Investment Strategy

Great news: we’re entering crash season

Monday saw looks of shock and horror pass over the faces of TV anchors. They discovered that no amount of hairspray can prevent a quiff from wilting. That even heavily caked-on makeup can be smudged by tears. That manicured nails are poor implements to dig into polished desk tops. And that artificially inflated stock prices can go down as well as up. Crash season could be upon us, and that means there will be bargains to be had.

The week opened with some dramatic moves in world markets. The ball got rolling in Asia, where stocks were down across the region by about 5% on Monday. The Chinese market fell nearly 9% (and then another 8% on Tuesday). Japan was down 5% on Monday (and then 4% the following day).

As the world turned on its axis, and European traders shook off the excesses of their weekends, European stock markets also fell – typically by around 4%. At one point the French CAC 40 index was down by twice as much.

The sense of panic built. Tension was in the air. The world waited with baited breath. What would happen when the huge US market opened?

As it turns out, quite a bit. The Dow Jones Industrial Average (DJIA) plunged over 1,000 points, or 6.6%, soon after the open.

But then something strange happened. As fast as stocks had plummeted in the opening minutes a mini recovery kicked in. The market ended the day down 3.6%.

Many early price moves in the US were extreme. I happened to be taking a look at certain exchange traded funds (ETFs) on Monday. The price of one I was looking at plunged a massive 28% soon after the open, but soon recovered to end the day down just 3%. A little digging showed that loads of ETFs and individual stocks had followed the same pattern. Something was afoot.

They are free of emotion, but also tightly bound by the rules programmed into them by humans. Sometimes they go haywire.

What caused this? Who knows. Some people have theorised that it was caused by trading robots. Those are the automated computer algorithms that virtually roam through market data feeds looking for tiny anomalies and micro trends to profit from. They are free of emotion, but also tightly bound by the rules programmed into them by humans. Sometimes they go haywire.

Or maybe it was entirely human influence. An initial overreaction to events elsewhere in the world, followed by swift realisation that things weren’t so bad. It’s just as plausible, perhaps more so.

But either way, what set this all off? Why were all the carefully groomed TV anchors gritting their perfect teeth instead of smiling inanely through them, as they usually do?

Well, there’s been plenty going on recently to say the least. One thing grabbing the headlines was that China allowed its currency, the renminbi yuan, to fall a bit last week. It’s down 4.4% since the end of July against the US dollar, and less than that over the past year.

To put that into perspective the Japanese yen is down 21% against the dollar over the past two years. But that didn’t stop lots of breathless headlines about the Chinese move being a massive devaluation. The reality is that it was just a massive surprise.

In other words, the Chinese authorities caught a lot of leveraged speculators on the hop, with the potential for further adjustments to come. Plus it’s felt by many to signal that China’s economy is in deep trouble.

“Deep trouble” for China’s economy – if you happen to breathe the rarified air inhaled by economists and investment strategists – means it may fail to grow above 7% a year.

Why the magic 7% level? I have no idea. But according to mainstream thinking – for many years now – the world ends if China grows more slowly than that. Never mind, in my view at least, that steadily slowing Chinese growth is inevitable over coming years and decades (see more here).

There was other notable stuff going on as well. North and South Korea have been baring their teeth at each other and rattling their respective sabres. They do this from time to time. It’s their “thing”.

As of today they appear to be calming down again, no doubt with pressure from both China and the USA being brought to bear on both sides. Let’s hope the de-escalation continues.

Plus there were bomb attacks in Bangkok, Thailand which are likely to hit the important tourist trade for that country…Turkey is muddling through a political and economic crisis…the Greek prime minister has decided, having ignored the referendum result on a new bail out, that the country needs another election just seven months after the last one…Brazil has had large protests against president Dilma Rousseff, who now has an approval rating in single digits…and the strife in Ukraine rumbles along in the background.

Then there’s that other elephant in the room. Much of Syria and Iraq remains under the yoke of violent religious fundamentalists, known as IS/ISIS/ISIL (take your pick), with little resolution in sight. Their latest publicity extravaganza has been to blow up a 2,000 year old temple in Palmyra, Syria because it doesn’t conform to their odious world view.

