by tonytran2015 (Melbourne, Australia).
#crash share market, #investment, #market crash, #share market, #signs of crash.
As a small investor (or gambler ?) you can also pick up the warning signs of an impending share crash.
To possess that ability a small investor has to have a realistic knowledge on how some listed companies crash and on how such crash can generate a market wide crash. This posting is my a short guide to picking the signals.
1. The operation of a company listed on a share market.
Let us be simple about it.
A company on a share market is just a business, a money making machine. Its value depends on its anticipated income and its trade name plus net tangible asset backing (liquidated values).
A company listed on the share market has to bear the extra burden of extravagant salaries and bonus to directors, showmen, corporate executives (who all seem NOT KNOWING the business which they are overpaid for), external advisers, external consultants (to advise, with absolutely NO liability, the directors and executives!), snake oil salesmen (to sell to clients what they don’t need and can barely afford).
When you buy shares in that company, you are entitled to share a percentage of the profit and loss of that business (or show?).
Essentially, directors, executives, external advisors, external consultants (see reference  for some type of consultancy no one needs) are playing a game of passing the buck by separating duties of care and liabilities. The show is set up to PREVENT share holders like you SUING any of them.
You have been WARNED!
2. Long con by Pump and Dump Operators.
Vested interests always want to inflate the values of companies for their higher salary, bonus, commissions, fees and stamp duties.
They will pump and dump shares in the company. The (typically six years plus) long con of pumping is hard to detect (a lie told for long enough will be believed). It makes people believe in the (hyped up) “long term growth” of the company. (See reference  for a typical pumping of share prices from in 2011 to 2017).
New shares will be issued at “premium” to the nominal value of the shares. The money collected is then used to pay for expenses to keep the company going until another new share issues (but not for paying dividends to existing share owners) !
The last buyers (believing that there would be bigger fools) buy in at many times the worth of the company. When the eventual dumping comes they would lose all their hard earned money.
After each share crash there is no actual change in the production capacity of the company. Only its ownership, clients, suppliers and bankers change. The crash in the bigger market and the recession in the even bigger economy only comes due to the actions of those people.
Australian government also encourages (since about the year 2000) the Long Pump Con with its Income Tax policy (on loss of franking credit when holding “put options”): If you invest in shares, you can claim your share of the income tax paid by that company (currently at a flat rate of about 30%) as your personal tax already paid by the company on your behalf; it is called “income tax franking credit from your dividend”. However if you also bet that the price of those shares will fall you will lose all that tax credit while if you bet that the price of those share will rise, you can keep all your dividend franking credits!
It is understandable as the government collects more stamp duties on share transfers when share prices have been pumped up.
3. Causes of a crash of a single company
Figure: List of single sufficient causes for a company crash. Any single cause in this list can cause a company to go bankrupt.
a/- Its banker does not want to be its easy going, friendly banker anymore. (The bank knows more than you do about the imminent cash flow of the company; see also ).
b/- Its clients can buy cheaper elsewhere.
c/- Its suppliers have switched to new clients (with no cash flow problem) who pay more promptly after each delivery.
d/- The company has run out of new subscribers for its new share issues (which is a substantial source of income providing for its yearly expenses).
e/- If the company cannot pay its debt installments and expenses on any due date, it is required by laws to be liquidated.
4. Events in a company crash.
a/- Directors resign as they want to wash their hands more than 6 months ahead of the official liquidation. Why should they risk being investigated while there are extravagant pays for other shows elsewhere?
b/- Share holders realize that they have bought only thin air hyped up company shares and they all want to sell to the next fools or to anyone else to stop their own bleeding.
c/- The share market suspends the trading of that company’s shares and may even de-list it to bury the embarrassment.
d/- The last batch of share holders practically lose all their money: EVERY HYPE HAS TO END.
5. Traditional signs pointing to a market crash.
Figure: Signs of crash for share markets. You cannot expect any crystal ball to change its colour to warn you of an imminent share market crash but you can notice yourself the signs prior to such a crash.
The share market is where people buy and sell shares in (market) listed companies. People buy and sell according to their perception of the sustainability of the finance conditions in the country of the companies.
The finance conditions stand on top of one another to build a tower to the sky ! It only needs the agitation of some big investors to make the tower tumble causing a market wide crash.
Prior to a share market crash there are few signs as given in the following:
a/- There is an increase in the Price/Earning ratios of companies (Investors hope for bigger fools) while their operation is not profitably expanding and their Net Tangible Assets remain nearly unchanged. (see the ref. added on 10May2017). Before buying you have to work out the number of years to get back your capital if there is no bigger fool.
The P/E ratio should be inverted to give you a comparison to the interest rate of government bonds which has little chance of being wiped out.
b/- There is an increase in merger and acquisition activities with the illusion that bigger is better for profits (An admission that many companies are not well managed. The lives of companies are stretched on the hope that they can reduce their overhead or get better under new managements !).
c/- There are a lot of initial public offers (IPO’s) of new companies (on the share markets) with unclear, questionable earning capabilities (Institutions want to benefit from people’s greed !).
People buy on hope into any company to be in the herd. The whole market goes up much faster than the national GDP and GNI.
According to reference , “S&P 500 stock index edged up… market capitalization of the companies in the index exceeds $20 trillion. That’s 106% of US GDP, for just 500 companies!” .
d/- There are a lot of margin lending (by banks to investors who bet that short term market dips are very unlikely but if any dip does come they usually lose their investment/bet and usually most of their savings). There are also a lot of “Call Warrants”, which are effectively shares bought on borrowed money, with deposits and dividends assigned to the lender.
