What You Need To Know About The Coming Market Melt-Down

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Everyone knows it’s true – the market is due for major correction. It’s coming practically any day now.

Clients, friends and family members – they’re all voicing their concern over the length of this bull market. After all, 2008 was nearly 10 years ago. And we all know bull markets don’t go on forever.

The talking heads on the TV are all worried about how overvalued the stock market is. Using regular or cyclically-adjusted price-to-earnings ratios, or various other metrics, it’s easy to see how expensive stocks have become.

And the popular investment gurus are all predicting a major market crash is imminent.

Jim Rogers, whose Quantum Fund famously bet against the British Pound and brought the Bank of England to it’s knees, said, “A $68 trillion ‘Biblical’ collapse is poised to wipe out millions of Americans.”

Marc Faber, on CNBC recently cautioned viewers that “investors are on the Titanic” and stocks are about to “endure a gut-wrenching drop that would rival the greatest crashes in stock market history.”

Literally everyday, anonymous bloggers at ZeroHedge proclaim that we’re on the brink of a major collapse. And it’s not just talk – they back up their claims with hard data and charts.

Unfortunately, all of these people have been consistently wrong for seven years.

If you believed everything you read on ZeroHedge, you’d end up sitting in your bunker in the wilderness with a shot gun across your knees, wearing a tin-foil hat.

Drawing any actionable insights from statistical or economic data is very hard, no matter how much data-mining you do, or how clever your thesis sounds.

Consider the case of Russian stocks.

By the end of 2015, Russia had gone to war against Crimea, and the dramatic fall in oil prices from $100 to $30 meant major cuts in government spending as they could no longer balance their budget.

Their GDP declined 4% as unemployment increased, coupled with a whopping 13% inflation and a 9% decrease in real wages. The Ruble declined in value, and it looked like a couple of rough years ahead for Russia.

The largest companies were state-owned enterprises with a reputation for being run by thugs, er, I mean Putin’s buddies.
And Putin’s reputation for imprisoning wealthy businessmen wasn’t exactly working in their favor either.

Against this backdrop, it would understandable if you decided to skip on any investments in Russia.

But of course, Russia’s stock market was the best performing country in 2016, returning 50%.

Making short-term investment predictions based on economic narratives is very,very hard. The most obvious outcomes never pan out, and recommended courses of action usually fall short.

Stock markets exists to make us look foolish!

And some people are more foolish than others.

Jim Rogers and Marc Faber saw success early in their careers, but have been making consistently wrong public predictions for over 15 years. They show up on TV every few months and like religious fanatics keep declaring the end is nigh.

As I’ve mentioned before, this has been the most hated bull market that I can remember, and I’ve been following the stock market for 25 years.

Since 2011, experts have claimed all sorts of reasons why this bull market can’t last.

The job growth is fake, there’s been no wage growth since 1999, inflation numbers are false, government debt is too high, corporate profits are too low, corporate profits are unsustainably high, companies aren’t reinvesting their profits, companies are buying back too much stock, the Federal Reserve is propping up the market, the Federal Reserve is keeping rates artificially low, and so on.

Despite this negativity, the stock market has kept chugging along. If you had listened all these “experts”, you would have missed out on some amazing gains over the past several years.

Investors are so worried about that coming collapse, they’re pulling money out of stocks and waiting for a better price to re-enter the market.

Meanwhile, Central Banks of the world are issuing debt at close to zero interest rates, and using some of that money to buy stocks.

Say what?

It’s true. You can buy a Swiss government 10-year bond and get LESS money back at the end of ten years. Or you buy a 30-year bond and make a lousy 0.25% return on your money.

And the Swiss National Bank is taking your money, turning around, and buying billions of dollars worth of US stock. As of March 31st 2017, they disclosed they owned $83 Billion worth of US stocks. This includes billions in Apple, Microsoft, Johnson & Johnson, Amazon, Facebook and Google. And each month they keep buying billions of dollars more.

