World markets are discounting that something big will happen

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For my latest musings - please visit www.scottreeve.com
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This is my take on the world economy - Preserve your wealth while you still can!

The current talk is that the US and Europe may go back into recession. The reality is that they never left recession that hit in 2008. Bogus diluted statistics, such as inflation, unemployment rates have falsely portrayed the economic reality being felt by individuals in towns and cities around the world. Arguably many cities have been in depression for the last decade (look at Detroit and parts of Europe). The world economy is now on a detox diet and it will take many years, if not decades, to clean it up.

The markets are currently discounting that something very, very big is soon to happen. The markets always do this long before the average man on the street and the media realise it.

It could be a combination of things:
*country default;
* Euro monetary changes (Greece is insolvent, and other countries are close behind);
* central bank quantitative easing (monetising debt);
* major bank failure (particularly in Europe); and
* a significant slowdown in China.

All of these things are very real and we are already seeing the effects of this on world markets.


European contagion

All the major Euro countries are so intertwined lending billions to each other. A contagion will quickly spread when more of the bad debts rise to the surface.

Most of the current Euro-cris discussion is centred around Greece. By many measures its economy looks quite sick. It's sharemarket is now at its lowest level in 18 years (This is debt implosion!).

On other measures it certainly doesn't look as bad as other countries. Greece doesn't have the largest amount of government or private debts in the world, or the highest debt-to-GDP. One big difference is that it owes a much higher per cent of its debt to foreign creditors (foreign banks and countries).

Many argue that its non-sovereign entities which are clamping down on Greece. ie. the Global banking cartel led by the IMF, the World Bank, the Federal Reserve etc working in tune with the credit rating agencies (Moodys, S&P, Fitch). All I ask is what is the interests of the global banking groups? All actions to date show that they put their interests and survival ahead of everyone else. They do not care about the sovereignty of nation states.

So which countries banks' have the most at stake with Greece?

The following interactive chart I put together uses Bank for International Settlements data demonstrating which countries banks are most exposed to sovereign Greek debt as of the first quarter ending March 31 2011.

The most exposured banks are (by country):
French banks US$56.9 bn;
German banks US$23.8 bn;
UK banks US$14.7 bn;

The most exposed individual banks are:
BNP Paribas with US$7.1 bn (France)
Dexia with US$4.8 (Belgium)
Société Généralewith US$3.8 (France)

This is just the banks. When you add Government's holding Greek debt the amount is another US$145 bn.

Chart : There has been a huge widening of bony yield spreads and risk insurance on credit default swaps. Greece has gone parabolic. Portugal and Ireland are where Greece was a year ago.

or as Alan Kohler puts it, when the financial crisis hit last time in 2008, it was about liquidity (banks wouldn't lend to one another). This time around its about insolvency. There is plenty of cash around, but the banks might be broke.

Chart:
source: Alan Kohler, ABC News, Sept 2011

The dominoes are lined up

The next graph shows why the banking system is trying to fix Greece before it sets a precedent. You may have heard that Spain and Italy are "too big to fail, too big to bail". Europe bank exposure to Spain and Italy's are 6 to 7 times worse than Greece.

Chart :

The harsh reality is that no industry should be bailed out, including the banks from country to country. The ongoing debt crisis has come about because banks have lended and taken billion dollar bets to keep this unsound monetary system going (which is based on nothing but paper money generated out of nothing).

Monetary systems do blow up - why is the Euro any different?

One article I came across discuses that country default is more common than we are led to believe. There were a number of large defaults in the 1980s and 1990s in emerging countries across the Americas and eastern Europe. Economist Carmen Reinhart states that the list of deadbeat countries included

"current investor favorites like Brazil, which defaulted in 1983, went through a bout of hyperinflation in 1990 and effectively defaulted again, for the same reason, in 2000"

Reinhart and Professor Rogoff show that, on average, nations add 86% to their debt loads within three years of a credit crisis. At the same time, government revenue falls an average of 2% in the second year after the onset of the troubles. The way things are heading Greece and other Euro countries are heading down this path. Debts need to be rolled over...just like...a few snow flakes can lead to an avalanche.

