Take Profits in a $1.5 Quadrillion Bubble

Keith Fitz-Gerald Apr 03, 2015

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.

Now, I’m not out to ruin your day. Seriously. I know that this is scary stuff.

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,

Keith Fitz-Gerald

31 Responses to Take Profits in a $1.5 Quadrillion Bubble

  1. George Goiuld says:

    I could not agree with you more . I’ve been a professional trader investor since 1970 . And your comments on John Templeton and the 1.5 q possible disaster is growing bigger as well as the national debt every moment . Instead of gold , gold etf’s or Gold stocks , what do you think Or what portion of an individual’s wealth might be put into say SDS ultra short etf . Thank You and I enjoy your commentaries Cheers, George A.Gould

  2. Jennifer says:

    Thank you for the insite and honest information and in the format that doesn’t require listening to an
    hour video which I definitely don’t have time to sit through.

    Your articles and information is key for me as a beginning investor in the market. We have invested in Real Estate that which we understand and can see — but it was time to get started al be it – small in the market.

    Much appreciated!

    Jennifer Lohmann
    ALL PRO – Property Services, LLC

  3. GEORGE DAHL says:

    A quadrillion is a number that should scare everyone.
    To bad it does not scare those who produced it.
    Thank You for the alert
    George Dahl

  4. Chuck Rosen says:

    Thank you in advance for your opinion to my comment. Through history, as the point has been discussed by you on a continual basis, all regimes come to an end usually due in a large part to the poor safameguards and abuse to their currancies. (I know my spelling skills are at the lower end of all scales, so please try to get by).

    In the overwhelming examples, gold and silver were a major part and sometimes the entire makeup of their currancy.
    Over the last century there have been many examples of precious metal manipulation. Do you see where in addition to “your need catagory not would like to have catagory” a significant portion of need would be in the precious metals, not paper but physical silver and gold due to the fact that after the dollar’s demise we don’t know what or which country and corresponding currancy will be replacing the dollar but we can safely presume that gold and silver will be relative in an increasing portion to the U.S dollar?

  5. Robert Sands says:

    I have always assumed the derivatives scare does not take into account that there are PUTS and CALLS in some ratio. They balance to some extent. So the total dollar value of all derivatives (puts and calls being just one of many) is not so intimidating if you remind yourself that it is the “out of balance” measure of derivatives that could tip things over. I yield to wiser analysis on this point of “counter party positions”. Maybe it is not ALL derivatives but just identifiable pockets of risk and imbalance. So maybe it is unhedged derivatives that are the problem. Please tell me, Keith.

    • Fallingman says:

      Good luck with that whole “the positions offset” thing when the SHTF. Again, talk with Lehman about that. Oh, that’s right, they no longer exist.

      Of course, notional is not the same thing as net, but net doesn’t reveal the actual risk either. You get a counterparty to fail and it won’t just be about the people they stiff. It’ll be about generalized PANIC on the street. It’ll be instructive to watch the ripple effect.

      Think tidal wave.

      These TBTF/TBTJ boyz and their shadow banking pals have been playing with matches … around gasoline … and that has a funny way of not working out so well. They figure they’ll be bailed out again. But you can’t bail out a ship that’s had it’s hull blasted to smithereens.

      By the way, this ain’t about garden variety puts and calls. This is about (crappy) Asset Backed Securities, Credit Default Swaps and other exotic contacts entered into privately. Remember 2007-2008?

      Nobody really knows how big or explosive this bomb is. And you won’t know until it goes off.

    • Matt says:

      I agree wholeheartedly with this comment, and what Robert writes is exactly what I was thinking. Almost without exception, derivatives are taken bilaterally on the underlying instruments. Perhaps there could be an argument for the “net” difference in, say, Long/Short positions in Oil based derivatives as being somewhat relevant to Keith’s argument, but on the whole, in any liquid derivatives market, much of the exposure will be balanced.

  6. Ellis Baxter says:

    At your leave .., I might add in the debased moral currency? This is a new paradigm and in the future there will be some stocks that will be highly resistive to the emotions of the market. There will be the rest that will be more affected by the events of the market …, and supply & demand will become a more important consideration as this new paradigm occurs pushing the “must haves’ to ever higher levels. I see a division of 1% of the chosen few, 3% in the questionable range, and 96% in the rest i.e. a full time bear market.

