Cut back stocks. Add to your gold holdings. Behavioural finance analyst Ken Norquay says the stock market is riskier than ever: add to your gold holdings over the next few months.
In March 2020, the US Federal Reserve Board announced it would print money—“as much as it takes”—to prevent deflation. Almost six months later, the US stock market has touched another new high. The S&P500 hit 3,588 on September 2, 2020. It appears that the Fed has once again succeeded in fending off deflation and a stock market collapse.
Their next problem is the pandemic-stricken economy: business is hurting and people are talking about depression. We can only hope that the flood of money being printed is washing into the economy too.
In my stock market book, Beyond the Bull, I emphasize the combative nature of the financial markets. It’s a battle. There are winners and losers. Today’s battle lines are clear: the forces of deflation vs. the forces of inflation. Excessive tight money will detonate a depression and deflation. Excessive easy money triggers hyper-inflation. Economists are eloquently setting out their bold forecasts and advising us all what to do with our investments. Let’s examine the usual financial markets and try to become wiser investors by gleaning guidance from the markets themselves.
US stock market
In several columns, I have written about the five-point broadening pattern, a dramatic stock market chartists’ pattern that foretells doom and gloom caused by increasing speculation in the market. The Fed’s free money policy has created a pattern I’ve never seen before: a seven-point broadening formation. Consider this data:
1. Peak to Trough: Late January to mid-February 2018: S&P500 dropped 340 points.
2. Trough to Peak: Mid-February to September 2018: S&P500 rose 408 points.
3. Peak to Trough: September 2018 to December 2018: S&P500 dropped 594 points.
4. Trough to Peak: December 2018 to February 2020: S&P500 rose 1,047 points.
5. Peak to Trough: February 2020 to March 2020: S&P500 declined 1,202 points.
6. Trough to Peak? March 2020 to September 2020: S&P500 went up 1,396 points so far.
Each of these dramatic stock market up and down swings has been bigger than the previous swing. This indicates a progressive increase in the amount of speculation in the stock market. It’s like a casino where the world’s biggest investment managers are placing heavy bets on either inflation or deflation. When the market drops, it’s because they are selling en masse, betting on deflation. When it climbs back up, it’s because their collective buying is betting on inflation.
In the past three years we’ve seen three stock market crashes. Each time the market has clawed its way back up. Statistically, the US market is in an up trend. Investors have smiles on their collective faces—exactly what an incumbent president would want. But there is a real chance that there will be yet another stock market slam dunk; possibly another October crash.
Canadian stock market
The TSX Composite Index is a mirror of its US counterpart, but there are a few important differences. Those differences reflect the TSX under-performance. For example, when the US market made the upward swings noted above, the Canadian market made only modestly higher highs. When the markets swung down, the Canadian lows were significantly lower. Statistically, the Canadian market is barely up: the late summer 2020 high was only 2.5 per cent above the January 2018 high. Only 2.5 per cent in 33 months! The US market rose a whopping 24.9 per cent in the same time. Secondly, the down swings have been worse for the TSX than for the S&P500.
Of the many reasons for this under-performance, the two most obvious are: (a) the under-performing energy stocks represent a greater percentage of the TSX than the S&P500 and (b) the stellar high tech sector represents a greater percentage of the S&P500 than the TSX. For now, the long-term trend of the TSX is neutral even though statistically the US market is still up. This is the only time in my 46-year stock market career that I have seen this divergence. Note also that the Canadian market is still showing a five-point broadening formation, not the unprecedented American seven-point formation discussed above.
US and Canadian bonds and interest rates
The reason 20-year-plus interest rates have become so difficult to assess is the Fed’s aggressive demand—actively buying the bond market to stimulate the US economy. Since the 2008-10 financial crisis, bonds have been in a volatile up trend, climaxing in Fed Chairman Powell’s Ides of March announcement of his aggressive ‘print money’ policy. For the last seven months, bond interest rates have been inching slightly upwards on average. Canadian bond yields have been cooling down more steadily since the 2008 crisis. For now, the long-term trend of both Canadian and American interest rates is down.
US dollar vs. basket of non-US currencies
For five years now, the US dollar has been swinging gently between 90 and 100 based on this index. A ‘flight-to-safety’ short-term up swing occurred in the March 2020 crisis: the peak was just over 102.5. The US dollar has dropped back to around 92.5 in August. The long-term trend is neutral.
Canadian dollar vs. US dollar
Since the oil price crash that ended in 2015, the loonie has been in a sideways, neutral trendless drift. In the short term, the loonie has bounced back from its oil-related low of March 2020.
Our working hypothesis is that a long and volatile down trend in oil prices began in 2008 and may have ended in March 2020. The end of the down trend would be signalled by (a) a sharp decline accompanied by an extreme in investor pessimism, (b) followed by a bounce back up, (c) followed by a renewed decline where investor pessimism is even higher than at the March low, but the price holds up. Technical analysts call this (c) phenomenon ‘a test of the low’. So far we have seen (a) and (b). For now, we will describe oil’s long term price trend as neutral. Note: this same scenario is also true for the price of oil stocks as measured by the Amex Oil Index. Energy stocks are well into the (c) ‘test’ now, in spite of the fact that the US stock market averages have been in a sharp short-term up trend since the beginning of The Fed’s ‘free money’ policy.
The long-term up trend began in the 1970s when Richard Nixon un-pegged the price of gold after decades of $35/oz. stability. The up trend started and stopped several times, with a notable high in September of 2011 just over $1,900/oz. Then it dropped below $1,100 in December 2015. The up trend resumed, and gold briefly touched a new high in late August, 2020. The long-term trend is up, once again.
What To Do?
With these unprecedented pandemic-inspired financial events and with central banks’ unprecedented reaction, what should an ordinary investor do?
Let’s consider alternative courses of action.
We could try to out-fox the markets. That’s what portfolio managers try to do. Consider this: in 1920, Germany experienced ultimate inflation where the Deutsche Mark became worthless. In 1930, the opposite occurred in North America, when deflation (and depression) took the value of cash through the roof.
In hindsight, we can imagine that the US central bank of the late 1920s, having learned a lesson from the Germans, acted too aggressively to prevent hyper-inflation. By doing so, the Central Bank triggered deflation. Based on the Fed’s current ‘print more money’ monetary policy and the government’s ‘give free money to the people’ fiscal policy, the Fed is tempting the forces of hyperinflation. Should we continue to speculate on real estate and the stock market in hopes that the Fed will continue to get it right? Or should we bet against the Fed, sell everything and pay off our debts?
Should we try to outfox the markets?
Or should we invest prudently, hedging our bets by investing in some inflation beneficiaries (stocks, gold, real estate, commodities, ‘hard assets’) and some deflation beneficiaries (cash, gold, short term government bonds)?
What should an ordinary investor do in the light of this battle between inflation and deflation? Is there an investment that benefits from both inflation and deflation?
Gold bullion is considered both an inflation hedge and a safe-haven currency in times of deflation.
Re-assess your investment asset mix. The stock market is riskier than ever: Cut back now. Gold is in a long term up trend: add to your holdings over the next few months.
This is an edited version of an article that was originally published for subscribers in the October 2020/Second Report of The MoneyLetter. You can profit from the award-winning advice subscribers receive regularly in The MoneyLetter.
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