Any temporary dip will force Margin Lenders to sell shares of Margin Borrowers resulting in an amplification of the temporary small dip into a longer lasting and more serious dip which may force out even more Margin Borrowers and the market index keeps on falling. The situation will be further aggravated if there are also at that time large derivatives (betting) contracts leading to contagious defaults by many of the bet takers.
Currently the ratio of margin lending to capitalization of the Australian market is only about 1%. If the same also holds true for other markets then margin lending cannot cause much damage in the current condition.
(Note added on 1 April 2017: On Feb 2017, margin loans on shares reached 0.528trillions [6, 7] while capitalization of S&P 500 shares reached 20trillion . Margin loans in US thus stand at nearly 2.5% in Feb 2017).
e/- Short-term interest rates are much higher than long term ones for Reserve Bank loans and Treasury Notes (People run out of real wealth making ideas for the long term and can only play the short term games of passing the buck with borrowed money in existing unsustainable structure. In the 2008 crisis, Citi group had used Short term available money and foreign money to bet on the up or down of various financial indices; the betting led to the required rescue by tax payers’ money ).
f/- Uneven development of different sectors of the economy resulting in unsustainable economic condition (for example a construction boom in areas with no jobs, no roads, no people to pay for the newly built buildings leading to heavy debts by builders caused by production of unwanted goods).
g/- Everyone talks and seems to know everything about investment on the share markets (People knows that passing the buck makes much more money than doing real manufacturing/servicing. Herd mentality is obviously in action here, see also reference ).
6. Events in a market crash.
Greed and fear and herd mentality cause a market wide crash.
When fear overcomes greed, they all want to sell out at the same time, at any cost to cut loss.
The gamblers, the uniformed investors, the loose bankers, creditors all lose their money. The market will usually be suspended immediately by a computer after any deep loss.
The patient investors may pick up good investment during crashes. The time window for a big dip is only about 10 minute wide and you must be a regular client of some friendly stoke brokers or possess a reliable internet trading software to have your order processed in that hectic time. I have seen my friends doing it.
Then everyone still not burnt will want to invest in real estate instead only for some of them to get burnt again in that ensuing property (new type of) bubble!
7. Avoiding getting burnt
a/- Remember that no one wants to sell a money making machine. If it is sold to you for cheap, there must be some problems.
b/- Use your money to pay out all your debts, their interest payment is usually HIGHER than any after tax return on any listed company investment.
c/- If you still have spare money, set up your own business or investment property. You will know the “true and fair” value of your business. You can hire and fire. Your voice can be heard. You also avoid paying extravagant salaries to directors and snake oil salesmen. With this type of experience, you may begin to make judgement on the values of listed companies.
d/- Don’t invest in any company whose activities you cannot fully understand. If you cannot understand their way of making money then probably they CANNOT make money. Don’t think that extravagantly paid directors will solve the impossible problems for such a company.
e/- Only gamble on the share market with what you can afford to lose. There are always new types of traps invented to catch you.
f/- If you cannot sleep at night with an investment then you cannot afford to lose: Cut the loss and get out.
Being alert to the signs may help you getting burnt. It has certainly helped me and my friends.
(have been augmented after 29 Apr2017)
. Ex-HBOS banker ‘sold his soul for swag’, bbc new, http://www.bbc.com/news/business-38842723, 2 February 2017.
. Wolf Richter, S&P 500 Earnings Stuck at 2011 Levels, Stocks up 87% Since, Straight Line Logic , https://straightlinelogic.com/2017/02/19/sp-500-earnings-stuck-at-2011-levels-stocks-up-87-since-by-wolf-richter/
. Barry Ritholtz, Excessive CEO Pay for Dumb Luck, bloomberg.com, https://www.bloomberg.com/view/articles/2017-03-06/excessive-ceo-pay-for-dumb-luck, accessed 07 Mar 2017.
. Colin Twiggs, CEO pay is rigged | Barry Ritholz, Gold Stocks & Forex, https://wordpress.com/read/feeds/289142/posts/1366147221, 07 Mar 2017.
. tonytran2015, Bankers given outrageous incomes by their boards, https://survivaltricks.wordpress.com/2016/12/22/bankers-given-outrageous-incomes-by-their-boards/, posted on December 22, 2016.
. Mish Mishtalk, Margin debts hit record high-coinciding with extreme-consumer confidence, mishtalk.com, http://mishtalk.com/2017/03/30/margin-debt-hits-record-high-coinciding-with-extreme-consumer-confidence-analysts-say-dont-worry/, 30 March 2017.
. stock-markets-sit-blithely-on-a-powerful-time-bomb, sentinel blog, http://sentinelblog.com/2017/04/22/stock-markets-sit-blithely-on-a-powerful-time-bomb/, accessed 22 April 2017.
. Yashaswini Swamynathan, Reuters, The S&P 500 is worth $20 trillion for the first time, business insider, http://www.businessinsider.com/sp-500-market-cap-crosses-20-trillion-for-the-first-time-2017-2, Feb 13, 2017.
. The last time this happened the market crashed, sentinelblog.com, https://sentinelblog.com/2017/04/22/the-last-time-this-happened-the-market-crashed/
.How Henry Walker Eltin imploded, https://www.crikey.com.au/2005/02/02/how-henry-walker-eltin-imploded/, 02 Feb 2005, accessed 05 May 2017.
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