The Charts that Defined Financial Markets in 2018

With the end of 2018 quickly approaching, this will be our last market update for the year. So for something a little different, we will take a look back on 2018 with some of the more interesting charts in finance, that defined a year of excessive risk appetite across multiple asset classes, and potentially several market tops.
 
It was quite an eventful year, as we saw arguably the largest bubble in history burst in Crypto, the Australian property market falling at an accelerating pace, and the resurrection of volatility in equities. US stocks are on their way to the worst December performance since the Great Depression of 1931, as the Federal Reserve tries to pull a rabbit out of a hat and normalise interest rates in an environment where government and private debt far exceed GFC era levels.
 
The story of 2018 in finance is the great unwinding of the monetary stimulus of the last decade, as Central Banks begin to reduce their balance sheets and tighten policy. With so many warning signs across different economies, it is really hard to pinpoint where the next crisis will come from, but the story of the Global Financial Crisis is not over – it continues, and the problem of overly excessive debt has not been solved, but has been exacerbated by a decade of even easier monetary policy.
 
Before we get to some of our favourite charts of the year, a quick summary of YTD returns so far, and we saw Gold in AUD hit a yearly high this week, above $1,770 per ounce:
 
S&P500 -                     -6.3%
Dow Jones                   -7.92%
Nasdaq Composite      -6.82%
ASX200                        -9.16%
Shanghai CSI 300        -23.90%
FTSE100                      -12.69%
Nikkei 225                   -10.42%
 
Gold (USD)                  -3.23%
Gold (AUD)                 +6.36%
Silver (USD)                 -13.8%
Silver (AUD)                -6.0%
Platinum (USD)           -15.2%
Palladium (USD)         +18.7%
Brent Crude Oil           -18%
AUD/USD                    -7.6%

Overvalued and Overleveraged

Source: Daily Mail Australia
 
In Australia, the biggest immediate risk to the economy is our housing market. This year saw property prices start to roll over with Sydney prices on average falling around -8% and Melbourne down -5.8% this calendar year. Whilst the RBA is yet to voice concerns, just a 15% nation wide drop in prices would cut a huge +$1 trillion from the housing stock value.
 
We also saw the NSW government already facing an $8 billion stamp duty shortfall as the market has cooled considerably and clearance rates have dropped dramatically from just a few years ago. The chart above really highlights the excessive build up in household debt, with prices (relative to income and rents) looking incredibly overvalued compared to historical norms.
 
The above chart really highlights what could be the end of a debt-fuelled boom in property prices, as availability of credit is drying up and the psychology of interest-only investors chasing capital gains has changed. Australians in recent years have stretched themselves to the limit with the household savings ratio evaporating to 2.4% from 8% in 2014. This year could well be looked back on as a significant year in which the property market started to cool, and we think prices will need to correct further in coming years.

Australian Peso

The AUD continued to lose ground against the Greenback this year as the RBA has been stuck at a cash rate of 1.5% whilst the Federal Reserve raised their benchmark rate to 2.5% this year. The AUD/USD will finish the year around negative 7% and with the RBA backed into a corner with housing debt, we stand by our call that the next move in interest rates could likely be lower.

YTD Performance - Cryptocurrencies

 
In what was supposed to be the year that cryptocurrencies really took off towards the moon (apparently), we saw the exact opposite with arguably the largest financial bubble in human history popping in spectacular fashion. Many of those new participants chasing retirement-transforming gains in crypto ended up with retirement-transforming losses, as we saw close to a $700 billion reduction in the total market capitalisation since the peak in January this year.
 
Yearto date, the total market cap of cryptocurrencies went from $620 billion on January 1 to around $114 billion today. So on average, investors experienced an 80% drawdown on their crypto accounts since the start of the year and potentially more than that depending on which crypto tokens were favoured.
 