  7. Ken Rasmussen says:

    Keith, thanks for a good read. I have a question however and I would be interested in your opinion. I had to declare bankruptcy 8 Years ago, result a total wipe out. I’m now 70 years old and during the last 8 Years recovered from that loss. I’ve never been an investor I now have approximately 900,000 to invest to keep me in cash flow until I die, which is inevitable, what options would you recommend to this old guy. I would to retire but not sure if I should yet. Thanks for your response.

    • Fallingman says:

      Mr. R,

      As much as he might like to, I can tell you Mr. Fitz-Gerald is prohibited from giving individual advice.

      My advice FWIW is to worry less about cash flow and more about capital preservation. Think maximum safety. To me that means plenty of cash, gold, and truly bedrock securities … with calls sold consistently again the positions and stops in place and/or put protection or some inverse funds for protection against the washout, which many see coming, myself included, and which Mr. F warns about in this article.

      Good luck.

    • Iris says:

      I’ve been looking at Equity Build for hard money investing. They seem secure, you are in first lien position, and they’ve not had any bad loans. Min interest with initial $50K investment is 12% for 2 years, paid monthly, and higher dollar amounts earn higher interest payments, according to a schedule they publish. Hope you find this useful.

  8. Robert Hartness says:

    Keith, I do like your method of analysis and the principle you outline. I responded to your recent recommendation
    about ESKO and dipped my little toe in as an opening gambit. What I’m wondering is what sort of trailing stop would you recommend? 10-15-25

  9. Robert Hartness says:

    What would be your recommendation for a trailing stop on my recent buy of ESKO ? A % or a specific price?

    I really like your contrarian approach and your independent turn of mind.

    • RJ says:

      I entered a “stop” for ESKO with Schwab at $2/share in light of it’s recent trading range. With this security, however, I was unable to add a trailing stop. Your broker may be different.

  10. Gerrit Zweers says:

    Is it possible for us little investors to have our portfolio inspected by you to help weed out the unsafe stocks and options? If so how can we reach you?
    Thank you, Gerrit

    • Keith says:

      Hello Gerritt.

      Unfortunately, I cannot do that for you because that would constitute individualized investment advice. However, stick with Total Wealth and, if you’re interested, perhaps the Money Map Report where I lay out a structure and specific criteria that may help you evaluate your existing holdings.

      Best regards and thanks for being part of the Total Wealth Family, Keith 🙂

  11. Chris H. says:

    Keith… thanks for you newsletter! How do you feel about inverse funds like TVIX? I have recently invested in this S&P inverse fund and I’m wondering if you have any warnings I should look out for?

  12. C. Bambury says:

    Well if its really going to be this bad then surely the trends to be invested in are
    1 FOOD companies people still have to eat
    2ALCOHOL with all this fear and depression people will still drink.
    3 guns you may need to defend yourself.
    4 tobacco huge in Asia
    5 A little gold
    6 defence
    7 defence related tech.
    8 Health we are all getting older

  13. yngso says:

    Whitney predicted municipal defaults like Detroit etc, and they happened. Stansberry has predicted a sharp fall in the value og the USD, causing superinflation in the US. Can this be related to the “Quad bubble”, and if so how?

    • Keith says:

      Hi Yngso.

      Absolutely related and that’s sharp thinking. Respectfully, Stansberry is missing out on the connections I outline a few responses below to one of your other posts which is why despite calling for it for several years you have not seen that happen. One of these days, the USD will crash while bringing on hyper inflation and ultimately the doom and gloom crowd will call that out as having “predicted” it. However, that’s like correctly calling 10 out of the last 2 recessions. It’s also worth noting while we’re at it that Whitney has been terribly wrong with subsequent predictions just as former PIMCO Bond King Bill Gross has.

      Never forget that the markets can remain irrational longer than you can remain solvent as the old saying goes which is why you never want to lose sight of the opportunity cost associated with investing in the meantime.

