1. You Know the Bubble is Bursting When the Last Bear Throws in the Towel.

    To paraphrase one of the great gems of Wall Street wisdom, “Nothing infuriates a man more than the sight of other people making money.” That’s a pretty good description of what happens during the late stage of a stock market bubble.

    The bubble participants are making money (at least on a mark-to-market basis) every day. Meanwhile, the more patient, prudent investor is stuck on the sidelines — allocated to cash or low-risk investments while watching everyone else have fun. This is especially true today when the bubble is not confined to the stock market but includes exotic sideshows like crypto-currencies and Chinese real estate.

    It gets even worse when investors are taunted by headlines like the one in this article, “Investors Can Either Buy Bubbles or Be Left Far Behind.” This article is a case study in the “Bubblicious Portfolio.” Infuriating indeed. Actually it should not be.

    On a risk-adjusted basis, the prudent investor is not missing much. When markets go up 10%, 20% or more in short periods, market participants think of their gains as money in the bank. Yet, that’s not true unless you sell and cash out of the market. Few do this because they’re afraid to “miss out” on continued gains.

    The problem comes when the bubble bursts and losses of 30%, 40% or more pile up quickly. Investors tell themselves they’ll be smart enough to get out in time, but that’s not true either. Typically investors don’t believe the tape. They “buy the dips,” (which keep dipping lower), then they refuse to sell until they “get back to even,” which can take ten years. These are predictable behaviors of real investors caught up in real bubbles.

    It’s better just to diversify, build up a cash reserve, have some gold for catastrophe insurance, and then wait out the bubble crowd. When the crash comes, which it always does, you’ll be well positioned to shop for high-quality bargains amid the rubble. Then you’ll participate in the next long upswing without today’s risks of a sudden meltdown.

  2. Get Ready for a North Korean H-Bomb Test in the Atmosphere


    North Korea is suffering an unusual and self-inflicted setback in its nuclear weapons development programs — “mountain fatigue.” North Korea uses underground facilities in Mount Mantap to test its nuclear detonations. The most recent test on Sept. 3 was of an H-bomb, North Korea’s most powerful yet, estimated to have produced a blast of up to 280 kilotons.

    The combined effect of this blast and prior tests has hollowed out and weakened the structure of the mountain itself. Based on seismic readings from the area, including a series of earthquakes, Japanese and Chinese scientists had warned North Korea that the mountain was in danger of collapse. A collapse of this sort could prove disastrous to China because it could release a huge cloud of buried radioactive material that would be carried by prevailing winds over Chinese cities.

    Then on Oct. 30, as reported in this article, the warnings proved correct. Several tunnels collapsed, killing as many as 200 North Korean workers. It was not the total collapse some feared, but it was an indication that the threat of total collapse is real.

    North Korea will likely keep using the facility because they don’t care about worker deaths or radioactivity exposure for their own people or the Chinese. The North Koreans are solely focused on crossing the finish line in their quest to develop a nuclear-armed arsenal of ICBMs aimed at the U.S. to ensure that the U.S. does not attack the Kim regime. (By the way, if you’re interested in a more in-depth version of my analysis of the path to war with North Korea, you can find it in video archives on my Collide channel, here.)

    Yet nature may have the last word. If the Mount Mantap facility is rendered unusable due to extraordinary damage, Kim will have to continue his nuclear weapons testing elsewhere. This implies tests in the atmosphere, something Kim had already threatened to do before this recent tunnel collapse. That will be viewed as even more provocative by the U.S. and the rest of the international community. The vagaries of nature as expressed in a collapsing mountain may provoke one more escalation on the path to war in the form of atmospheric tests of nuclear weapons.

  3. One Aircraft Carrier Group Can Defeat Any Foe. North Korea Faces Three


    It’s not often we get to include an article from Popular Mechanics in our Five Links feature, since our editorial focus is financial. Yet in a world where the financial and geopolitical converge, an expert assessment of military forces of the kind provided in this article does have major implications for investors.

    The U.S. has a total of 11 aircraft carrier strike groups. Each strike group is led by a nuclear-powered aircraft supercarrier. Ten of the supercarriers are of the Nimitz Class and one is of the new Ford Class, with improved technology and other operating efficiencies. At any one time, as many as eight of the carriers may be in home port undergoing repair and maintenance, for training or otherwise awaiting deployment. Only four or five are actually underway in one of the U.S. Navy’s major areas of operation (AO) at once.

    This article describes that right now, three aircraft carrier strike groups are in the Seventh Fleet AO in the western Pacific, converging on the Korean Peninsula. Each strike group contains more firepower than the entire navy of any other country in the world. Now the U.S. has concentrated three strike groups on Korea. At a minimum, this is a show of force designed to convince North Korea’s leader, Kim Jong Un, to stand down from his efforts to build an arsenal of nuclear-capable ICBMs that can end civilization in the U.S.

    Let’s hope that works. If not, these same vessels will be used to destroy the Kim regime and eliminate the threat once and for all. The latter outcome, highly likely in my view, is not priced into markets. When it is, probably early in 2018, look for rallies in Treasury bonds, the U.S. dollar and gold, with potential collapses in emerging markets as hot money floods back into the U.S. as a safe haven in a world on the brink of war.