…it does serve as a reminder to the world that these thugs are still on the loose and that they mean business.

The destruction of an ancient relic may not seem like a big deal for stock markets at first glance, even if it’s tragic for archaeologists and historians. But it does serve as a reminder to the world that these thugs are still on the loose and that they mean business.

And then there’s the US Federal Reserve, champion of the people. Provided, that is, that the people concerned are investment bankers, hedge fund managers and assorted oligarchs. The rest can be damned.

The question is whether and when the Fed will move ahead with scraping interest rates off the floor, where they’ve been lying prostrate for the past seven years. The theory is that, if rates rise, countries and companies will come crashing down under the burden of their debts.

Since we’re probably talking about a rate rise of just 25 basis points at first, or 0.25%, this all seems a little overdone – for now at least. Weak or non-existent corporate profit growth is a much better reason to doubt exceedingly high stock prices in the US (and certain other developed and emerging markets).

But the world is a highly leveraged place – perhaps more than ever before. And speculators have got used to the promise of cheap money over the past eight years. That was when the last bout of market exuberance reached its peak.

The debt addicts and money junkies need to keep getting their regular fix of cheap or newly printed money from their dealers at the central banks. Take it away and they get cold turkey…and cold feet.

The debt addicts and money junkies need to keep getting their regular fix of cheap or newly printed money from their dealers at the central banks. Take it away and they get cold turkey…and cold feet.

So take your pick. There’s plenty for people to worry about. As there always is. It’s just a question of what’s in fashion. And here’s one more thing.

In the late 1990s, at the investment bank where I used to work, the chief executive at the time was convinced that September and October were crash season. And he’d run the bank’s global stock trading business before being elevated to the “C” job, so had as good a chance as anyone of knowing what was going on.

The idea was that northern hemisphere traders and fund managers – mainly based in New York, London and Tokyo – go on holiday in July and August. Not all at once of course, but each at some point.

This gives their brains time to start functioning again, away from the hubbub of the financial circus. And there’s also the question – of paramount importance, no less – of locking in profits before the end of the year. That’s because that’s when bonuses are calculated.

So, after having some time at the beach to think, the money shufflers come back and start dumping positions. Result: prices fall, and often crash.

But it’s just a theory. And the theorist in question had started using a lot of cheap looking hair dye at around the same time. It could have oozed into his brain and affected his reasoning. So who knows.

The crucial thing is that when bargains are scarce – by which I mean prices are high relative to underlying values and to history – all investors should have plenty of cash put aside

The crucial thing is that when bargains are scarce – by which I mean prices are high relative to underlying values and to history – all investors should have plenty of cash put aside. And that’s exactly how things have been for the past few years.

Your cash is your “dry powder”. You can use it to buy stuff on the cheap when panic strikes. At that point prices will plummet to irrationally low levels, driven by the mob of short term speculators and their trading robots.

This is why it’s great news when prices fall – at least for private investors like ourselves. Whether it’s a “crash” or a “correction” it’s not something to fear.

On the contrary it’s something to enjoy. That’s because of the bargain basement opportunities that are left in the aftermath. Buying cheaply is the perfect way to ensure that future profits come rolling in. In fact it’s the only way.

I, for one, hope that crash season is upon us.

Stay tuned OfWealthers,

Rob Marstrand

robmarstrand@ofwealth.com

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Rob is the founder of OfWealth, a service that aims to explain to private investors, in simple terms, how to maximise their investment success in world markets. Before that he spent 15 years working for investment bank UBS, the world’s largest wealth manager and stock trader with headquarters in Switzerland. During that time he was based in London, Zurich and Hong Kong and worked in many countries, especially throughout Asia. After that he was Chief Investment Strategist for the Bonner & Partners Family Office for four years, a project set up by Agora founder Bill Bonner that focuses on successful inter-generational wealth transfer and long term investment. Rob has lived in Buenos Aires, Argentina for the past eight years, which is the perfect place to learn about financial crises.