How 0.5% Can Wipe Out 80%

It’s been a long time coming.

The All Ords has once again (ever so barely) stuck its head above the 1 November 2007 peak of 6,873 points…a period of 13-plus years to reach break even.

Shares for the long term? Maybe. Maybe not.

Port Phillip Publishing

Source: Yahoo! Finance

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If you went into the Aussie market on the back of the hype in 2007, it’s been a looooong time from peak to peak.

Investors took the elevator ride down in 2008/09, wiping out all gains made since 2003.

Then it’s been a staircase climb back to break even.

It’s been a slightly different story in the US.

The 2008/09 downturn wiped out all gains made on the S&P 500 since January 1997…wiping out a decade of upside.

But since then, the Fed has worked overtime bounding up the recovery staircase.

The US market is way beyond its pre-GFC peak

Port Phillip Publishing

Source: Macrotrends

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However, there is one similarity between the two charts.

When the S&P 500 plunged more than 30% in Feb/Mar 2020…the All Ords, tethered to Wall Street, fell an almost identical amount.

Our market doesn’t get the gain, but it sure does get the pain.

We only seem to dance in step to the more sombre tunes played by Wall Street.

Should the US market fall 70% in value (as I suspect it will), then you can be assured our market is going down the elevator shaft with it.

Perhaps we won’t go splat at the same level. We might be cushioned at the 60% loss marker. Some consolation that’ll be. At 2,800 points we’ll be back to a level first breached in late 1998.

The peak in the All Ords in late 2007 was preceded by months of investor fervour.

Our market had been on a 20%-plus per annum compound run for nearly four years. How good was that?

You’d be stark raving mad not to borrow money at 8% to invest in a ‘sure thing’ returning 20% PLUS dividends.

And borrow they did…via the loan facility called a ‘margin loan’.

Anyone who’s been around markets a little while knows how that ‘borrow to invest’ exercise ended for investors. In a word…badly…especially for investors of advisory firm Storm Financial.

As reported by on 12 October 2009 (emphasis added):

Among an estimated 14,000 people caught up in the collapse [of Storm Financial], almost 500 have lost everything, including their homes and life savings. They had been encouraged by Storm to mortgage their homes to invest in the sharemarket. When it collapsed last year, many were ruined.

When margin debt is involved things can go real bad, real quick.


When you borrow to invest, the lender wants to keep a healthy buffer (margin) between its money and any market downside.

If that margin gets a little too thin for the lender’s liking, then investors will receive a ‘margin call’…put more money in to restore the safety buffer or the lender will start selling your investments to cover (partially or fully) its loan exposure.

Here’s the latest data on US Margin Debt (red line to left-hand side) in comparison to the S&P 500 Index (blue line to right-hand side).

Port Phillip Publishing

Source: Yardeni Research

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Debt levels rise in tandem with the market.

Seriously, how dumb is that?

Will lessons never be learned?

But this is what happens when a market has a prolonged period of positive gains. People somehow convince themselves in the permanence of the trend.

Big mistake. Huge.

If the trend was enduring, the market would be redefined as linear, NOT cyclical.

Markets do not progress in a straight line. They rotate from up to down to up to down.

The ‘up’ part of the cycle tends to take much longer than that of the down.

And here’s why.

The US margin debt chart shows there’s a lot of borrowed money riding on that blue line (S&P 500 Index) continuing to go up.

When, not if, this market provides a repeat performance of 2000/03 and 2008/09, the selling volume — forced by investors receiving margin calls — will send that red line into a vertical descent.

These are very dangerous times to be playing with someone else’s money.

After more than a decade of stellar gains, surely people must realise the US market is due — sooner or later — for a (massive) correction.

Or perhaps they don’t think this is possible. The Fed will once again save the day.

That’s a crazy brave belief. Never before in the history of man has there been linear progression…it is always cyclical.

Can the Fed really and truly rewrite the history of human nature? I doubt it.

When that rather obvious reality becomes apparent, then it’ll only take a few snowflakes to cause an avalanche.

Most people don’t realise how little it actually takes to move a market.

The Australian Stock Exchange has an average daily turnover of AU$5.6 billion and a market capitalisation of around AU$2.2 trillion.

On a daily basis, the buying and selling of 0.25% (yes, 0.25%) of stock moves the market.

That means, 99.75%  of stock stays in the drawer.

Very few people realise how markets move at the edge of a very thin margin.

Most people think in a crash it’s a case of everyone yelling ‘SELL, SELL, SELL’. When in fact, it’s only a tiny minority who have very loud (and panicked) voices.

This wafer-thin volume of daily trading determines whether portfolio values rise or fall.

All it requires is for daily turnover to double — to 0.5% — and we have an avalanche…possibly resulting in a 70% or 80% fall.

The remaining 99.5% of stockholders will stand there with mouths wide open…trying to comprehend what just happened.

With margin debt of US$750 billion, it’s not hard to see how daily volumes on Wall Street could suddenly double…especially with margin calls.

Should the down days start to mount up and a pattern of ‘lower lows and lower highs’ emerges, more indebted borrowers will feel the pressure (either internally or externally from the lender) to sell.

By any reasonable valuation metric, the US share market is over-overvalued.

There is very little margin (literally and figuratively) for an error of judgement.

Once the market starts its descent down the elevator shaft, all it’s going to take is a 0.5% push to create the velocity for an 80% fall.


Vern Gowdie Signature

Vern Gowdie,
Editor, The Rum Rebellion

Vern has been involved in financial planning since 1986.

In 1999, Personal Investor magazine ranked Vern as one of Australia’s Top 50 financial planners.

His previous firm, Gowdie Financial Planning, was recognised in 2004, 2005, 2006 & 2007, by Independent Financial Adviser magazine as one of the top five financial planning firms in Australia.

In 2005, Vern commenced his writing career with the ‘Big Picture’ column for regional newspapers and was a commentator on financial matters for Prime Radio talkback.

In 2008, he sold his financial planning firm due to concerns about an impending economic downturn and the impact this would have on the investment industry.

In 2013, he joined Fat Tail Investment Research as editor of Gowdie Family Wealth. In 2015, his book The End of Australia sold over 20,000 copies and launched his second premium newsletter, The Gowdie Letter.

Vern has since published two other books, A Parents Gift of Knowledge, all about the passing of investing intelligence from father to daughter, and How Much Bull can Investors Bear, an expose on the investment industry’s smoke and mirrors.

His contrarian views often place him at odds with the financial planning profession today, but Vern’s sole motivation is to help investors like you to protect their own and their family’s wealth.

Vern is Founder and Chairman of The Gowdie Advisory and The Gowdie Letter advisory service.

The Rum Rebellion