  4. This Looks Like the Kind of Snowflake That Could Start an Avalanche


    The first cracks are starting to appear in China’s great wall of debt. The Chinese debt binge of the past 10 years is a well-known story. Chinese corporations have incurred dollar-denominated debts in the hundreds of billions of dollars, most of which are unpayable without subsidies from Beijing.

    China’s debt-to-equity ratio is over 300%, far worse than the U.S.’ (which is also dangerously high) and comparable to that of Japan and other all-star debtors. China’s trillion-dollar wealth management product (WMP) market is basically a Ponzi scheme. New WMPs are used to redeem maturing WMPs, while most of the market is simply rolled over because the underlying real estate and infrastructure projects cannot possibly repay their debts.

    A lot of corporate lending is simply one company lending to another, which in turns lends to another, giving the outward appearance of every company holding good assets, but in which none of the companies can actually pay its creditors. It’s an accounting game with no real money behind it and no chance of repayment. All of this is well-known. What is not known is when it will end.

    When will confidence be lost in such a way that the entire debt house of cards crumbles? When will a geopolitical shock or natural disaster trigger a loss of confidence that ignites a financial panic? There was little prospect of this in the past year because President Xi Jinping was keeping a lid on trouble before the National Congress of the Communist Party of China, which just concluded. With the congress behind him, Xi is ready to undertake reform of the financial system, which means shutting down insolvent companies and banks.

    Now the first bankruptcies have begun to appear, as shown in this article. Dandong Port Group, which does business in the hot zone near North Korea, has just defaulted on its debt. This may be the opening default in a wave of defaults about to hit. The question is whether President Xi can implement his planned reforms and clear up insolvent companies without turning the process into something more dangerous that can spin out of control.

    The early signs are that this restructuring process will be more difficult than Xi expects and that the potential for panic is higher than at any time since 2008.

  5. This Look Behind the Bitcoin Curtain Confirms Our Worst Fears


    We’ve written before about how the bitcoin market is populated by drug dealers, money launderers, terrorists and worse. We’ve also written about how users buy, sell and store their bitcoins on “exchanges” that are really unregulated and unvetted computer networks that occasionally disappear or crash, taking their customers’ bitcoins with them.

    Tax authorities, securities regulators and law enforcement are now converging on these exchanges. Users may be unpleasantly surprised when some of the exchanges are shut down and bitcoins are frozen or they start receiving tax assessments for paper gains on prior transactions. In this article, readers can take an even deeper look at the underbelly of the bitcoin ecosystem.

    Most bitcoin “mining” is done in China because mining depends on massive computing power and the enormous amounts of electricity needed to run and cool the machines. Electricity is cheap in China because it is subsidized by the government though a huge network of coal-burning plants (one reason why the air is black and unfit to breathe).

    The miners are in a “club” (described in the article) that has ambitions beyond bitcoin. The Chinese miners are trying to dominate distributed ledger technology not in competition with the government but in cooperation with it. It’s a play to disrupt and ultimately destroy existing payments systems, including those based on the U.S. dollar.

    Meanwhile, the typical bitcoin purchaser has no faith in the enduring value of bitcoin — he merely considers it a speculation that looks favorable compared with the limited investment options of most Chinese investors (basically stocks and real estate that are both already inflated). The Chinese know bitcoin will crash; it’s just that they believe they’ll be able to dump their bitcoin on another sucker before the crash comes.

  6. What Do Robots Know About Fear, Greed or Panic? Probably Nothing


    The robot revolution on Wall Street, which combines huge processing power and artificial intelligence, is nothing new; it’s been going on for years.

    First, Wall Street automated routine payment-processing tasks and a large portion of back office settlement and clearing. Next came trading functions. Automated order entry and matching replaced humans who had formerly acted as stock specialists. Finally the robots started to replace wealth managers.

    If you’ve ever opened an account with a large wealth management firm and had your adviser ask you about your age, planned retirement date, goals in retirement, current savings, etc., and then turn around and recommend a set program of future savings with a formulaic approach to stock and bond allocations, you may have thought to yourself, “Hmmm, a computer could do this.” You’re right, a computer can do it, and they are.

    Wealth management and asset management together are projected to lose over 230,000 jobs to computers in the next seven years, according to this article. But, there’s a dark side to automation that’s far worse than just the loss of jobs. The computers are being programmed to perform asset management and trading tasks at a time of low volatility and unprecedented gains in stocks. As prices go higher, the computers allocate more money, which drives prices higher still, which leads to more money being allocated and so on in a feedback loop that knows no bounds.

    What happens when markets break, which they inevitably do? Who will stand up to a wave of sell orders coming from all the robots at once? This could look like the Oct. 19, 1987, crash (22% in one day) on steroids. Computers can be taught to match orders and allocate assets, but they don’t know how to navigate the fear and panic that comes with a market crash. The most likely outcome is that the robots will make the next crash worse than any human-caused crash before.