Will the market boom or bust in 2015?

19 Comments

1. 

   Bruce Meiers
   March 12, 2015 at 4:15 pm:

   Roger,
   Rather than looking for Black Swans or a Real Estate collapse I suggest browsing history to see if there are any change that may suggest that economic and stock markets are facing imminent trouble and I would like to consider two point for discussion, the Dollar DXY and Bonds.

   We know currently that bond yield and bank deposits are giving negative returns throughout many parts of the western world and since 1929 central banks have reduce interest rates where possible to hopefully revive an economy, but there is a very delayed response to the stimulus after a downturn has started. One wonders why interest rates are at historically low rates in a supposedly rising economic environment.

   Since mid 2014 the US Dollar (DXY), which is an index based on six currencies, has been rising dramatically with potentially major side effects. An uptrend in the DXY usually lasts around ten years and previously created significant liquidity problems throughout emerging markets (EM), remember the 1998 Asian crisis and Russia defaulting, but the rise has also had a large impact on companies in the S&P 500 as fifty percent of their profits come from overseas entities hence lower profits to repatriate, and over the last couple of quarters this has been the case with GAAP earnings.

   The DXY change has also started to manifest in the sales to inventory ratio in the USA that is now higher than immediately post 2008 Lehman, unfortunately this means there is a significant amount of money tied up in goods sitting in warehouses. The situation is not inducive to ongoing employment levels as companies cut orders for material and labour until there is balance, unfortunately in a slow moving economic environment this will take considerable time.

   Another way that a rising DXY manifests is in the movement of hot money. Hot money looks for a profit anywhere and tries to avoid the danger of capital loss. This is causing a flow of hot money into the America, where the US is considered the cleanest dirty shirt and US Treasuries are the safest asset class in the world followed by the US Dollar, consequently there is a flow of hot money from EM and DM countries to US Treasuries as witnessed over the last twelve months. US Treasure sales are proceeding very positively.

   The loss of liquidity is clearly visible in the number of Reserve Banks that have cut interest rates this year (slightly less than thirty) with the objective of weakening their currency and making the country more competitive thus inviting a return of liquidity for cheap assets. Commodity producing countries and EM countries feel the brunt of the lost liquidity as hot money exits commodity investments initiating weakening and then falling commodity prices worldwide, the excesses of the last ten years will be reversed. Over the last few years the US has significantly reduced its oil purchases overseas owing the shale fracking, hence, with the curtailing of QE3 and reduced oil purchases there is significantly less US Dollars that are available for re-deployment, hence less worldwide liquidity. There will be an EM crisis.

   I might remind you that bonds have two components, yield and value, both of which can be used depending on the economic situation. Across the DM world interest rates are being forced down and this will continue for a very long time as we have witnessed in Japan over the last twenty years, so expect interest rates to remain very low for a long, long time. Any significant rise in rates will put that country into a depression very quickly. The US Federal Reserve is flirting with a rate increase and if this occurs it will be reversed in a short period of time.
   Interest rates will continue to fall because GDP throughout the world has been falling for decades and will not start to rise until private and sovereign debts are significantly reduced.

   • 

     Roger Montgomery
     March 13, 2015 at 10:30 am:

     The inventory ratio is definitely a deflationary hint and something to watch. Thanks for sharing those insights, thoughts and opinions. They are very useful to everyone reading the blog. Thanks again Bruce.

2. 

   Roger Montgomery
   March 10, 2015 at 8:43 am:

   This comment came in from John, via email:

   Roger,
   Thanks for this newsletter. It is putting what’s happening with mixed messages on the economy into perspective.

   Its interesting that the Net Margin on mega companies is historically high and other companies are fairly normal.
   I’m assuming these mega companies are mainly the big 4 banks and Telstra who have been making huge profits and it seems to be the banks and Telstra that have driven up share prices. Given that these returns will fall back to being more normal it seems to be these mega companies who are likely to have profits hit hard with further weakness in the economy and have large share prices falls. I think this is logical as higher levels of business weakness and increasing unemployment will result in loan defaults and reduced Bank profits.