Whilst some bullion dealers adapted to selling their client’s cryptocurrencies during the “mania phase”, we at ABC Bullion preferred to side with Jim Rickards and Peter Schiff on the topic, consistently warning investors of the potential bursting of the bubble, and the key differences with gold as an asset class. You can read more in our end of year 2017 report ‘Bitcoin, Bubbles & Bullion’ here.

Biggest Bubble in Human History

 
The chart above from Bloomberg shows a comparison of Bitcoin’s latest run with other well-known financial bubbles in history. The temptation of getting rich for doing nothing has been around for centuries and history repeats itself over and over in financial markets, just across different asset classes, as the psychology is always the same. With volumes peaking right at the top, the crypto market very quickly became a gigantic transfer of wealth from the majority of participants who would have got in at the top, to those who were in early pre-2017.

Treasury Yield Curve Over S&P 500

 
Late in 2018, we had new fears of a US recession gripping investors as a leading indicator in previous recession flashed a warning sign. The 10-year and 2-year US treasury yields got within 10 basis points, and temporarily inverted late this year, which is an event that has preceded many of the last US recessions, and at an average of around 2 years prior.  We can see with the above chart that the last two times this happened was shortly before the S&P 500 topping and the US economy going into a recession.

United Nations of Debt

Another cracking chart via Visual Capitalist takes a look at the percentage of world government debt by country. The US wins for the largest government debt pile by dollar value at +$21 trillion, Greece wins the race in terms of a percentage of GDP with 275%, and Japan wins as probably the most concerning fiscal position when you consider possible global implications, with government debt over 230% of GDP.

Debt is Good

 
The above chart is via Bloomberg and shows the expansion of global debt in the last 15 years, more than doubling from $100T in 2003 to $247T in 2018. Largely fuelled by government and corporate borrowing under an ultra low interest rate environment globally. Global debt to GDP this year exceeded 318%, and Central Banks think it’s a good time to start tightening monetary policy.

China’s Banking System Asset Growth

 
The growth of banking system assets in China since the GFC has completely dwarfed that of other developed countries. Concerns are growing over China’s wealth management products (WMPs), as higher risk shadow banking assets are estimated to have grown to around $10 trillion.
 
Many look to China as the hero of economic growth in recent times, but the country has gone through a massive credit expansion, building a $34 trillion pile of public and private debt along the way.

The Great Unwind

Since Central Banks decided to cross the Rubicon on monetary policy post-GFC, we have seen asset purchase programs lead to the greatest expansion of combined balance sheets in our lifetime.  In the chart above, we see Fed, ECB, BOJ and BOE combined balance sheets peaking in 2018 and starting to roll over. Possibly the most important chart in financial markets today, as moving forward the attempt to reverse this is entirely uncharted territory.

Bank of Japan Takes the Cake

 
Keeping with the theme of CB balance sheet expansions, and Japan takes the cake for the most absurd monetary policy and market distorting operations. After a massive bond-buying program failed to spark any significant rise in inflation, the Bank of Japan started buying Japanese equities via direct purchases of Nikkei ETFs, effectively winning the gold medal for market manipulation.
 
If you own any shares on the Japanese index, you have a 40% chance of seeing the BOJ on the top ten holders’ list as the Central Bank has become the largest net buyer of Japanese stocks since the launch of ‘Abenomics’ in 2012. The above chart shows the expanding balance sheet of the BOJ and 2018 was the year in which we saw this swell past 100% of GDP. This one will surely anger free market capitalist proponents.

Is the Bull Market Over?

 
Bull markets don’t last forever, and investors must be guessing how long the post-GFC bull market in US equities will last, as we are looking pretty long in the tooth. Equities were having a good year up until October this year, when volatility was resurrected from the grave and sharp sell-offs across tech stocks pulled the market lower into December. The above charts are the Nasdaq index in the US and the ASX 200, and one can easily see the correlation. All moving averages have swung into bearish formation and it looks as if there is a more concerning longer-term downtrend developing, as opposed to a short correction.
 
