It's very hard to short a bubble, because you never know when a bubble will burst. The Nikkei was in a bubble at 25,000 points – then it went to 39,000.
Let's say central banks will continue to print money and keep rates at zero or below, then what is the worst investment? It's cash. If you are really bearish about the world, then you don't want to be in cash, you need to invest.
Oil
There is a real danger that oil could go up substantially, maybe not immediately, but in the long run,
Bonds
Everybody says they hate bonds. The 10-year Treasury yields 1.74 per cent, which is very low, but compared to Japanese and Swiss bonds it's relatively attractive. US government bonds still have upside potential, especially if the US Fed continues to implement lower and lower interest rates.
I am spending a lot of time thinking that the current financial system, that we can all agree is not sustainable in the long run.
The big question is how will it all unwind? Will it unwind with a breakdown of democracy, with a breakdown of law and order? We just do not know. But one of the potential significant problems that may occur is what the Fed and other central banks actually wish for and that is inflation. There is a good chance that commodity prices have bottomed out and that inflation in general will accelerate.
In other words, people’s cost of living will start to go up more than what is desirable. And that will depress real earnings, but it will be good for assets such as commodities, especially precious metals. Obviously, very negative for bonds and probably negative for equities when yields go up. So, I want to own some commodities. If you look at sectors in the US or globally, what is inexpensive?
Gold shares have rallied 100 percent from the lows, but they came down before by 90 percent, so they are still relatively inexpensive. You look at basic stocks that are producing copper or aluminium, these companies are not terribly expensive from a long-term cyclical point of view. So there, I see some value and that is where I would put some of my clients' money. If you come with USD 1 million, I am not going to buy and put it all in gold and gold shares, that would be irresponsible. But I would tell you, maybe you should have at least 25-30 percent of your money in an asset that cannot be printed by central banks.
The US market is so much more expensive based on price to sales, price to earnings, price to book than any other market in the world that US stocks are in my opinion more vulnerable than in general perceived.
We were in February of this year at 1,810 on S&P 1,810 from here would be a decline of more than 10 percent.
But if the market goes to 1,810 we could go down also to 20 percent or even 40 percent. But I believe that as we would approach the February lows on the S&P at 1810 that the Fed - under the influence of the money printers and people like Larry Summers - and other central banks will step in and start to buy equities to support the market.
European banks are in a very poor financial condition. They will need more capital but in theory, the European Central Bank (ECB) and other central banks can essentially provide liquidity to the established banks and the governments if they like. They can basically bail out banks. They may have bail-ins here and there where some bond holders -- like there are coco bonds outstanding -- would get hurt to some extent but basically the government can essentially buy shares in the Commerzbank or Deutsche Bank and recapitalise them.
As a result of that, the government will be an owner of the 50 percent of the bank or 30 percent or whatnot. That is all possible. We just don't know. We are writing a report about this in a not-so-realistic economic and financial world.
I would tell my clients we have had an incredible bond market rally since 1981. Bond yields are not going to go down much more, they may not go up substantially but they are not going to go to -5 percent. So, the bond market is relatively unattractive.
Does it mean that equities are much more attractive? That is far from certain because if yields on say the US 10-year treasury goes to 2.5-3 percent, that may hit back the equity markets as well.
So, I would tell the guy, look I am happy to invest your money but the returns over the next 5 or 10 years will be very disappointing to you because you expect to make between 8 and 12 percent on your portfolio every year. That is simply not going to happen.
The belief is obviously that a Trump victory would be negative for asset markets, for the US market, and that a Hillary victory would be positive. But I am not so sure about this belief for the simple reason that Hillary is basically a neocon and a warmonger. She has invaded or supported the invasion of variety of countries already. So, that may lead to more international tension. Whereas Trump is more aware of the fact that the US' superpower standing is gradually waning and that other countries are coming up and that US cannot fight and be the policeman of the whole world. [Trump realizes] they have to gradually start to negotiate with other countries on equal terms.
The Fed sniggers at the thought of a Trump victory. They are supporting Hillary Clinton as incidentally as the entire media establishment is support Hillary Clinton and is anti-Trump.
My view is that in this environment we have now clear voices at the Fed and other central banks that basically they should be able to implement negative interest rates and that they might do well if they bought equities. So, under this scenario, you ask yourself what is actually the downside risk.
In my view under both Trump and Hillary will continue to print money, there is no other way out, the system is basically bankrupt.
