Take Profits in a $1.5 Quadrillion Bubble
Three successive Fed Chairs have denied its very existence – yet the numbers are too galling to ignore.
According to The Bank of International Settlements, there are now $692 trillion in global derivatives worldwide. Factor in credit default swaps and exotics, and the total notional value jumps to an even more jaw-dropping $1.5 quadrillion dollars. That’s a bubble 21 times greater than the value of the entire world’s economy.
All told, global derivatives are 20% more prevalent than they were in 2008… right before they helped cause the global financial crisis that still roils markets today. And, get this – despite a massive cleanup of big banks and financial reforms laid out to an anxious public keen to restore trust in the “system,” the numbers are still increasing.
Big banks are more opaque than ever and the Fed is either clueless or blind – perhaps deliberately both. They assume that the risks of trading all this (insert the four-letter word of your choice) is much smaller than it really is because the risks of one offset the risks of another.
What they’re really saying is that they don’t believe everything will fail at once. Ask anybody who worked at Lehman how that worked out. The risks are very real and the results potentially devastating.
But there’s actually a way out if you’re prepared ahead of time, and that’s exactly what we’re going to talk about today.
Here’s what you need to know now before this $1.5 quadrillion bubble disturbs the markets.
Denial of Financial History Built This Bubble
How we got here is sadly familiar.
The “smartest guys in the room” have peddled us a series of legislative changes intended to modernize and improve our financial system. In reality, they created laws and self-serving regulations that allow them to pile more debt on top of an already unstable foundation.
So far, their arrogance has allowed them to ignore the lessons of Japan’s recent economic history, not to mention 2,000 years of recorded monetary history before that. But they can’t do it forever, any more than the Romans, the Spanish, the Portuguese, the French, or the English could.
As each decade adds more derivatives exposure then the one before it, this inverse pyramid of debt will collapse under its own weight. And there will be nothing that can be done about it. Today’s cash-poor governments are hardly equipped to deal with the kind of meltdown we’re talking about here.
Thankfully, though, you don’t have to inherit their problems. Believe it or not, you have solutions the big banks don’t, and that means you can do things they can’t to preserve your wealth and even profit when the time comes.
Four Steps You Can Take to Beat the Bubble Economy
First, understand that large financial institutions need to invest for returns and keep their money moving at all times. The amount of leverage they carry guarantees that they always have to pursue riskier investments to generate the same incremental returns.
You don’t have that obligation.
As an individual investor, you have flexibility they’d love to have. For example, you can implement a safety-first portfolio that ensures the return of your money is always given a higher priority than the return on your money. You can move into or out of the market as needed.
Many people think that means limiting your choices to investments with no upside. That’s not true at all.
Simply shifting your focus from “nice to have” companies that will come and go based on whims and prioritizing “must have” choices is a good start. There’s no doubt in my mind that medical, defense, and energy-related holdings will outperform the current crop of “nice to have” media darlings.
Many already are, and the performance “gap” is only going to grow more pronounced in the years ahead. A good example is Raytheon, a “must have” defense contractor that has returned more than 170% since I recommended it to Money Map Report subscribers in August 2011, significantly higher than even the S&P 500’s 101% bull run over the same period. Contrast that with media darling and “nice to have” GoPro, which has dropped by 42% since early December 2014 alone.
How do you know which is which – a “must have” or a “nice to have”? Simple… if you can’t live without something, it’s a “must have.” Everything else is a luxury and a risk you don’t want to take…not now.
Second, don’t walk away from long-term bonds and fixed-rate investments – run away from them. This advice makes a lot of people bristle, but I include most annuities and whole life insurance providers in this category. They’re just too risky in the face of rising interest rates, which will cause these investments to crater.
Short-term bonds and variable-rate instruments are a different story. With these investments you at least get a limited capacity to absorb the changes that will come from rising interest rates and a changing global financial system by continually recycling into new, higher-rate instruments as they become available. Plus, you avoid a majority of the risk that comes with volatility at longer durations.
Third, big banks and trading houses have to trade – and most of them not very well lately, I might add. That generates fees, and they use your investment accounts as fodder.
The only way they can do that is to convince you to do the same. They’re pretty good at it too, judging from the fact that the top 25 firms generate more than $15 billion in fees every year via commissions.
So you want to make sure you’re equipped to “buy and manage” rather than buy and “hope.”
The easiest way to do that is by using tactics we talk about all the time here at Total Wealth, ranging from portfolio allocation to trailing stops and position sizing. By keeping risks small to begin with, you’re never put in the unenviable position of being at their mercy.
Fourth, and finally, you want to keep a longer term perspective. Do so and the profits will follow. Leave short-term noise and hyperactive moves to the day traders who do not understand the luxury and stability afforded us by the Unstoppable Trends we follow and the Tactics we use to grow our wealth.
I know that the numbers I’ve outlined make it seem like the end of the financial universe is upon us, but history shows that’s simply not true, especially if you learn to buy at points of maximum pessimism.
Sir John Templeton – you’ve heard me mention him before – was perhaps the greatest proponent of this. And with good reason.
In a move that is now the stuff of legend, he bought shares of every company trading under $1 on the NYSE (including 34 already bankrupt) in 1939 on the eve of WWII, correctly reasoning that sentiment would eventually recover… as would profits. Years later, every company of the 104 he bought that day – save 4 that proved worthless – were sold at a profit.
Templeton went on to perfect his strategy of buying during points of maximum pessimism, and ultimately amassed a fortune so great that he gave away more than $1 billion to charity before he died in 2008. Early investors in his fund turned every $10,000 invested into more than $2 million by the time he sold out, generating an average annualized return of 14.5% since inception.
My point in telling you all this and in sharing some truly staggeringly scary figures is that all is NOT lost.
There will always be sectors, countries, companies, and choices to make that will favor buying over selling.
The “must haves” I talk about constantly are called that for a reason. Not even a $1.5 quadrillion bubble can derail them, because people will never stop spending money on stuff they’ve got to have.
The challenge is being savvy enough to buy when the time comes and to manage your money appropriately in the meantime.
Buy low and sell high!
Until next time,