Waiting for the next shoe to drop – Will It Be a Pump or a Flat?

June 19, 2014

Did you know the U.S. just booked a negative quarterly GDP? If the next quarter is negative, technically we're in a recession. 

Vlad "The Impaler" Putin appears to have plans to bring back the Soviet Union’s glory days, when bigger was better. 

We now have a phone app called Uber that's worth just under $20 billion, about what Sony (SNE) is worth, and it’s not even publicly traded yet; that’s just its private market value. Venture capitalists believe they can take it public or sell it for $30-50+ billion. What is this new app, you ask? Basically just an easy way to hire a limo from your smartphone.

In general, a skittish market full of fearful investors reacting to bad news could mean better future returns. It’s when optimism runs too high that future returns suffer.

As we've noted in previous months, bond and cash yields are too low now to cut way back on stocks, contrary to previous periods of stock market optimism. The problem with this sensible strategy is that everyone's starting to do it, and when everyone starts doing anything, even investing sensibly, that can lead to stretched stock valuations. 

It's not clear where the next significant slide will come from. We don’t have a broad tech and growth stock bubble like we had in 2000. We don’t have a real estate bubble propping up the economy. Not that you need a reason for the stock market to slide. There's still no consensus as to what caused the crash of 1987, and experts differ on the reasons for the 1929 crash as well as the depth of the economic problems following the slide. 

We’re not seeing flagrant public euphoria for stock investing. Professional investors and businesses seem the most jazzed about paying up to invest or acquire other companies. Still, we’re seeing too many investment ideas coming down the pike – much of it in the form of exchange-traded funds (ETFs). 

Just because more people start making music or art doesn't mean you magically get proportionally more good music or art. The volume of new investing ideas usually means most of the new ideas will underwhelm, if not flat-out fail. This appears to have already been the case, since the ETF boom kicked into overdrive a few years back.

What  Will Cause the Next Stock Market Slide?

As we gear up to make some relatively minor changes to the Powerfund Portfolios, let’s take a brief look at the nature and potential causes of the next stock market slide, and rate them on a scale from 1 – 10, with 1 being very unlikely to cause the next fall and 10 being almost certain to cause the next fall. For longtime MAXfunds readers, this is sort of like our old Psychic articles, only in a summer release, because everybody knows that's the best time to put out good movies. Does 22 Jump Street come out in January? No, it doesn’t.

NOTE: This will be a two part series, with the second installment coming in mid-July! Don’t forget to sign up for email alerts for trade and article updates!

(Another) Real Estate Crash – 3

What? So soon? Stranger things have happened. When interest rates began to climb last year, mortgage origination shut up like a clam, although rates are still low and monthly payments quite reasonable compared to rents, unlike in 2006. Still, this real estate mini-boom is mostly about low interest rates making property ownership compare well to renting.

If we get another crash, it won’t be like the last bubble, which didn't collapse because 30-year mortgage rates went up. It'll be because higher rates will adjust home prices down to keep the monthly payment the same. 

Real estate's like a long-term bond. It has a high duration, which is a measure of interest rate sensitivity. How high of a duration? With all other things being equal, a home should fall in price by about 10% for each 1% increase in 30-year mortgage rates.

Investors seem comfortable with that risk, even buying with borrowed money, yet remain skittish about owning actual long-term bonds. Fortunately, (we hope) significantly higher rates don’t seem likely in the future.

Income Inequality – 5

Maybe I should stop reading  Capital in the Twenty-First Century, that hot summer beach read from French economist Thomas Piketty. Unlike most bestsellers, this one comes complete with economic formulas and graphs. If there are any murders (not including the French Revolution) or romantic interludes, than I haven’t gotten to the fun parts yet. So far, it’s a bit of a downer.

The danger to the economy here  isn’t so much the possibility that income inequality will collapse in on itself as an unsustainable economic situation, but more that the fixes being proposed might cause more problems than the problem itself. What’s worse than a New Gilded Age? An old Dark Age. 

While Piketty points to the very long-term trend of inequality with capitalism, we’re also now in a time when millions and even billions can be earned for marginal effort or time invested, historically speaking. The latest in a long string of strange self-made multi-millionaires is the kid who posts edited videos of himself  playing video games and having fun on YouTube and earns (so says the WSJ) $4M a year. The flipside is that taxi companies, and ultimately, drivers, are one self-driving car invention and widespread Uber adoption away from being innovated out of a job.

Iraq/Russia/??? – 4

In Wall Street lingo, our investment in Iraq is underperforming. A few years ago, things seemed optimistic globally, what with the Arab springs and all. But while growing trouble can definitely hurt the stock market and the global economy in the shorter run, there don’t appear to be any situations that could end worse than Vietnam, which ultimately became a productive member of the global economy. There may be plenty of evil dictators in the wings, but none of them are sitting on a productive diversified industrialized economy like the one with which Hitler was able to finance endless expansion plans. Didn’t Ukraine and other expensive schemes already bankrupt the Soviet Union once?

Next month, stay tuned for the probability that the Next Big One will happen as a result of a Falling Dollar, Deflation, Inflation, Recession, the Collapse of China, A Growth Stall, and more!