It might be time to sell your shares and your house

Another big financial crash could be coming.

There is a lot of evidence that markets are doing that thing they do. Getting out of whack.

It’s hard to believe that this could happen again so soon. In the past, major financial events have been interspersed with decades of good times.

But to count on history repeating would be … brave.

Here’s the symptoms of the problem. Stocks are super high, with the US markets setting records:

DJIA high
Source CNN

That could be a good thing right? Companies get high valuation when they have high earnings. And high earnings mean a healthy economy!

Hmm. 

Price to earnings chart
Source

This chart shows a ratio of stock prices to company earnings. It shows that prices sometimes get well out of line with earnings and the market can’t sustain that.

How can this happen?

As anyone who has played monopoly knows, the more times people pass Go, and the more money in the system, the higher the asking prices for trading properties. 

The same thing can happen at a much bigger scale. The more cash in the global economy, the higher asset prices are.

Here’s evidence that cash is swilling around in the global economy like burger wrappers in the passenger footwell.

Greece government bond yields
Source

The Greek government can now borrow money at 6 per cent. In 2012 they had to pay over 30 per cent. That’s how much cash is lying around. Even though Greece’s problems remain dramatic (e.g. 27 per cent unemployment), money managers are happy to give €€€€ to the government. Similarly in Spain, where unemployment is 25 per cent, bankers are happy to lend money to the government at the lowest interest rates since 1789. Seventeen. Eighty. Nine. 

Meanwhile Dutch interest rates are at their lowest in 500 years.

You can also spy the global economy’s excess cash in the way Facebook is buying things like WhatsApp, for $19 billion, and in the near-record valuation of Apple even as iPhone enthusiasm is being studied by historians. 

Here’s how the New York Times describes it:

“Around the world, nearly every asset class is expensive by historical standards. Stocks and bonds; emerging markets and advanced economies; urban office towers and Iowa farmland; you name it, and it is trading at prices that are high by historical standards relative to fundamentals.”

Australian stocks have rallied hard in the last two years, and here’s a chart of Australian house prices, just to show that our assets are not immune. 

House prices
Source

Global markets have not got to this point without a reason. The billions pumped into the economy by central banks doing quantitative easing explains the surplus cash. 

The Bank of International Settlements has said that this has caused capital “misallocation” on a scale similar to the GFC. 

So what could happen next?

The United States is now planning to stop its five-year quantitative easing program, this October

The billions a month it “printed” will cease to arrive at the banks and they will have to go back to more old-fashioned ways of finding capital.

Then, we find out if economic growth can catch up fast enough to make all those high prices make sense, or if everything crashes. 

Plummeting asset prices in North America and Europe would hurt us, no doubt. But a fall in China has already begun and that simultaneity would be the worst case scenario.

Last time round, China was basically immune from global financial contagion. But this time, everyone agrees China is in an asset bubble that is already ending. 

china property prices
Source: Economist

If asset prices fall fast in China and the West at once, it will be time to move your savings into something very very safe.*

*You know I’m not a financial advisor, right? Right.

 

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thomasthethinkengine

Thomas the Think Engine is the blog of a trained economist. It comes to you from Melbourne Australia.

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