   Why this isn’t already happening with the present downturn is a mystery to me but maybe because there is a lot of funny money flowing into realestate from overseas allowing otherwise distressed properties to be sold at increasingly high prices thus saving the bacon of the many Aussies who are now loosing their jobs. When Sydney realestate prices start dropping and highly leveraged purchases go into negative equity territory then there will be a flood of houses onto a falling market and the proverbial will hit the fan. The government foresees this hence the increasing capital ratio requirements and the gradual easing of interest rates (to ensure fuel is not put on this overheated sector of the market).
   I think sound companies hit by low commodity process (BHPB, Rio, Newmont, Woodside etc. ) that are still making good profits are the stock to buy into at the moment and keeping a good proportion of cash to buy bargains when prices fall is a good strategy.

   Regards,
   John

3. 

   Aaron Somner
   March 9, 2015 at 12:06 pm:

   An important aspect to understand is that in order for there to be a stockmarket crash like 2008 capital must have some place to go. 2008 saw falling interest rates due to the flow of money from stocks to bonds. The traditional flight to quality. So capital would have to concentrate into the bond market with respect to large institutional funds. The problem is that capital is already concentrated in the bond market producing negative yields. The flow of capital would have to accellerate into the bond market driving interest rates to what, -5%, -10%. This needs to be looked at from a practical perspective. The biggest threat to the worlds economy is government debt particularly Europe. So in a situation of a panic and a worlwide recession, these European countries will be in serious risk of default as they are having problems servicing debt now. Is this where capital will be flowing to while recieving negative yields? The next panic will be out of the bond market. If so where will it go? The only place big enough is the stockmarket and corporate bonds. Essentially the current bubble is the bond market and when that bubble bursts the rise in stockmarkets will be alarming particularly in the USA where the rising US dollar will attract capital from all over the globe. The rising US dollar will also be very deflationary as we know from our Australian experience. I know how this sounds but in a panic would a fund manager with billions under management run into a safe haven yielding -5% or even -10%. Is that what the montgomery fund would do?

   • 

     Roger Montgomery
     March 10, 2015 at 8:42 am:

     Thanks Aaron. If only the markets and their participants were always so rational!

   • 

     Kelvin Ng
     March 10, 2015 at 12:47 pm:

     Hi Aaron, I agree wholeheartedly. The next panic will be a panic out of the bond markets (especially sovereign bonds) into the stock markets and private assets, including gold. It will be a panic caused by loss of confidence in governments. Gold and gold mining stocks will be a big buy (hopefully after a final capitulation below $1000 per ounce).
     Kelvin

     • 

       Roger Montgomery
       March 12, 2015 at 1:29 pm:

       There’s also chatter about a Chinese 1929. Possible? By definition black swan events aren’t anticipated. Be careful about flying into the zapper that attracts gold bugs.

     • 

       Kelvin Ng
       March 12, 2015 at 8:28 pm:

       Hi Roger, considering where the yields of European sovereign bonds are trading, nobody is anticipating anything.
       Kelvin

     • 

       Roger Montgomery
       March 13, 2015 at 10:21 am:

       Stay tuned for a piece on this in the next day or two.

     • 

       Kelvin Ng
       March 16, 2015 at 8:29 am:

       Hi Roger, a further comment on gold – if gold goes below $1000, probably by this time next year, it will have halved from its all time nominal high. It’ll become even more of a dirty word than it is now in investment circles. It does not make sense to become more bearish the more the price of a commodity falls.
       Kelvin

     • 

       Roger Montgomery
       March 16, 2015 at 8:58 am:

       AGree but predicting its direction is pure speculation.

4. 

   Duncan Lenton
   March 8, 2015 at 11:55 am:

   Roger

   Great article that seems to fit with a very small, but growing, number of analysts who err on the side of positive gains to come. One analyst, not in the class of Montgomery,and others stated that we are on the cusp of another 2008. A time when massive gains were to be had. Then it was a time for the small caps. Now is a time for a wide range of stocks.

   To get the full story from the one analyst above you have to pay for the paper and the 16 stocks that are most likely to have good to massive gains. I say this purely so you understand the type of article this is and the brilliant sales techniques they employ. The article is just $49. Cheap for obvious reasons.That does not mean their analysis should be discounted and is backed up by much of what you says.

   2008 was a time i had a few quid in the bank and even i was lucky enough to make good money. When i say lucky i mean lucky as i had no idea what i was doing. If i was a Montgomery team member I’m sure my $100k would have turned into near $1m.