So, money printing will continue and then the question is what will happen to asset market? In theory, they can continue to go up. As I pointed out, I am not optimistic about the global economy. But if you print enough money -- central banks' balance sheets have increased sixteen times between 1998 and 2015 -- why can't they go up another 10-20 times in the next five years? In that scenario, the Dow Jones could go to 100,000 and so on, anything is possible. We don't know how far the math professors at central banks will go.
The last few years, active fund managers, by and large, have been playing a lottery. Some have done well, and some haven't. In general, active fund management has suffered badly at the expense of indexing. I believe, we are moving into a period where small investors have a huge opportunity to make money, as they have a window to capitalize and take advantage of market inefficiency.
Index funds mostly buy large companies. As a result, it leads to undervaluation of smaller companies, and that's where I see an opportunity for the individual investors.
The US Fed has grossly overestimated growth rates of the economy, and it appears that it the economic growth has slows down considerably. I think by December 2016, the economic statistics will be even worse. So no rate increases will happen then ....
Janet Yellen vs Clinton vs Trump
If Hillary Clinton is elected, I very much doubt that she will increase interest rate. If Trump is elected, the likelihood of her increasing interest rate is very high.
In the last few years, as you know, the world has gone into an indexing madness. They just put money into an index. I believe the next 10 years will allow active managers to make a lot of money because they can move from one sector to another. Now some will outperform and some will underperform, but at least they have an opportunity. If you just index, usually you will underperform the index.
My view is that the U.S economy has been slowing down over the last 12 months and corporate profits have been coming down over the last 12 months, and so it’s not a good time to increase interest rate.
On the other hand, the Fed went to almost zero interest rates in December 2008. So in December 2016, we are now eight years, at zero interest rates, the economy must be stinking if you can’t increase interest rates during eight years of an expansion so something is wrong. So my view is that they should have already increased it in 2011 and basically they should increase it now.
I think on balance, zero interest rate – and now there are many voices that propose negative interest rate – is rather negative for the economy.
I think it would be good for the world if we had a U.S. President who is not a neocon and that is not guided by people like the Bush family and Dick Cheney and so forth, but someone who is prepared to see the world the way it is. The world is not as it was a 100 years ago where western powers were able to colonize the world and impose their will.
Today, we have countries like India and China and even Russia that have become very powerful. And so we have to negotiate with these countries keeping in mind their perspective, not just our perspective of the world.
And this is something Hillary Clinton just can’t do. She was Secretary of State so we know what her record is. She supported the invasion of Iraq. She supported and launched the invasion of Libya and she supported also the nation-building in Egypt and the war in Syria – all major disasters. And so I am saying to myself, maybe after all, Trump is a better choice.
Basically we have volatile markets and we have a lot of leverage in the system. Hedge funds borrow money to buy gold, silver, equities, bonds, and currencies. So if you look over the last 2 years, gold dropped almost 30 percent. So we have this volatility. People say well the markets are not volatile, but that’s not true. There’s a lot of volatility. And I think that the positioning in gold was heavily long. And you have to see some of the hedge funds. They know what the positions of other hedge funds are. And so when they know a hedge fund is heavily long gold on the margin, they may squeeze that position out by selling gold. And then the hedge fund which has large positions may have to dump gold and the price goes down. And then they can cover.
We ... don't know how the world will look like in five years from how - how crazy and insane the central bankers will become. Central bankers can buy all the government and corporate bonds. As in the case of Japan, they can also become a major shareholders in companies. So in essence, they can buy all the stock market. Through money printing, the world can move into State-ownership, socialism and communism.
Today, Britain is completely irrelevant for the world economy. It contributes less than 4% of the global GDP and is a very small manufacturer. What is relevant for the world are growth rates in China and India. A number of analysts fail to understand that if India gets its act together, then it could have a growth rate of maybe 5% per annum....we need that consistently.
A consistent growth rate of 5% is an incredibly high rate. We don't have any growth in Europe and Japan. If we were to measure the GDP correctly in the US, there would be no growth. And we are talking about a demographically attractive population. What India needs is liberalization of businesses and the reduction in government intervention. That apart, a number of things have to come into place. But, there is hope.
If you keep printing paper money, the supply of money increases and assets that are in short supply or limited supply—whether it’s a Ferrari or a Gaugin painting—they are in tight supply, so they will appreciate.
They will not all appreciate at the same time and to the same extent. There will be bubbles in real estate and collectibles; there will be bubbles in equities, as we have had three times since 1999.