Even though Australian equities may not seem as bubbly as the US market when looking at valuations, this will not stop the ASX from suffering if we see a bear market in US equities on the back of tightening monetary policy. Since the October highs, the Nasdaq is almost in bear market territory at -18% and the ASX is off -12%.

The Canary In the Coalmine

 
A personal favourite for the year, the share price of chipmaker Advanced Micro Devices (AMD). A snapshot of overall market sentiment on steroids, this stock can act like a canary in a coal mine for signalling periods of peak ‘irrational exuberance’. The last two irrational spikes in the share price coincided with the overall market peaking in 2000 and again in 2007 shortly before a bear market in the S&P 500. This last spike to $32 was in September this year and right before the market started to sell-off in October.

Deutsche Bank VS Lehman

 
One from Seeking Alpha is the share price of Deutsche Bank and the similarity with the demise of Lehman Brothers. $DB now trades at a new lifetime low of $8.19 per share and it has been a horrific year for those trying to pick the bottom. A telling chart for the Euro zone as this is the leading bank in Europe’s strongest economy. Go figure.

Gold and USD Rising in Unity

 
Acommon misperception of market pundits is that a rising interest rate environment is bad for gold prices, as it should coincide with USD strength, but there is more than meets the eye.
 
It is counterintuitive but gold does not need a weaker USD in order to rally. 2018 is perfect example as the charts above show, if we continue to see volatility in equities, it is possible to see both the US Dollar index and gold move higher in unison, as both can act as short-term safe havens. Since the sharp sell-off in equities started in October, the USD index is up 3.2% from the lows, but gold is up even further at 5.9% off the lows.

Gold Loves Rate Hikes

 
Lastly, another counterintuitive chart from an earlier market update this year. The above chart is gold in USD since 2016, with all of the Federal Reserve rate hikes during that period. As you can see, we generally see weakness in the lead up to the hike itself, but once it’s over, gold has rallied sharply on most occasions.
 
When the Fed first started the rate hike cycle from 0-0.25%, gold was trading around $1,050 per ounce. Now, after nine hikes, the federal funds rate much higher at 2.25-2.5%, and gold is trading at USD$1,260, which is around 20% higher than when the rate hike cycle began. If your financial advisor told you to steer clear of gold due to rising interest rates, perhaps you should look for another one.

Conclusion

In what has been a long wait for precious metal investors, there appears to be some big changes on the way in financial markets as we move into 2019, and potentially a golden light at the end of the tunnel. Those with a ‘balanced’ portfolio in superannuation will probably be frustrated at their performance moving forward in the next few years, as it will be so much harder to get anywhere near the gains we have seen post-GFC, during this period of excessively easy monetary policy worldwide. The final conclusion of the experiment will require Central Banks to unwind their balance sheets back to more reasonable levels, and we just do not know what will happen in capital markets as a result.
 
In what could be one of the most important times in history to have gold exposure, it is a shame that conventional industry and retail superfunds do not allow even the smallest allocation. Don’t be surprised if we indeed see a bear market in equities moving into next year, as the market deserves to move considerably lower, as valuations have been much higher than historic norms by a number of measures. As volatility continues next year we expect 2019 to be a much better year for precious metals, as gold remains under owned by western investors.
 
We wish everyone the best success in investing over the holiday break and wish you all a happy festive season!

Until next time,
 
John Feeney
ABC BULLION
 
Disclaimer
This publication is for educational purposes only and should not be considered either general or personal advice. It does not consider any particular person’s investment objectives, financial situation or needs. Accordingly, no recommendation (expressed or implied) or other information contained in this report should be acted upon without the appropriateness of that information having regard to those factors. You should assess whether or not the information contained herein is appropriate to your individual financial circumstances and goals before making an investment decision, or seek the help the of a licensed financial adviser. Performance is historical, performance may vary, and past performance is not necessarily indicative of future performance. Any prices, quotes, or statistics included have been obtained from sources deemed to be reliable, but we do not guarantee their accuracy or completeness.