   To me, i look at the very basics as i have extremely limited understanding of Global markets. There does seem to be many similarities to 2008 predominately with the huge amount of negative information being reported. The end of capitalism is nigh and we are all doomed. Cash is dead and keeping it in the bank is pointless. Fear is a great way to control people and by pushing people away from saving accounts, the only place to go is property and the stock markets. Property, to me, is way too expensive and risky and, although, markets may not be cheap, if you are invested in quality businesses that we need today and will need in the future surely any short term losses will be just that? Therefore my confidence is in the market to rise. At this point I’d expect Roger to start selling, making massive gains for me, and wait for that big pull back to buy again for moderate annual gains.

   I also think that it’s the heads of the world banks could be controlling that fear. So how do the banks benefit from us taking our money out of savings accounts? If George Soros is closely linked to the Rothchilds, where is he investing? The Australian National Review.

   Cheers for now
   Dunc

   • 

     Roger Montgomery
     March 9, 2015 at 10:58 am:

     Thanks Dunc, I have had to remove the names because I know little about the quality of what they do.

5. 

   Guy Davis
   March 6, 2015 at 8:02 pm:

   Hi Roger, thanks for the great post.

   At risk of perpetuating your comment about a human tendency to cling to what conforms to your one’s personal view and dismiss what doesn’t fit the chosen narrative, I would like to poke a few holes in the bullish case.

   I secretly suspect you will have already thought of my ideas and are just being polite to the bulls :) So here goes…

   Firstly, to say that the wave of money flooding markets due to QE and low interest rates looks set to continue therefore asset prices will keep inflating may certainly be true in the short term, however embracing this statement is akin to ditching a value based approach and jumping on the speculative bandwagon. A speculator could be right for a time in the current climate and do well on paper, but sheer logic suggests that they will not all be able to exit the auditorium through the doggy door when the proverbial hits the fan.

   In reply to the “PE Ratios not lofty” I would counter that the use of the Nasdaq is a poor point of reference. The tech wreck was centered on the Nasdaq’s largely technology related listings and the overall S&P 500 listing in 1999 and 2000 would be a better comparison with the current outlook. As Russell Muldoon has himself posted several weeks ago, while the Nasdaq may not be as high as then, the average S&P 500 stock is higher than any point in history. In 2000 the Nasdaq was so high that it dragged up the valuation of larger indices, such was the prevalent bubble, however the current S&P 500 numbers don’t need any help to look dangerous, with Russell’s point and the Shiller PE sitting at 28 next to a long run average of 17 standing for themselves.

   To the argument that earnings yields look like good value to next bond yields, I think this overlooks the fact that bonds themselves are looking extremely frothy. This is not a case of shares vs bonds. It is a case of bonds and shares vs cash. Bonds have already been squeezed to the point where there is no more blood to be had from the stone and to say that shares look like good value in relation may be true, though it will be little consolation to outperform bubble like bonds over the medium term, if you are in turn trounced by the safety of term deposits.

   To your friends research regarding bond yields, it needs to be remembered that companies have artificially boosted their dividends and that this may well prove to be at the sake of growth down the track. Obviously, in normal times, high yields coincide with bare market bottoms and corrections (ie. cheap prices) and therefore long term returns have been favourable from these points. However, we are a fair way past cheap valuations and looking at engineered yields as a bullish sign in the context of the whole outlook might be doomed to fail over the medium term.

   The point that markets can remain expensive is certainly true, however this is not a solid foundation to build a stance around and leaves the awkward question of when to get out if one’s entry in the first place wasn’t based on any fundamentals. Every dip would become a “sliding doors” moment for someone in this situation wondering if the dreaded correction had arrived. To look to one of the greatest crashes in history, albeit only seven years old, and gain strength that things went a lot higher before the abyss is a risky proposition.

   Finally, while I take the point on margins possibly adjusting to a new normal in an increasingly technology driven world, to say that margins will not mean-revert this time sounds eerily like “this time it’s different”.

   I’m not hiding my money under the mattress under the bed or anything ( I’m currently 100% invested, although this is down from leveraged to 300% from 2010 till 2014), it’s just that I will be systematically raising my cash waiting with each meaningful new high. This is because, while prices might go a lot higher yet, the downside is starting to look worrying.

