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Current investment risks Australians face

Extreme risks from a long-term historical perspective.

Historically extreme debt in much of the developed world - depression risk

December 01, 2016

Debt bubbles usually lead to economic depression.  Economic depression is bad because unemployments tend to become very high and shares and property prices crash.

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The US has its biggest debt bubble ever. 

 

“There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.”

– Ludwig von Mises (Austrian School of Economics).

Australia also has very high debt by historical standards.

December 04, 2016

And while total debt to GDP is no higher than 1929, personal debt (mainly mortgage debt) is by far the largest (per GDP) ever in Australia's history. Personal debt is the dangerous sort of debt because while governments can spend money they do not have, and in most normal circumstances, governments can borrow (because they have the backing of tax-payers to repay the debt), individuals do not have such flexibility. Therefore, high levels of personal debt can lead to situations where there is a dramatic reduction in personal spending (leading to severe recession), if for example interest rates were to rise sharply or some event suddenly makes the population far more cautious (eg rising unemployment) or in a global financial crisis-style of event.

Australia's record private high debt created record house price bubble

December 04, 2016

Ninety percent of Aussie private debt is mortage debt.

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Here is David Murray (chairman of the Financial Systems Inquiry) view 2/12/16 on house prices.  https://switzersuperreport.com.au/video/david-murray/  Yes, he does compare Australia house prices to Holland's Tulip Mania (bubble) in 1637.

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Some of the best long-term research on Australian house price history has been done by Philip Soos and Paul Egan and colleague in Melbourne.   https://www.prosper.org.au/2014/12/18/soos-and-egan-australian-property-chart-pack/  Soos and colleagues submission into 2015 parliamentary house price inquiry.  http://www.aph.gov.au/DocumentStore.ashx?id=cafe7b04-e06c-4e30-8286-370fc3bbb4c5&subId=351955

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Bruce Baker's submission to David Murray's 2014 Financial Systems Inquiry is found here http://fsi.gov.au/files/2014/04/Baker_Bruce.pdf

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Another source of discussion on Australian house prices is here http://www.macrobusiness.com.au/category/australian-property/

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Real Aussie house prices vs that of others

December 04, 2016

Germany is a good example of how house price normally behave. Over the very long-term, history (eg USA, Amsterdam) indicates that house prices go sideways in real terms. A divergence can occur for a decade or two, but then there tends to be a reversion to the long-term sideways trend. 

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If you wish to explore some of the global  real house price data in more graphic detail, you could go here http://www.economist.com/blogs/dailychart/2011/11/global-house-prices 

Debt bubbles and asset price crashes highly correlated

December 05, 2016

There is a very high correlation between debt bubbles and asset price crashes. Possible 100% correlation.

High levels of personal debt can lead to Minsky moments

December 04, 2016

According to Wikipedia, "A Minsky moment is a sudden major collapse of asset values which is part of the credit cycle or business cycle. Such moments occur because long periods of prosperity and increasing value of investments lead to increasing speculation using borrowed money. The spiraling debt incurred in financing speculative investments leads to cash flow problems for investors. The cash generated by their assets is no longer sufficient to pay off the debt they took on to acquire them. Losses on such speculative assets prompt lenders to call in their loans. This is likely to lead to a collapse of asset values. Meanwhile, the over-indebted investors are forced to sell even their less-speculative positions to make good on their loans. However, at this point no counterparty can be found to bid at the high asking prices previously quoted. This starts a major sell-off, leading to a sudden and precipitous collapse in market-clearing asset prices, a sharp drop in market liquidity, and a severe demand for cash."

Historically extreme money printing by developed world central banks - hyperinflation risk

December 01, 2016

Over the last 15 years, we have seen the biggest period of central bank money printing in the developed world ever. Usually massive money printing by central banks leads to hyperinflation like we saw in the Weimar Republic in the early 1920s - and as we have seen in Zimbabwe over the last 10 years or so. Hyperinflation is dangerous because it destroys the value of saving in banks - destroys your purchasing power.

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The quaint term that central banks have adopted to label their money printing is quantitative easing.

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Money printing by different countries:

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Inflation is starting to build it seems.

December 04, 2016

Inflation can be damaging in a number of ways. First, inflation chews away at the purchasing power of your savings. But right now, the bigger issue is probably that rising inflation tends to result in rising bond yields, which increases the discount rate by which all other assets are valued, thus causing falling prices for assets such as shares and listed property.  

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Signs of rising inflation in the USA are starting to show. http://puzzlefinancialadvice.com.au/Inflation/Inflation_in_USA-signs_it_is_starting_to_rise_161008.pdf Historically when inflation starts to rise in USA, rising inflation tends to be exported to the rest of Western developed world. Inflation now seems also be rising in China... and China is also an increasing influence on broader economies.

