Crash Alert – What the Smart Money Is Doing

Crash Alert - What the Smart Money Is Doing
Composite image from original photos by Anne Nygård and Ruben Sukatendel

From Peter Reagan at Birch Gold Group

We already know from last week that Powell’s Fed pledged to keep raising interest rates to combat inflation.

That’s a problem for the stock market. Stocks and corporate bonds have been supported for the last 14 years by near-zero interest rates and endless quantitative easing (QE). The entire financial market has adapted to this “new normal” which supports otherwise-unthinkable valuations of stocks paired with shockingly high levels of both corporate and sovereign debt.

If Powell’s plan works like it should, it’ll be the equivalent of yanking the rug out from under the financial markets. Markets will plunge without their easy-money lifelines (exactly the opposite of the “pivot” Wall Street optimists were hoping for just last week).

It finally looks like Wall Street is waking up to reality… While I’m writing, the U.S. stock markets have hit their lowest point of the year (so far). The investment-grade bond market has lost more than 12%. The traditionally conservative 60/40 stock/bond portfolio, recommended for decades as the gold standard for those of us saving for retirement, is having its worst year since 1936.

I don’t think the carnage is over — because if we look where the smart money is going, we can see that hedge funds and institutional investors are bracing for a crash.

And by “crash” I don’t mean a bad day. Or an off week.

I mean a replay of September 2008, when the federal government was taking over mortgage companies and Lehman Brothers failed and the wheels completely came off the global financial system.

Here’s a quick look at the smart money trail.

Historic amount of crash protection purchased

Sometimes it’s a good idea to review what the big hedge funds and institutional investors are doing with their capital.

We call it “watching the smart money.” (After all, if billions of dollars are moving into or out of a specific industry or nation, there’s a reason – and that reason is informed by countless numbers of Ph.D.-holding certified market wizards who work for international banks and hedge funds.)

Like all investors, the smart money wants to do things:

  1. Make more money
  2. Avoid losing money

Jim Rickards, who has enough connections in the investing world to qualify as an insider, recently received a warning from one of his sources:

A colleague informs me that institutional traders — not mom and pop retail investors — have recently taken out over $8 billion in “crash protection.”

Oh, by the way? “That’s a record high,” he says. The last time we saw such a surge in crash protection was just prior to the collapse of Lehman Bros. in 2008.

The biggest investors – the smart money — are spending record amounts on a type of trade called “option puts” which pay off when the market goes down relative to bets in the opposite direction.

“Again, these guys are the ‘smart money,’” Rickards emphasizes. “They must know something the average investor doesn’t.”

While it’s entirely possible they all know something we don’t, I find it much more likely they’re simply realizing what so many of us already know.

Asset bubbles are bad enough – but superbubbles are catastrophic

Most of the time (say 85% or so), markets behave rationally. Assets are priced based on their fundamental value.

When assets are bid up to irrational levels, they usually come back down – that’s what we think of as an asset bubble. About 10-12% of the time, financial markets are either in an asset bubble or recovering from one.

Then there’s the other times, maybe only 3% of the total throughout history. Those other times when multiple sectors of the economy are all bid up to astronomical valuations simultaneously.

We call that a superbubble. They’re very rare and incredibly destructive.

This theory mostly comes from GMO co-founder Jeremy Grantham – and he’s certain the U.S. is entering the “final act” of a historic superbubble right now:

The current superbubble features an unprecedentedly dangerous mix of cross-asset overvaluation (with bonds, housing, and stocks all critically overpriced and now rapidly losing momentum), commodity shock, and Fed hawkishness. Each cycle is different and unique – but every historical parallel suggests that the worst is yet to come.

As I’ve written about before, this type of speculative frenzy has historically followed the same pattern. Grantham comes to a similar conclusion – again, based on history:

in the U.S., the three near perfect markets with crazy investor behavior and 2.5+ sigma] overvaluation have always been followed by big market declines of 50%

Now here we are, having experienced the first leg down of the bubble bursting and a substantial bear market rally, and we find the fundamentals are far worse than expected.

So what’s this “sigma” Grantham talks about?

It’s shorthand from statistics. Given a standard distribution of data, we express how close a given value is to the “normal” range using the lowercase Greek letter sigma (σ).

Most of the time, things are normal. It’s when things are abnormal that prudent people take notice. A 2.5+ sigma event should happen about 2% of the time.

Now, it seems to me that Grantham’s “fundamentals are far worse than expected” is a perfectly plausible explanation for institutional investors to defend themselves with record levels of “crash protection.”

For comparison, Grantham says the U.S. is in the final act of a similarly catastrophic event on par with the 2001 dot-com bubble, the 2008 Great Financial Crisis and the 1929 collapse that preceded the Great Depression.

Is it a good idea for everyday American families to do what the smart money is doing? Taking steps to protect their hard-earned retirement savings from another massive financial collapse?

Personally, I believe in hoping for the best and planning for the worst.

Even Mom and Pop investors can take precautions

Grantham warns us:

Only a few market events in an investor’s career really matter, and among the most important of all are superbubbles.

When superbubbles collapse, fortunes are lost. Companies go bankrupt, sometimes entire industries disappear. Unemployment surges. Financial security feels like a fairy tale…

Unless you’ve prepared in advance.

With the ongoing collapse of both stocks and bonds (and even home prices are starting to fall!), here at Birch Gold Group we’re helping hundreds of everyday Americans just like you find the security and stability they’re looking for. Diversifying with historic safe-haven stores of value like physical gold and silver isn’t a step big institutional investors or hedge funds can take. They usually prefer exotic financial derivatives and paper-based investments that are easy to flip.

Tangible precious metals aren’t about making a quick buck! Rather, they’re about the opposite: not losing your bucks quick. Regardless of their timeless appeal throughout human history, physical precious metals aren’t for everyone.

You may be exhausted watching stocks and bonds plunge month after month. You may just want the peace of mind that comes with knowing that your hard-earned savings won’t be wiped out by a sovereign default, a bank collapse or an unexpected announcement from the Federal Reserve. If that’s the case, then physical precious metals might be exactly what you need. If you want to learn more, the team at Birch Gold is here to help.

Why not sit out the next financial crisis? Seriously, who needs the stress? Take the steps you need to ensure your financial security so you can focus on the things that really matter.

2022, bonds, Featured, jeremy grantham, market bubble, stock market