   Thanks again and it is certainly going to be a fascinating next couple of years,
   Guy

   • 

     Roger Montgomery
     March 9, 2015 at 12:23 pm:

     Agree with those closing sentiments Guy. Thanks for taking the time to write and share them.

6. 

   Bruce Meiers
   March 6, 2015 at 1:52 pm:

   When close to a market cycle top the main concern for an investor should be conservation of capital, therefore, they should sit in cash especially if future time may be limited. Hence, even if an investor misses the last ten percent market rise, they avoid the devastating losses.

   The problem of course is knowing when the market is going to reverse direction and very few investors actually predict this event accurately over many cycles, George Soros comes to mind.
   George currently has taken a very large position covering this cycle change.

   This morning I read an article written about an indicator of market cycles that has proven accurate over the last twenty years. Essentially the indicator is the ratio of margin debt (USA) to its twelve month moving average. When overlaid over the S&P 500 it has been an accurate predictor of market direction and is now signaling a market downturn. There are many other short and long term market indicators with varying degrees of accuracy.

   Determining where the market is placed in the current cycle and how close we are to the market high is difficult but may be achievable. A country’s stock market is generally influenced by the economy, and when considering the USA the Economic Cycle Research Institute (ECRI) has a very good track record with its various indices and has been suggesting since about September 2014 that world growth has been slowing.
   As a rule of thumb they suggest watching the movement in sales, production, income and employment, in that order, and consider whether these elements are pervasive, pronounced and persistent.

   The Baltic Dry Index has recently fallen to an all time low and this generally supports the weakening global growth. GDP figures in Europe, China and the US also support this conclusion.

   Australia is heavily reliant on the global economy and China will not save us this time. Unfortunately moving into this leg of the cycle Australia faces extraordinary problems probably never faced before, the commodity prices are falling dramatically, mining capex falling, the automotive shut down and real estate borrowing maxed out; I hope we don’t have any major droughts in our farming areas.

   Every investor and investment company have their particular method of determining an investment position and risk, I am no exception. My belief is that stock markets around the world incorporate all current knowledge, fear, euphoria, etc, and that is displayed on a second to daily basis. The market is not efficient, but embodies some remarkable trends both long and short. The problem is capturing these trends mathematically so they can be displayed graphically.

   Over the years I have developed several long term Coincident Indicators that have proven accurate over one hundred years and now track fifteen worldwide stock market indices, each index also includes a two hundred day and fifty-day exponential moving average. When the primary Coincident Index reaches its peak on the third market cycle leg and the three graphed lines invert then the market has declined in every case. The Coincident Index peak is usually timely and the inversion can be before or after the market final high, so the market can reach new highs after the Coincident Index has peaked. Of the fifteen indices tracked, three have not inverted although they appear to have reached their peak in recent weeks.

   • 

     Roger Montgomery
     March 9, 2015 at 12:30 pm:

     Great thoughts Bruce. Thanks for sharing these useful insights. feel free to send some graphs through (not your calcs of course), and we can post your comments along with the graphs, if that is something you are happy to share. I think many of us must be able to remember Lakshman Achuthan from ECRI making his recession call that was ultimately wrong. Good to keep an eye on what Bridgewater and Ray Dalio are thinking.

7. 

   John E
   March 6, 2015 at 11:30 am:

   Hi Roger,

   Superb coverage of the current investment conundrum.

   Your main takeaway point is to concentrate on quality business and not so much on the economic cross winds – although we need to be aware of them.

   I think we’re in the very early stages of a slowdown here is Aust. The irony of the situation is that in previous market downturns over the decades, the market anticipates this and corrects down. No correction (as yet).

   People are becoming so complacent to low rates and expect them to last a very long time – this supports your thesis that we may see a huge rally at some point. I think div franking is also a huge factor in how people judge value here compared to around the world.

   A lot of money will be suckered into this market and any further RBA rate cuts will only exacebate this. I’m fearful of a situation where we see a stock like CBA trade at $150 yielding 3.5% gross because we also experience zero or negative interest rates here.

   Patience is certainly the key and not lowering your standards as normal can become ‘unnormal’ very quickly.

   • 

     Roger Montgomery
     March 9, 2015 at 12:31 pm:

     Patience always works a treat when it comes to investing John. You’re spot on.