Something is rotten in the state of financial markets. They’re potentially setting up for their next crash.
We’re a ways off on that crash (as opposed to a small pullback or correction). Corporate profitability remains strong. Interest rates, while rising, are doing so at a glacial rate. The stock market rally since 2009 feels long in the tooth—and it is. But bull markets don’t die of old age. They die because they get exciting, and investors rush into stocks with a sense of euphoria.
Meanwhile, many point towards the cause of the last market crash—housing. They see strong real estate markets around the country with rising prices as a cause for concern. While there are some markets that look overpriced such as Miami, New York, the Bay Area, and Washington D.C., most real estate markets are below their 2007 housing-market mania peak price.
Market history repeats its cycles of booms and busts. But the reasons behind them change. I wouldn’t look to housing as a reason to cash out of the markets just yet.
In fact, there’s nothing in the private sector that seems likely to cause the next market crash at the moment. No, we have to go somewhere else for that.
Right now, markets remain unduly influenced by large actors like central banks. After all, they’ve set interest rates so low since the financial crisis that stocks remain the best game in town relative to other assets like cash, bonds, or even alternatives like gold. Those low interest rates remain a problem. But that’s not the worst of it.
There’s another way banks can be troublesome as well—by buying up assets like non-government debt. Central banks bought huge amounts of so-called toxic assets during the financial crisis. But they’ve bought other assets as well. Some central banks are even now in the business of buying stocks. And that’s where the future trouble could lie.
The Financial Times reported last week that the Federal Reserve owns more than 14 percent of the US total public debt. That’s not so bad compared to some other central banks, like the ECB and Bank of Japan, which have much bigger exposure. Even England, culturally similar to the United States, has 25 percent to 30 percent of its government debt owned by the Bank of England.
That’s just bonds. The Bank of Japan is buying shares of Japanese companies, and is now a top 10 shareholder in 90% of Nikkei stocks. The Swiss National Bank is a big buyer of billions of dollars of US stocks.
This is concerning to say the least. Free markets will have big and small players alike, but when a few big players come to dominate a given market, we stop getting accurate price signals. This is a slippery slope to central banks — as proxies of the government — gaining more control over the markets, even if it’s inadvertent. In theory, once a bank owns 10 percent of a company, they could lobby for seats on the board of directors.
That takes central banks from being theoretically independent to having a more direct say in how the private sector is controlled. As if they don’t have enough control indirectly with money printing and interest-rate setting powers already!
That sounds like a recipe for managed markets, as well as government-managed economies. Should such a scenario unfold, we’d see markets and companies get socialized via central banks, not through governments and the will of voters.
What’s more, any large buyer of stocks, whether a central bank, a company itself, or a billionaire investor, tends to keep the share price from falling too much. But what’s the endgame of central bank stock buying? What happens when the Swiss think it’s time to sell their Apple shares? With one big player dominating the market, they may have plenty of individual investors to sell to, but not at the rate they’d need to unwind their position quickly. When big players try to dump their holdings in something, there just isn’t the capital capacity in the market for that trade to unwind without a massive move in prices.
That’s why I see this as an area where the market could crash next. Most folks are looking for another credit crunch or another housing crisis. But it could simply be that central banks have bought so much of everything that when it comes time to sell, there aren’t enough big buyers to pick up the slack.
It’s a bizarre factor, at the very least because it’s outside economic growth which tends to cause the biggest changes in stock valuations. It’s outside things like currency fluctuations or individual levels of fear and greed in the market as well.
How can an investor protect themselves? A few ideas come to mind:
Buy smaller companies. A central bank can’t put a billion dollars into a company that’s only a billion dollars in size. It just won’t move the needle for them to acquire smaller companies entirely—and that’s too much management on their end. Smaller companies might not rally as much as bigger companies if central banks really step up their buys in the stock market, but they’ll be more insulated from the danger involved.
Buy gold. Central banks are still buying the metal as a means of diversifying their portfolios, and you should too. It’s not a huge market either, and central bank sales could weigh here. But if the stock market falls into a tailspin—for whatever reason—having some wealth hedged in gold can provide safety and immediate returns.
Finally, when all else fails, hold some of your wealth in cash. Cash is an option to buy quality companies more cheaply in the future. And there’s no better buying time for an asset then when there’s a deluge of sell orders hitting the market. Whether that happens at companies big or small, held by banks or individuals, the best way to avoid the worst of a crash is to have cash on hand to take advantage of the opportunities it creates.
Again, we’re likely a ways off from the next market crash. And it might take another crash for central banks to really start directly propping up the stock market with their buys. But there are still plenty of opportunities to stay invested in the market’s current uptrend while staying safe, and even hedged.
Andrew Packer is a Senior Financial Editor with Newsmax Media. He currently writes the Insider Hotline investment advisory, serves as investment director for the Financial Braintrust, and writes the monthly newsletter Crisis Point Investor.
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