The Stumble Cycle

Sovereign defaults--when a country stops paying its bills--go in waves, often following global financial crises, wars or the boom-bust cycles of commodities. Some countries, like Spain and Austria, mend their ways; others, like Argentina, are repeat offenders.

Chart :

The combination can be fatal for investors holding bonds issued by financially shaky countries like Argentina or Greece, which sell a lot of their debt outside their own borders (as does the U.S.--45% of all publicly held debt). As a nation's finances deteriorate, foreign investors sell their bonds, putting upward pressure on interest rates. That usually sets off a spiral including a deteriorating currency, which, if the bonds are denominated in foreign currencies, makes it impossible for the country to pay its debt. Greece doesn't have to worry about this last syndrome, because it uses the euro. But that might make things worse since it can't print its way out of its financial difficulties. "It's like entering a prize fight with one hand tied behind your back," Bass says. Argentina takes a different tack. Still struggling in the wake of its 2002 default on foreign-held debt, its president recently tried, and failed, to seize central-bank dollar deposits (and cashier her central banker) in order to repay overseas debt.

France

Following from earlier discussion, the big questions are which of the big European banks will go under first. The largest French banks, Credit Agricole and Societe Generale have billions in exposure to Greece and other Euro countries.

Chart : The share prices of the 3 largest French banks have fallen 73%, 87% and 87% since start the debt crisis started in 2008.



Italy

Until recently UniCredit was the largest bank in Italy by market capitalisation and a major euro-zone bank. It owns other large banks in Germany, Austria, and Poland with around 40 million customers all up. As the following charts shows, the market is dumping the two largest Italian banks. UniCredit is one of the "too big to fail and bail" euro banks and many of its depositors lie outside Italy, making and bail out practically impossible.

An ironic twist to this is that, UniCredit's predecessor was a bank called
Credit-Anstalt. This bank collapsed in 1931 which lead to a contagion which took Europe off the gold standard and pro-longed the Great Depression. Few people remain from the last depression era. Perhaps the money lessons need to be relearn?

Chart :



Australian dollar

The Australian dollar is a proxy for commodity prices and ultimately China. The Australian dollar has recently fallen sharply to 97 cents and has hit a major support level. If this fails there is another major support level at 94 cents.

Chart: The Australian dollar managed to bounce off the firs support level at US$0.97



Commodities

Overall commodity prices are not showing that China is in immediate trouble. Base metals: copper, zinc, nickel, lead etc are not in a major bear market yet. This may mean that the current correction will be short lived. If base metals start free falling and other negative signs come from China (popping of housing bubble?), than the Australian dollar and commodity prices will fall a lot (a huge amount) further.

Gold

Meanwhile, gold and silver have recently experienced a significant correction. Chart wise (USD/gold), gold's correction is not unhealthy. Gold was sitting at 11 year bull-market resistance line and its trending support line is about US$1550.

Chart:


As I posted recently, I believe the gold demand is getting stronger, and will remain strong, despite the recent price volatility. Since that post it has been reported that Mexico, Russia, South Korea and Thailand have all made large purchases in 2011 and globally, central banks are set to buy more gold this year than at any time since the collapse of the Bretton Woods system 40 years ago. The IMF even reported that European Central banks have started accumulating small quantities of gold after selling on average 400 tonnes of gold a year since 1999.

Silver

Silver plummeted last week by 34 per cent within trading days. It went straight through two key support levels and bounced back above them. After hitting a low of US$26.03, silver rebounded 28 per cent in 28 hours.

Chart: Silver fell 34 percent within 4 trading days, then bounced 28 percent within 28 hours


Is this volatility unusual? Silver is a very small market and historically has been prone to major corrections. My research shows that the major corrections in the last few years has lead to an increase in demand for physical silver (from mints and bullion dealers). I believe this will happen again.

Australia

Take away mining and Australia is in recession, and as I stated early, the key to the Australian economy is whether China can keep its economy upright. If it shows signs of weakness, commodity prices will collapse (along with oil, gold and silver) and the Australian Dollar will fall 10 or 20 cents against the USD.

