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The Biggest Collapse in History Just a Matter of Time

May 19, 2016

In this issue:
» PSU banks are available dirt cheap
» Global fund managers bullish on emerging stocks
» .....and more
0:00
Rahul Shah, Co-Head of Research

In 1988, disaster struck Yellowstone National Park in Wyoming. What started as many small individual fires quickly spread out of control to become largest wildfire in the history of the park. More than a third of the park was a sea of black when the ash finally settled.

But what if we told you the Yellowstone wildfire was a disaster waiting to happen?

The reason goes back to the establishment of forest management in the United States. The forest management started to view wildfires as a threat to the natural resources. The practice of fire-suppression thus came into being. Blazes weren't allowed to take their natural course.

This practice proved disastrous. Eventually, the fires could no longer be controlled and converged into the largest wildfire in the park's history. Not only did it wipe out 30 times the acreage of any previously recorded fire, it also destroyed grazing grounds and altered the ecosystem.

Now, there's nothing tragic about wildfires. They are totally natural. They keep the ecosystem in balance. They are nature's answer to 'out with the old, in with the new'.

But what has wildfire to do with economics and finance? In my view, it's the most elegant way to explain what's wrong with the global economy today.

You see, dead, decaying plants are no good for the ecosystem. They have essential nutrients trapped inside them that could be put to good use if they were somehow extracted. And this is precisely what a wildfire does. It turns dead and decayed plants into ash, thus returning the nutrients to the soil. These nutrients are then used either by the existing plants or new, sprouting seeds.

Shouldn't an economy function in a similar manner? Shouldn't sick and inefficient companies be allowed to fail? Shouldn't the assets and the capital trapped inside them be released back into the economy? Wouldn't this pave the way for capital to be used more productively and thus improve the overall health of the economy?

Sadly, policymakers - like the forest management team in the US - are not up to the task. They have interfered every step of the way. The tech bubble, the subprime crisis, the European crisis, you name it and the central bankers have stamped out the fire prematurely. This has led to a world awash with debt and growth of exactly the wrong kind.

This level of crisis suppression could have disastrous consequences on the scale of the 1988 Yellowstone wildfire. The next crisis could be the most devastating of all. You see, the more they interfere, the larger the fire will be.

We're not the only ones making such dire warnings. An entire galaxy of super investors is of a similar view.

Mark Spitznagel, for example, an investor who we have written about before, has gone to the extent of saying that markets these days are totally under the influence of central planners. He warns that the biggest collapse in history is inevitable.

How can you protect our savings from getting roasted? Well, gold is fireproof. Putting 10-12% of your portfolio in gold would be a good first line of defence. Put the rest in fundamentally strong companies run by great management teams. But don't overpay for them. And keep some cash handy. For the financial fire won't last forever. And it will make way for a fresh round of growth. Cash, like ash, can provide the nutrients we need to regrow after disaster hits.

Do you agree with these super investors that the biggest collapse in history is almost certain to happen in the near future? Let us know your comments or share your views in the Equitymaster Club.


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2:30 Chart of the day

Just yesterday we highlighted to you how India's banking system continues to battle the war against surging bad loans. The aggregate bad loans of the 26 banks that declared their March 2016 quarter results have jumped 87% YoY resulting in a 132% YoY surge in provisioning. With that, seven public sector banks slipped into the red during the quarter. Overall bank earnings slumped 98% YoY and the dismal financial scorecard of public sector banks clearly stood out.

To add to that, state owned Punjab National Bank (PNB) yesterday reported a record Rs 53.7 billion net loss for the quarter ended March 2016 compared to Rs 3 billion profit in the same quarter of the earlier year. Worse, the management is not even sure if this is as bad as it gets or that worse may follow. And this is India's third largest public sector bank we're talking about.

Not surprisingly, as today's chart of the day shows, the stocks of public sector banks across the board are lying in the dumps:

Public sector bank valuations: Scraping the bottom

Public sector bank valuations: Scraping the bottom


The financial media are aghast at this state of affairs. An editorial in the Mint today asks: 'How did bank boards, chief executive officers, regulators, auditors and rating agencies not understand well before now that there is an unholy mess on the loan books of Indian banks? Or did they know and remain silent?'

But the answers may not be as black and white as yes or no. There have been a combination of factors at play for substandard lending practices. In the world of banking, one of them surely is 'everyone else is doing it, so why not we?'. When picking banking stocks, this is why it makes a world of sense to choose only those banks with managements that are fiercely independent in their decision making.

3:45

We have seen time and again just how influenced Indian stock markets are by foreign fund flows. And things seem to be turning for the positive on this front.

As per reports, global fund managers put together are increasing their allocation to emerging market equities these days after almost a year and a half. The May 2016 Bank of America Merrill Lynch survey of fund managers points out that a net 2% of fund managers are now overweight, the highest reading since September 2014.

This compares to a net 8% being underweight emerging equities in April, and 33% at the start of the year. That said, while this may be a positive for market sentiments, foreign funds flows are known to be extremely capricious, and their direction can change overnight. Thus it makes sense to not give too much important to this while making investing decisions.

4:20

The Equitymaster Android App has been a huge hit and has garnered more than 10,000 users, with a rating of 4.2. Just recently, we released the Equitymaster App for iOS. It now has a few hundred people and has a rating of 4.5.

Our apps are a convenient way for you to access our honest views and opinions on investing in India. And we are super excited that both the Apps have received such a great response.

So go ahead, download the Equitymaster iOS App here ...and if you have an Android phone you can join more than 10,000 Equitymaster Android app users here.

4:40

The Indian stock markets were trading weak today on the back of sustained selling activity across most index heavyweights. At the time of writing, the BSE-Sensex was trading down by about 240 points. Losses were largely seen in FMCG and telecom stocks.

4:52 Today's Investment mantra

"There's been far, far, far more money made by people in Wall Street through salesmanship abilities than through investment abilities" - Warren Buffett

This edition of The 5 Minute WrapUp is authored by Rahul Shah (Research Analyst).

Today's Premium Edition.

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Equitymaster requests your view! Post a comment on "The Biggest Collapse in History Just a Matter of Time". Click here!

2 Responses to "The Biggest Collapse in History Just a Matter of Time"

Omar

May 22, 2016

Cash in the form of bank FD's..is it safe? and can be a "keep some cash handy" as per Rahul Shah "The Biggest Collapse in History Just a Matter of Time"

Like 

Prakul

May 22, 2016

Hi Rahul,

I was smiling all the way while reading your article.
I like to remind you of the article "Here's why Sensex can rise 70% over next 2-3 years" (31st March 2016)

Not sure what has happened in 49 days, that inspired you to write this article?

Thanks,
Prakul

Like (3)
  
Equitymaster requests your view! Post a comment on "The Biggest Collapse in History Just a Matter of Time". Click here!
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