The Big Risk Is That Almost Every Single Asset May Decline

One of the things that has worried me over the years is the possibility of nearly all assets declining. I first came across this concern from Marc Faber, who has often pointed out that the bull market in the last 5 years has been very unique. Almost everything--US stocks, emerging market stocks, emerging market bonds, commodities, gold, junk bonds, real estate, art, collectibles--have gone up since the early 2000's. It is very unusual. Historically, if commodities prices went up, broad-market stocks went down. I don't think too many would have imagined that the S&P 500 would hit an all-time high while oil prices go up 5x from $20 to $100. The huge decline in the US$ is part of the reason but that alone cannot explain any of this.

Although the situation may not turn out as dire, the possibility exists. I feel like some of what Marc Faber said in 2007 describes the current situation quite well. Let me quote his words from a Financial Sense Newshour interview with Jim Puplava from January 2007 (bolding of text is by me):

MARC: I think that all asset prices have gone up dramatically since, you know, depending 2001, 2002, 2003, but basically we’re up everywhere. If I look around the world there are very few assets that are not expensive. And the big surprise for this year could be that liquidity tightens even if the central bank tries, say, to keep monetary policy easy, because if you look at the Middle East, suddenly all of the markets are down between 50 and 60%. There’s still plenty of liquidity. But the issue there is that liquidity growth slowed down – it didn’t accelerate anymore. And if I look at international reserves in the world they’re still growing at 18% per annum, but they’re no longer growing at an accelerating rate. So it could be that at some point in 2007 liquidity tightens.

I’d also like to make the point that when markets go up they create liquidity because [when] an asset goes from, say, 100 to 200, it increases the borrowing power of the owner of these assets. And when asset prices go down (and we’ve had an appetizer of that in April, May 2006 when suddenly the markets went down – suddenly liquidity dwindled)…And I think the big test for liquidity will come once there is a correction. And I think we’re by historical standards in one of the longest bull markets, which began in October 2002; we’re in a bull market that by historical standards is about average length in terms of magnitude; and since July 13th 2006 when this latest leg in the bull market started we haven’t even had a 2% correction. Now, I lived through the 70s. In the 70s the markets moved sideways but every year the Dow went up and down by about 25%. And here we are and we haven’t had a 2% correction since last July. Something big is going to happen one of these days. And I would not rule out that markets may continue to go up, but as a buyer the risk now is actually quite high compared to the potential reward. It’s as John Hussman recently wrote that there are so few bears (from converting these very few bears into bulls) that the market will not get a lot of ammunition on the upside. But if suddenly so many bulls turn cautious or negative then obviously the downside can be quite substantial because people will liquidate their positions. [8:56]

Marc Faber is into technical analysis--I am not--so I don't pay much attention to the latter part of the quote. It's also very difficult to make money off any of this because it's hard to predict the timing. However, one can avoid getting themselves stranded in a storm by paying attention. On top of all this being largely prescient, one of the key things he points out is how liquidity is amplified when asset prices rise. We can see this in action. In reverse!