China kept the world economy somewhat afloat during the global financial crisis, and is the sole reason why Australia didn't go and stay into a technical recession. One of the key barometers on the health of China is commodity prices.

Tourism has been in recession for many years now, in part to the high Australian dollar and a tightening of consumer belts.

Manufacturing has largely been in recession for a number of years except for businesses with astute management and niche business models.

Manufacturing insolvencies growing

Despite insolvencies around the world dropping to their lowest levels in nearly four years, Australia is headed in the opposite direction. This year is shaping up to be a record one for business failures on a par with troubled Eurozone countries. The most recent D&B Global Insolvency Index, ranking business failures in more than 30 key economies, found Australia's insolvency rate was on a par with indebted countries such as Italy, Spain and Hungary. Australia recorded a 12.1 per cent increase in business failures in the June quarter compared with falls elsewhere in the world of 5.7 per cent. D&B said its findings tied in with Australian Securities and Investments Commission data which pegged 2011 as a record year for insolvencies.

Business failures in manufacturing have soared 60 per cent in three years. Almost 300 manufacturing firms went broke in the first six months of this year, the business analyst Dun & Bradstreet says, and just 14 new manufacturers started up. By contrast, in 2008, 974 new manufacturers got off the ground, and only 392 folded.

Retail

Retail is finally entering recession. This has long been coming, even though the likes of Westfield (and other groups) have been creating mega-shopping centres around Australia. The whole retail industry relies on ever increasing amounts of debt (more credit cards and increasing consumption). This model is dead, and there is currently too much competition in Australia alone (before you look at internet shopping of overseas products on eBay and the like). Take electronics, there are so many major stores competing on price, and margins are getting thinner. Many of the private equity firms which bought up a lot of the retailers in recent years have failed, as over-inflated sales targets have missed the mark. In the last 12 months several major groups have entered administration: REDGroup (Borders/Angus and Robertson bookstores); Colorado Group (Jag, and shoe shops), Allied Brands (Baskin Robbins, Cookie Man), Krispy Kreme doughnuts, and Starbucks Australia. Most recently sharper falls in consumer spending has forced Harvey Normany to scrap its Clive Peeters and Rick Hart brands (7 stores to close) and David Jones announcing a 10.3% drop in fourth quarter sales and now expects a small profit for the new financial year.

Sizeable retrenchments are coming.


Housing

Chart:


Lastly, this is a very good presentation by Mike Maloney


Cheers
~ Scott

Superannuation wake up call - markets do not always work for the better good

People around the world are slowly waking up. Politicians and the financial industry have been perpetually lying to us about our retirement future.

In the US this first became abundantly clear in 2008 with the collapse of Fannie Mae and Freddie Mac, Lehmann Brothers and AiG and more recently with the smoke and mirrors game over US national debt. Likewise in Europe, the ongoing myriad of debt is rising to the surface exposing the vulnerability of sovereign nations to a poorly designed monetary system controlled by an international banking cartel which lies outside the nation's political systems. Whether Europe and the US continue to monetise debt and expose more debts, or embrace so called spending cut measures (austerity), the current monetary/economic systems will fall apart regardless. The point of no return was well over a decade ago. This point cannot be understated and it will have severe implications for everyone's every day lives, and expected future retirement years.

In Australia, the spin machine of politicians (on both sides of the fence) has perpetually endorsed the need for compulsory superannuation to fund individuals’ retirement needs. The biggest furphy of all is that “markets on average always go up” and that the Superannuation system will always work. A quick glance at one’s recent Super statement suggests otherwise. For several years I have had an agonistic view of the compulsory Superannuation system. The system is fatally flawed as it is heavily tied to the fortunes of the sharemarket, which itself is heavily influenced by changes in age demographics, major booms and busts brought about from a global debt-based monetary system and speculative malinvestments.