The same thing is happening in Japan. Bank of Japan has had a zero interest rate policy for 20 years. It’s recently started buying up shares in the Nikkei stock market. It’s now the top ten largest holder of 90% of Japanese stocks. And it’s going to keep pursuing this path.

In other words, global markets all come down to central banks propping them up. There’s a lot of money sloshing around searching for any sort of yield. You can imagine some of it is going to find it’s way in to the stock market.

Some day, the music will stop and this house of cards will collapse.

But that day is not today.

Why? Because everyone is expecting it.

If you think being fearful and pulling out of the stock market is a wise contrarian move, you’re wrong. Right now the sentiment of the market is negative. If you believe in an imminent stock collapse you’re just following the herd. A real contrarian would be bullish right now!

That’s not to say the stock market can’t drop 5-10% next week or month. As I said before, such declines are a usual and expected part of investing.

But I think the next major step for the market is a melt-up, and NOT a melt-down.

We are in the final innings of this bull market. And as we saw in 1998/1999, the last 12-18 months can easily see a 20-30% gain in the stock market, with certain sectors going up 50%.

Besides the US stock market is NOT the only game in town.

European and Emerging Market stocks are selling at lower valuations and are much better bargains right now.

As I mentioned last quarter, in our client portfolios we’ve made a larger than usual allocation to Emerging Markets.

After 5 years of declining prices, Emerging Markets finally turned a corner last year and are currently the top performing asset class year-to-date. Compared to the rest of the world, EM stocks are cheap. They’re also in the bottom quartile of the their own historic valuations, meaning they’re cheaper than they have been 75% of the time.

Year-to-date asset class returns:

Emerging Market Stocks   18%
Developed Market Stocks  14.5%
US stocks (SP 500)    9.3%
US mid-cap stocks   9.1%
US small-cap stocks   5.5%
International REITs   7.5%
US Bonds   1.95%
Emerging Market Bonds   9.3%
HighYield Bonds   13.9%
Floating-rate Bonds   -0.1%
Gold   5.2%
Gold Mining Stocks   -0.7%
Commodities   -5%

Gold Mining Stocks, the highest performing asset class last year returning 48%, are now underperforming. Conversely, we see that International REITs have perked up after several years of lackluster performance. Such is the curse of mean reversion, yesterday’s winners become today’s losers and vice versa.

Our recent allocation to China has also done well over the last quarter.

Chinese stocks received a boost last month when the MSCI Index committee declared it was increasing the holdings of mainland China stocks to it’s Emerging Market (EM) Index.

At $7 trillion, China is the world’s second largest economy, after the US. 70% of it’s companies are listed on the mainland stock exchanges and currently have almost ZERO exposure in your EM index fund. This “oversight” has now been fixed, and over the next few years more and more companies will be slowly added to the index.

This means that hundreds of billions of dollars will flow into these stocks over the next few years as passive index funds start directing more capital to this sector.

Our direct exposure in China is a way to get ahead of all these capital flows.

And of course, our strategy of favoring Quality and Value for our US stock allocation has paid off again this year, returning 13.5% vs. the SP 500’s 9.3% return. When we finally do see a major correction in the market, I expect this strategy to hold up better than a regular market-cap weighted fund.

In order to keep the compliance people happy, I’d like to remind you that past performance is no guarantee of future returns!

Remember, even if you invest at the most inopportune times, buying overvalued asset classes right before they’re about to crash, you can still come out fine on the other side.

If you had bought stocks at their peak in 2008 right before the market crash, you’d be up nearly 80% today. The only requirement is you stick to your allocation and have a long enough time horizon. As your time horizon increases, the likelihood of making money in stocks increases.

But chasing performance, constantly changing investment strategies and listening to the talking heads on TV can negatively affect your investments, and jeopardize your retirement.

Of course, this is easier said that done, especially when you’re constantly bombarded by negativity in the news.

So if you’re worried about what you hear on TV, usually the best thing to do is turn it off. You’ll end up with more wealth, and better health.

Happy Investing,

P.S: If you’d like to discuss your investment performance, retirement plans, or you’d like a complimentary portfolio review, use this contact form and we’ll schedule a time to talk.

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