I wanted to take a moment to address the notion of serious collapse and/or systemic failure.
First off, most people in general tend to be optimists or to generally believe that things will work out fine. So the idea of catastrophe is not something they spend much time thinking about.
Because of this and other factors I’m about to explore, for most investors the notion of systemic failure is virtually impossible to grasp. Most professional traders are usually under the age of 40 (in fact they’re typically in their mid to late 20s). As a result of this, they:
1) Didn’t experience the 1987 Crash
2) Have never seen a Crisis that the Fed/ IMF/ etc. couldn’t handle
Let’s add a secondary element to this. Most institutional traders today operate, for the most part, based on trading models. These models, in general, are quantitative and based on correlations and patterns, not qualitative judgments.
This goes a long ways towards explaining why the market has developed such simplistic trading patterns. Consider the “Monday market rally” phenomenon we saw throughout 2009-2010. Or how about the Aussie Dollar/Japanese yen correlation to the S&P 500 we saw throughout much of 2010-2011. As one asset manager put it to me recently, the market has essentially become “one big trade” with virtually all asset classes moving tick for tick relative to each other.
Let us consider the mentality these age demographics and professional working tools engender. In general, both of these factors make for short-term thinking and a lack of qualitative analysis. They also mean that items or developments that exist outside the universe of trading models (most of which are entirely based on post-WWII data), are outside the scope of these traders’ thinking.
This issue doesn’t merely pertain to traders either. Going back 80+ years, there’s never been a time in which the markets didn’t have a backstop in the form of the Fed/ IMF/ or some other entity. No matter the Crisis that erupted, there was always money printing and other monetary policies to calm the storm.
Now, let’s expand out analysis outside of professional traders to include asset managers and other institutional investors, the vast majority of whom are under the age of 50 or so.
Based on this age demographic, we find that there is an entire generation of investment professionals (aged 35-50+) who:
1) Have never witnessed nor invested during a bear market in bonds
2) Have never witnessed, nor invested during a credit market collapse
3) Have never witnessed a secular shift in the global economy
Consequently, the vast majority of professional investors are unable to contemplate truly dark times for the markets. After all, the two worst items most of them have witnessed (the Tech Bust and 2008) were both remedied within about 18 months and were followed by massive market rallies.
Because of this, the idea that the financial system might fail or that we might see any number of major catastrophes (Germany leaving the EU, a US debt default, hyperinflation, etc.) is on par with Bigfoot or Unicorns for 99% of those whose job it is to manage investors’ money or advise investors on how to allocate their capital.
If this doesn’t worry you, you need to start looking at the actual numbers in the financial system today. Here are just a few worth considering:
1) US commercial banks currently sit atop $248 TRILLION in derivatives
2) The US Federal Reserve is now buying 91% of all long-term new US debt issuance (at the same time China and Russia are dumping US bonds)
3) Japan already spends roughly half of its annual -tax revenues on debt payments and has relied on debt issuance more than tax revenues to fund its budget for four years now (how much longer can this last?)
4) Europe’s entire banking system is leveraged at 26 to 1 (Lehman Brothers was leveraged at 30 to 1 when it failed)
Folks, bad times are coming. It doesn’t matter what the trading programs or “professionals” thinking about it… the math simply doesn’t add up to us having a calm, profitable time in the markets over the next few years. On that note the time to be preparing for what’s coming is now.
If you’re looking for actionable advice on how to play the markets as well as real-world business ideas on how to generate wealth in this tough economy, I suggest checking out my Private Wealth Advisory newsletter.
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Graham Summers
Chief Market Strategist