It was no coincidence that major changes were made to superannuation arrangements in the early 1990s, when Paul Keating introduced the "Superannuation Guarantee" in 1992 (or compulsory superannuation for individuals). The political class knew they needed to act quickly to transfer the responsibility of one’s retirement from employers (and ultimately the Commonwealth Government through old age pensions) to individuals, as by 2025 one-in-five Australian’s would be over the age of 65.

What better time for the Government to introduce a compulsory retirement “savings” system, than to do it when the largest demographic, the baby boomer generation, were half way through their working careers – there would be at least another 15 years of compulsory contributions to help prop up the Australian sharemarket.

After more than a decade of compulsory contributions, Australian workers have now amassed over $1.28 trillion in superannuation assets. Australians now have more money invested in managed funds per capita than any other economy. Sadly, markets are prone to huge swings, and people will have to revise their superannuation retirement expectations markedly - and act to preserve what they have.

As Alan Kohler stated in his article of 15 August 2011, Stranded at super’s ground zero

The aim of retirement incomes policy in Australia for two decades has been to shift the burden of risk to individuals before the next big bear market hit. It
worked quite nicely. …

Kohler further explains:

The first fifteen years since the superannuation guarantee legislation was first introduced in 1992 went extremely well. The compound annual rate of return provided by the sharemarket – like manna from heaven – was 15.5 per cent.

And Australia was, and still is, overweight equities. That is, the proportion of our retirement savings invested in shares is about the highest in the world. The OECD average is for about half to be invested in fixed interest; in Australia that’s 10-20 per cent.

If we take a quick snapshot of the sharemarket and annualised returns for the last five years are now sitting at a big - ZERO.

The reality is that the 1990s was a period of excessive credit creation across the Western World. All big booms, end in big busts, and the 90s boom gave us the NASDAQ (dot.com) bubble and bust, and later the massive real estate boom and bust in Europe and the US (and soon to be China and Australia). The superannuation system relies on a worldwide debt-based monetary system with perpetual money creation and debt rollover to function. What we aren’t told is that expansion of the monetary system erodes our purchasing power, creates inflation (cost of living pressures) and misallocates capital and labour to non-productive industries and pet projects.

The other fact is that the “compulsory” element to superannuation in Australia is inflationary by nature. With the Government forcing employers to provide 9 per cent pay, by law, into a super fund, there is a continual inflow of extra money entering the sharemarket system every year, regardless of the current state of the economy or the mood of the sharemarket. In a bull market, super funds, as a substantial proportion of market participants, compete with other buyers in the market, which ultimately leads to higher and higher share prices. In bear markets, the Super funds continue to buy companies in the S&P indexes regardless of poor market or company fundamentals (including companies with suppressed share prices due to large capital raisings to raise liquidity).

The biggest problem of all, is the finance industry itself. Whether the market goes up, down or sideways, the fund managers collect their annual fees and commissions for doing next to no monitoring of your portfolio. They get billions of dollars of inflows into their industry regardless of economic conditions, which ultimately props up the financial industry than what would otherwise be the case. The Government in effect is intervening in the market in a huge way, nurturing bad economic habits by providing the industry with lots of capital it may otherwise not have had. As a result, bad behaviours have grown over time. Parts of the financial community (particularly investment bankers) have used more and more "financial wizardry" to make particular investments more attractive (such as infrastructure assets) and more leveraged. However the catch is that all the bad money gets flushed out of the market system at some point in the future. The future cannot be permanently bought through debt (monetary promises).

Percy Allan’s recent article of 14 September 2011, Bucking the bear market, suggests that things may well get worse and stay bad for many years to come. His studies indicate that the world is stuck in a secular bear market. Secular bear markets is a period of typically 15 to 25 years of major volatility, of large upswings, and several primary bear markets. For instance, between 1965 and 1981 (as seen in Chart 1)there were four primary bear markets in the US, displaying falls from peak to trough of 25 per cent to 45 per cent.

Chart 1: Secular bear markets example

Chart 2: 100 years showing major secular bull and bear trends

Chart 3: The typical phases of a secular bear market. We are in phase 3.

