I didn’t intend to go on about central banks and their monetary meddling today. But you have to be aware of what they’re doing in order to give yourself a fair chance of protecting your wealth.
In short, they’re trying to devalue their national currencies in the hope of stealing economic growth from other countries, and inflating asset prices to give people the illusion of wealth.
In this environment, what is the greatest risk? Sitting in cash, or being fully invested?
That is the greatest dilemma facing investors today.
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We are now over 10 years into the global economic expansion following the 2008/09 bust. But it feels like we’ve gone nowhere. Consider this, from The Wall Street Journal:
‘Central banks world-wide are poised to unleash some of the most aggressive monetary stimulus since the financial crisis a decade ago.
‘But the circumstances are different now, with policies aimed more at breathing life into decade-old expansions rather than at averting an economic collapse. And it is unclear whether the central bankers’ depleted tools will be adequate.
‘“We see the economy as being in a good place and we’re committed to using our tools to keep it there,” Federal Reserve Chairman Jerome Powell told Congress July 10, indicating the U.S. central bank is ready to cut interest rates later this month.
‘The European Central Bank also sent a clear easing signal in the minutes of its June meeting, which said there was broad agreement among officials that they “needed to be ready and prepared” to reduce rates and resume asset purchases to provide more stimulus.
‘Already some central banks in the Asia-Pacific region have lowered rates this year, including Australia—which has cut rates twice to 1%—New Zealand, India, Malaysia and the Philippines. Central banks in Korea and Indonesia reduced rates last week, as did South Africa’s.’
What can I say, do you have some gold?
But hang on. The last time global central banks went into a coordinated easing phase, around the time of the Eurozone crisis and Mario Draghi’s ‘whatever it takes’ speech, it ushered in a bear market in gold.
That was in 2012. It happened against all reasonable logic. I mean, the US, Europe and Japan were all in full QE mode, buying up government and corporate bonds and flooding the world with liquidity.
Yet gold fell, and continued falling for the next three years.
Why did that happen?
Put simply, the central banking policies ‘worked’. And by worked, I mean, restored confidence in the Eurozone and confidence that the global economic expansion would continue.
Gold is an anti-confidence investment. Around that time, a lot of uncertainty was already priced into gold. It peaked in 2011 at just over US$1,900 an ounce.
When central banks played their coordinated QE card and kept the foot on the monetary pedal, investors realised stocks were the place to be, not gold. At the time, stocks were cheap relative to gold.
Which is why the S&P 500 was the place to be in 2012, as unlikely as it seemed at the time.
But here we are in 2019. The roles are almost reversed. There is a lot of optimism priced into stocks. There is only the stirring of uncertainty priced into gold.
And central banks, once again, are going for the old ‘hail Mary’ — the cut rates and hope method of policymaking. Because, let’s be honest, they know nothing else.
But will the result be the same as in 2012, or will this time be different?
I have no idea what the answer is to that question. But the market is giving us a decent clue. Last month’s gold price breakout in US dollars was very telling indeed.
As you can see below, following that breakout, gold is now consolidating. I believe it’s only a matter of time before you see another major move higher.
Gold and stocks are positioned almost precisely opposite to how they were in 2012. It’s all about expectations and what is priced in.
After a five-year bear market, it’s fair to say that not much ‘worry’ was priced into gold…until recently. And with stocks at all-time highs, there is a considerable amount of optimism priced into equities.
That optimism is not altogether misplaced, especially given that optimism works with hindsight bias. Consider this, from The Economist:
‘Over the past 25 years America’s stockmarket has soared. Far from being built on thin air, this long bull run has rested on a boom in corporate profits. The worldwide earnings of all American firms, whether listed or not, have risen by 455 per cent over this period and are now 35 per cent above their long-term average relative to GDP.’
Earnings growth powered the bull run. Over the past few years, Trump’s tax cuts have provided another boost to post-tax earnings growth. But will solid earnings continue to justify rising stock prices? Here’s more from The Economist:
‘During recessions corporate earnings typically fall by a sixth or more. But even if the economy keeps on growing — at 121 months the expansion is now the longest on record — downward pressure on profit margins is on the cards. That would allow consumers and workers to get a better deal from big business, but presents two risks for investors and executives.
‘First, equity-fund managers and Wall Street analysts, accustomed to years of high growth, expect a rebound in profits later in the year. They may be disappointed.
‘Second, many firms have geared up their balance-sheets in the belief that the good times will roll on for ever. Corporate borrowing in America has risen to 74 per cent of GDP, above the peak in 2008; 40 per cent of the stock of debt is owed by highly leveraged firms with debts of over four times their gross operating profits.’
This is why ongoing growth is so important for central bankers to maintain. When a highly leveraged global economy slows beyond a certain point, the impact on equity markets will be severe.
We are not at that point yet. The US economy is still relatively robust. But bond markets are telling you a sharper slowdown is coming, probably later in the year.
Which means the big central banks will start easing very soon. But remember, stocks and gold are positioned very differently this time around.
That means, yes, this time is different.
Editor, The Rum Rebellion
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