Major central banks started with their easy money policies long ago. The first indication of money printing was essentially in 1998 with a bailout via the long-term capital management (LTCM). At that time, I don't think anything would have happened to the system. The central banks printed money massively and deliberately created the NASDAQ bubble. When this bubble burst, they deliberately created the housing bubble that was built on excessive credit growth. And when this bubble burst in 2007 - 08, they started in a coordinated fashion to print money by purchasing assets around the world.
The asset purchases by these major global central banks - the US Federal Reserve (US Fed), Bank of Japan (BoJ), European Central Bank (ECB) and the Bank of England (BoE) - have been increasing overtime, though the US Fed has stopped now.
My view is that the asset purchases by BoJ and the ECB will not stop. The balance sheet of the major central banks increased 16 times between 1998 and 2015. So why can't it go up another 20 or 100 times? Money printing is an unlimited action, until the system breaks down.
By when do you see this system breaking down then? Will this bubble created by central bank liquidity across asset classes burst anytime soon?
The bubble can last a long time, one just needs to increase the size of money printing continuously. As a result, asset prices - stocks and real estate - go up phenomenally. So in essence, we have a bull market across asset classes.
However, the value of paper money depreciates, as it has done for the last 30 years. Whatever the central banks do now, asset prices will depreciate against precious metals - gold, silver and platinum.
87 years old Jack Bogle founded the Vanguard Company in 1974. Today, Vanguard is one of the most respected and successful companies in the investment world. [In 1999, Fortune Magazine named Bogle as “one of the four investment giants of the twentieth century.”] In 1975, Bogle founded the Vanguard 500 Index Fund as the first index mutual fund available to the general public. Bogle’s innovative idea was that with his index fund, which would simply mimic the index performance over the long run, he would achieve far higher returns with lower costs than actively managed funds.
According to Bogle, we shouldn’t expect “a revisitation of the ’80s or ’90s, when stocks returned 18% a year…. Those planning on a comfy retirement or putting a kid through college will have to save more, work to keep costs low, and - above all - stick to the plan.”
The Wall Street Journal explains that “Mr. Bogle relies on a forecasting model he published 25 years ago, which tells him that investors over the next decade, thanks largely to a reversion to the mean in valuations, will be lucky to clear 2% annually after costs. Yuck.
Then why invest at all? Maybe it would be better to sell and stick the cash in a bank or a mattress. ‘I know of no better way to guarantee you’ll have nothing at the end of the trail,’ he responds. ‘So we know we have to invest. And there’s no better way to invest than a diversified list of stocks and bonds at very low cost.’”
Normally, I would not spend much time discussing Indexing. The point I want to make is that for the average investor (by definition a relatively small investor) “there’s no better way to invest” than Bogle’s strategy of investing “in a diversified list of stocks and bonds at very low cost.”
However, I am referring here to the average investor and not to the savvy financier who knows how to select one of the few active managers who actually outperforms an index over time, or an investor who has sufficient analytical skills and discipline to select companies that beat the index over time.
In a recent article for the Financial Times, William White observed that
“The monetary stimulus provided repeatedly over the past eight years has failed […] Debt levels have risen […] Consumers have had to save more, not less, to ensure adequate income in retirement. At the same time, easy money threatens two sets of undesirable side effects. First, current policies foster financial instability… and many asset prices bid up to dangerously high levels. Second, current policies threaten future growth. Resources misallocated before the crisis have been locked in through zombie banks supporting zombie companies. On the demand side, accumulating debt creates headwinds, leading to more monetary expansion and more debt […] On the supply side, misallocations slow growth, which again leads to monetary easing, more misallocation and still less growth.”
I have a high respect for Bill White as an economist because he identified the problems correctly. Unfortunately, I cannot agree with his view that “Only government action can resolve a global solvency crisis.”
Therefore, I expect more of the same: larger fiscal deficits, larger governments that will own not only their public debts but increasingly also equities through their respective central banks, which will happily continue to print money.
In this context my readers should remember the words of Paul Volcker:
“It is a sobering fact that the prominence of central banks in this century has coincided with a general tendency towards more inflation, not less. [I]f the overriding objective is price stability, we did better with the nineteenth-century gold standard and passive central banks, with currency boards, or even with ‘free banking.’ The truly unique power of a central bank, after all, is the power to create money, and ultimately the power to create is the power to destroy.”
With kind regards
Yours sincerely
Marc Faber