Chart 4: Secular bull vs secular bear markets


The next secular bull market my not begin until 2015 – 2021

A “buy and hold” strategy (or some say a “hope and pray” strategy), which is continually flouted by the financial industry and Government can be disastrous for investor share portfolios (including superannuation) during secular bear markets. Many investors and now many superannuation accounts are spending a great deal of energy trying to recover from previous losses. What if the next four to ten years continues to be a secular bear market? Could you wait until 2021 for the major volatility swings to end?

Allen states that “the Great Depression, like the global financial crisis was the product of excess debt which had to be expunged before a bull market resume”. The 1929 bust for instance resulted in secular bear market that didn’t end until the debt deleveraging was over. Does anyone seriously believe, at this point in time, that the hundreds of trillions of dollars worth of Government debt (from the US, to Europe to China) and banking debt could magically disappear within 10 years?

There are always profitable trading opportunities for those willing to look and manage the risk. Capital preservation should be the primary goal for any trader, particular in this secular bear market. Timing is everything and those traders who have their finger on the pulse of the market, could generate substantial return from the market swings. A mechanical (non-emotive) trading plan is absolutely essential should you dabble in the market, at any stage of a secular bull or bear market.

The Government needs compulsory Superannuation

Yet another reason why compulsory superannuation is a giant rort in Australia, is the excessive taxation place on it. In FY2011 the Australian Government collected $7.1 billion in superannuation taxes, not bad from a “compulsory” system the Government itself setup (expected to rise to $12.8bn in four years time). The Government also uses lots of other calculations and methodologies to manipulate individuals financial decisions when it comes to retirement. The Government’s aim is to keep people in the workforce longer. The perseveration age is being incrementally lifted so that by 2025, no one will be able to access “their” superannuation until the age of 60. Why should the Government decide this for you? Would you wait to 60 years age if these access restrictions weren't there?


So what is the alternative?

What if the advice of your financial planner, accountants, stockbrokers over the decades ended up being totally off mark at the point of retirement or during retirement? There is no backspace button to turn back time.

The alternative is to take responsibility for your own financial decisions, and be sceptical about all the financial advise thrown around. If we invest TIME into financial education about how markets work, investment opportunities and threats become a lot more visible. Further, a basic understanding of monetary history is an absolute must (particularly precious metals). Currency (or money substitutes) isn’t the most preferred form of money in certain times and debt systems which produce big governments do not always work out for the better. We need to understand what happens to markets during transitionary periods. Monetary systems typically only last 40 years and the last change was in 1971 - so its overdue to change again. The US-reserve currency system, and the Euro will not last for many more years in their current form. All fiat currencies are A new monetary system will emerge. Will your savings be tied to the old system or the next system?

For superannuation, diversification to reduce exposure away from the sharemarket is a must - asap. If you are 100% relying on Superannuation to work by the time you retire and throughout your retirement, you are not diversified from the major ups and downs from the market at all. By diversification I mean different assets classes such as exposure to gold and silver and cash. (Not diversification between banking shares and mining shares – all shares are susceptible to the major market swings). Gold and silver have both easily outperformed the world sharemarkets and all currencies for the past decade, and this is highly likely to continue for the next decade. Gold and silver in the hand has no liability (debt promise) to anyone and is a hedge against the Government and banking inflation-machine.

Self-managed superannuation will gain in popularity as more individuals take the responsibility of retirement from the financial industry back to where it belongs, in the home. Recently in August 2011, it was reported that self-managed superannuation grew by $3 billion in three months (7,500 new accounts).

I would also be inclined to think twice before taking any Government-induced incentives before throwing money into your compulsory super account (such as the superannuation co-contribution scheme). Would you make this decision without the Government offer on the table? If not, why should the Government incentive change your actions?

One needs to change their context on investing and have a light bulb moment where your context on the economy changes. The vast majority of people are still thinking about investing with a 1970s, 1980s, 1990s, 2000s mentality. The next decade will be very different. Always remember that the market does not care if you gain or loose money!, so you must take ownership of your money and do it as soon as possible.

Alan Moir Cartoon - this is how your super works

Southpark's take on the finance industry:


Cheers
Scott