarding stock investing, it’s important to take a big picture of stocks as an asset class. The common consensus is that stocks return an average of 6% a year (at least going back to 1900).
However, a study by the London Business School recently revealed that when you remove dividends, stocks’ gains drop to a mere 1.7% a year (even lower than the return from long-term Treasury bonds over the same period).
Put another way, dividends account for 70% of the average US stock returns since 1900. When you remove dividends, stocks actually offer LESS reward and MORE risk than bonds. If you’d invested $1 in stocks in 1900, you’d have made $582 with reinvested dividends adjusted for inflation vs. a mere $6 from price appreciation.
So as much as the CNBC crowd would like to believe that the way to make money in stocks is buying low and selling high, the reality is that the vast majority of gains from stocks stem from dividends.
The remaining gains have come largely from inflation.
Bill King, Chief Market Strategist M. Ramsey King Securities recently published the following chart comparing REAL GDP (light blue), GDP when you account for inflation (dark blue), and the Dow Jones’ performance (black) over the last 30 years. What follows is a clear picture that since the mid-70s MOST of the perceived stock gains have come from inflation.
Which brings us to today. According to official data, the S&P 500 is currently trading at a CAPE ratio of 25 and yields 2.3%. In plain terms, stocks are expensive (historic average for CAPE is 15) and paying little.
In other words, there is little incentive, other than future inflation expectations, for owning stocks right now.
By most historic metrics, the market is showing signs of a significant top. Here are just a few key metrics:
1) Investor sentiment is back to super bullish autumn 2007 levels.
2) Insider selling to buying ratios are back to autumn 2007 levels (insiders are selling the farm).
3) Money market fund assets are at 2007 levels (indicating that investors have gone “all in” with stocks).
4) Mutual fund cash levels are at a historic low.
5) Margin debt (money borrowed to buy stocks) is at a new record high.
This final point is key. Mutual funds are the “big boys” of the investment world. If they have become fully invested in the market, this means there are few buyers left to push stocks higher. This is evident in the fact that every time mutual fund cash levels dropped, stocks collapsed soon after.
In plain terms, the odds are high that a Top is forming in stocks. With that in mind,
if your portfolio is heavily invested in stocks, now is a time to be taking some profits. If you can, consider moving a sizable chunk into cash.
The market is extremely tired and the systemic risks underlying the Financial Crisis are in no way resolved. With investor complacency (as measured by the VIX) at record lows, the Fed withdrawing several of its more significant market props, and low participation coming from the larger institutions, this market is ripe for a serious correction.
This concludes this article. If you’re looking for the means of protecting your portfolio from the coming collapse, you can pick up a FREE investment report titled Protect Your Portfolio at http://phoenixcapitalmarketing.com/special-reports.html.
This report outlines a number of strategies you can implement to prepare yourself and your loved ones from the coming market carnage.
Phoenix Capital Research
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