      Best regards and thanks for being part of the Total Wealth Family, Keith 🙂

      • yngso says:

        Thanks Keith! I suppose my point was that we all need to get our heads out of the sand or whatever and see the possible risks. Predicting anything exactly is rare and only dumb luck…

  14. Panos Kleidaras says:

    Economics was coined by Aristotle, from oikos, home. And so it has been. until now, economics was governed by the same rules in running a household. As Mr Micawber said, if you earn 20 shillings and spend 19 shillings and sixpence, all is fine. If you earn 20 shillings and spend more there is a problem.

    Keith and Kent Moors are the most insightful commentators of Money Morning E-Letter. However, even Keith can’t call this one, except that it spurns all laws of economics since Aristotle’s time. A quadrillion is many many orders of magnitude away from anything experienced previously in the economic history of the world. As Keith says, we are in totally uncharted waters.
    What to do? Ancient Greece had a debt problem in 630 BC. Unwise debtors became serfs and even slaves. Solon brought in laws called the Seisachtheia, whereby all debts were wiped and things started again. In essence, this was a recognition that the economy goes on. People till the land, sell their produce, build houses etc. It is the money equivalnt of this activity, the currency which had become distorted.
    Maybe Modern Greece should do what Solon did.
    I think Keith is right about one thing. There has to be a reckoning sometime, maybe soon.
    Who knows what the washout will be?
    Where does this leave one’s share portfolio? Do you keep cash? If so, where, a bank? Which bank? As Keith says, we are in totally uncharted waters.

    Keith, your call. My feeble mind can’t even begin to comprehend what to do.

    • yngso says:

      Panos, your name suggests Greek ancestry. Greece is like a microcosm, a much smaller version of the problems in the world economy, it seems to me. I totally agree, this is too big to comprehend. That’s why I asked the question about the possible connection with between this and the USD. I kinda suspect that it does, or can, but would really like to see if Keith or any other “genious” here has any thoughts on this…

      • Keith says:

        Hi Yngso.

        There’s actually an extremely logical connection between this and the USD: 1) like it or not, the USD remains the world’s reserve currency which means that it comprises the dominant part of every Central Bank’s reserves. 2) the S&P 500 is the world’s most liquid, most traded instrument in institutional portfolios so every institution of any size trades, owns, or hedges it; and 3) that means the derivatives which are sold as insurance bridge the gap and arbitrage the difference.

        When the world moves to SDRs or a proxy that has the liquidity to absorb the kind of global volume we’re talking about here, that will change. But for now, the USD is the best looking horse in the glue factory.

        Best regards and thanks for being part of the Total Wealth Family, Keith 🙂

        • yngso says:

          The USD ain’t no gift horse either, so we’d better study its teeth carefully. Just because the USD is stronger now than than it has been for many years is no guarantee that it’s going to last. Therefore I think that we shouldn’t own only USD assets. The world is full of stocks and ETFs that most people know nothing about. I’m sure that lots of people would appreciate some hints about what to look at…

          • yngso says:

            Please let me just make my last comment a bit clearer: I’m not insisting that Keith now starts to talk about non- USD stocks etc. However, if anyone has any information to share I believe that could be really useful…

    • Keith says:

      Hello Panos.

      Thanks for the thoughtful reply and for chiming in. I doubt you have a feeble mind given the context of history you have outlined. That’s extremely important because history is what offers us perspective. The fact that you are not only aware of it but actively drawing comparisons gives you a huge advantage over other investors.

      I’ll have more on what happens next in upcoming columns. In the meantime, stick to the things we talk about all the time here at Total Wealth – the unstoppable trends, carefully selected “must have” companies and strict attention to risk management at all times.

      Together we are stronger even if the rest of the world isn’t…for now.

      Best regards and thanks for being part of the Total Wealth Family, Keith 🙂

  15. Fred Weber says:

    Basically, you’re doing a good job with M.M.R. – but for smaller accounts, there are just too many stocks listed. Why don’t you create a subset of your “dearest favorites” (let’s say an absolute max. of ten total positions, between everything), and list the relative % of each holding in the portfolio?

  16. rob kane says:

    Aren’t the hedge funds such as FAZ “derivatives” also – how will they survive the big meltdown and counterbalance our stock losses?

  17. rob kane says:

    Why do you prefer AWK to WTR? The comparative figures and fundamentals look to me to be better for WTR.

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