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You can see from the chart at this link (on a 10-year scale) that US CPI has been rising since beginning of 2015.  http://www.tradingeconomics.com/united-states/inflation-cpi    https://data.bls.gov/pdq/SurveyOutputServlet?request_action=wh&graph_name=CU_cpibrief

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Following the election of Donald Trump, inflation expectations have risen:

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Cash rates now starting to rise - crisis warning.

December 05, 2016

Historically, there is a high correlation between US rate rising cycles and major crises. This is probably because during periods of low interest rates, certain groups tend to take on too much debt. And then when rates rise, those with  "too much debt" default - and such defaults can have a snowball effect.

Investment returns are likely to be low in western developed world over next 10 years

December 01, 2016

In the adjacent chart, this gives you a sense of how US real returns reached a historic peak in 2000. If you did a similar analysis for Australian investments, the peak would be in 2007. The point is, when you reach historic peaks like this, they tend to be followed by a reversion to the mean (i.e. much lower real returns in the following 20 years or so, on average).

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Also - History indicates that when the US share market starts at valuations like now (CAPE10 of 26 in Dec/2016), the real returns over the next 20 years is likely to be negative. Bonds are also likely to deliver low returns, at 10-year yields in the Western Developed World is between 0%-2%. And with yields now rising (bear market in bonds), bond & fixed interest is likely to deliver below 2% - and possibly a fair bit lower. Property in the Anglo Saxon world also tends to be at elevated valuations. 

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So if you combine bonds, shares and property in a Anglo Saxon portfolio, real investment returns over the next 20 years is likely to be poor.

Biggest emergence event in history likely to lead to fall living standards in the West.

December 04, 2016

Emergence events are important because one of the features of an emergence event, is price convergence. A key price that will converge (emerging world vs developed world) in this emergence event is wages. Implications: For the developed world, the current emergence event is likely to result in a comparative decline in real wages, and for most workers the developed world, I think this will mean a comparative decline in standard of of living.

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There have been 3 major emergence events in the world over the last 200 years. Between 1870 and 1896, the USA with 38 million Americans, became a developed economy. In the 20 years from 1950, 83million Japanese emerged. Currently, we have 3.5billion Indians, Chinese and others in the emerging world are emerging from comparative poverty into middle class living. A key lesson of history, is that such emergence events generate a convergence of prices between the developing and developed economies. A key price which is highly likely to emerge is wages. This will result, I believe, in falling standards of living for most in the Western developed world over the next few decades.

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Of course, a secondary result is a shift in economic power from the West to the East. Some yardsticks on this:

* Marc Faber says that the emerging world already accounts for 70% of global trade.

* China overtook USA as largest economy in 2014 in Purchasing Power Parity (PPP) terms.

* By 2050, in order, the world's largest economies are expected to be China, India, USA, Indonesia, Brazil - and Australia might drop out of the G30 by that time. This represents a massive shift in economic power.

Technology change to lead to industrial disruption and unemployment.

December 04, 2016

Here are two reasons that you must take notice of the pace of technological change.

"The reason this post took three weeks to finish is that as I dug into research on Artificial Intelligence, I could not believe what I was reading. It hit me pretty quickly that what’s happening in the world of AI is not just an important topic, but by far THE most important topic for our future."

If technological change can have such massive impact on mankind, it can have a massive impact on your investments.

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Technological change is huge and growing at an exponential rate. The convergence of artifical intelligence, massive cheap processing power, high-speed cheap communication, cheap distributed sensors is changing our personal lives and businesses as we know them today. Technological disruption is allowing young up-start companies to successfully challenge large profitable long-established blue-chip companies. Robots are taking over jobs in factories at an increasing rate - and artificial intelligence systems are increasing going replace white collar and professional jobs.

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During the industrial revolution, the pace of change was sufficently slow to enable displaced workers to find work elsewhere, but this technological revolution is likely to happen so fast that verty large pools of unemployed seem likely.

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To quote from http://time.com/4569585/ai-robots-fears/:

“Robots will have taken over most jobs within 30 years leaving humanity facing its ‘biggest challenge ever’ to find meaning in life when work is no longer necessary, according to experts.

Professor Moshe Vardi, of Rice University, in the US, claims that many middle-class professionals will be outsources to machines within the next few decades leaving workers with more leisure time than they have ever experienced.

Speaking at the annual meeting of the American Association for the Advancement of Science annual meeting in Washington, Prof Moshe said the rise of robots could lead to unemployment rates greater than 50 per cent. “We are approaching a time when machines will be able to outperform humans at almost any task,” said Vardi, a professor in computational engineering.”

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