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Analyzing Key Market Risks For 2019 With A 40-Year Market Veteran

One of the most important factors an investor should consider is risk. Risk comes in two primary flavors that we will discuss in this article: risk of the market, and risk of the investment vehicle itself.

To explore both of these risks in the current economy, I flew out to Phoenix to interview someone very special who does very high quality research into both of these risks.

Lynette Zang has worked for over four decades in the financial industry, including extensive experience in both the bond and stock markets where she worked as a broker. She is currently the Chief Market Strategist for ITM Trading in the precious metals industry.

We taped the interview in her studio, which followers of her blog will be very familiar with. She has become somewhat of a sensation online for the in-depth analysis she does of the markets. She has recently conducted an interview with one of our own Seeking Alpha contributors, Danielle DiMartino Booth, whom is a former central banker with the Dallas branch of the Fed. I encourage my readers to check out that interview where Danielle discussed her experience within the Fed and how the central bank is a big risk to the markets right now.

You can view our interview in this video, and following I will analyze some of the key points on market and investment risk that we talked about.

Volume and Liquidity Risk

Our first discussion is around liquidity risk where the selling volume increases, and there are not enough buyers to smooth out the market which leads to price volatility.

Source: Lynette Zang

From the image above, it is clear that selling pressure in Apple has ramped up substantially and has caused Apple to fall through it’s moving averages. When this happens, investors that may have had a specific goal or investment timeline, may be priced out of selling for fear of taking very substantial losses.

And how many people actually predicted this type of selling volume in the stock based upon the existing sentiment that the market had for Apple up to this point? The answer is the vast majority did not.

Source: Lynette Zang

The next chart shows the same increased selling volume pattern in the Dow as we saw in Apple. If you are holding funds in a passive index tied to the Dow, or have significant components from that index, then you may be in the position of not being able to sell without taking very significant losses.

This type of pattern shift in selling volume substantially past the moving averages is going to put tremendous pressure on passive investors who don’t actively manage their own money, which as I have written in the past, seems to have dumbed down the market.

Further, if you are following sentiment and technical indicators only for your trading, you are much less likely to see this type of pattern shift coming and are more likely to be victimized by it.

Insider Selling

To the credit of many writers and readers on Seeking Alpha, insider selling is often discussed indicator of the health of a particular investment. However, what is more important from a broad market perspective are insider selling trends across the market.

For instance, I wrote in July about the trend of insider selling in the markets since the last financial crisis in 2008.

Source: Me via OpenInsider

Insiders have been net short of the markets since the last market crash. That is an incredibly long time for a very important market sentiment indicator to exist and went largely unnoticed by most investors and investment sites. Those that paid attention were likely already changing their investment allocations when the market selling pressure increased, while those that didn’t are now left holding the bag for the market correction.

Counterparty Risk

One of the single biggest risks in any investment is counterparty risk. For example, bonds have a huge risk in the opposite party making good on the debt repayments. The US government has $1.7 trillion in bonds coming due over the next five years. Either those bonds get refinanced in a rising rate environment or they have to be paid off. Since most people assume the US can never default, they assume low counterparty risk from the government.

However, as I pointed out in a recent article, there are not enough physical dollars to pay those bonds off and it would destroy the US currency in circulation if the government actually tried to do it without issuing new debt.

Source: Fred

Given that the fiat US dollar is created through debt issuance, that means the US can never fully pay off its debt, and will continue to issue more until it the market eventually collapses under its own weight. That is why interest rates on US debt are rising and the yield curves are inverting.

Source: CNBC

Note that the issue is not contained within the US, as the global yield curve started to invert earlier this year indicating the debt crisis is global.

Source: JPMorgan

Investment Vehicle Risk

From a stock perspective, you have counterparty risks that you probably don’t even realize. For example, if you hold your stocks through a typical brokerage, then you are not the real owner. You are not provided share certificates, and in fact you are the beneficial owners of that stock. The chain of owners above you has the discretion to use your equity as they see fit, as you can see in the graphic below.

Source: Lynette Zang

Your stock investments are in a vehicle that risk separate from the individual investments in your portfolio that you likely had no idea existed. If you are not the legal owner of those investments and others have the right to use your equity on their behalf for their own purposes, then how much additional risk just got priced into your portfolio and how do you calculate this risk into your expected returns?

The solution is to take ownership of physical stock certificates, but how many investors have actually done this?

Real Estate and REITs

As a real estate investor for 17 years, and as a professional consultant who worked with several different mortgage servicers, I have had a front row seat to the real estate market for quite some time. I sold almost all of my individual investment real estate in 2017 because I could see that the real estate was likely to start rolling over in 2018, which it has.

What about REIT passive real estate investments? Many think that despite the fundamentals of the market weakening, REITs will do fine as long as the companies can keep up their cash flows. But as Lynette pointed out in our interview, the REIT price does not have to tie directly to the Net Asset Value of the underlying investments. So the REIT price could remain strong while the fundamentals are weakening, setting investors up for pain when the REIT is eventually priced down when the fundamental weakness of the real estate market finally asserts itself.

As Lynette points out, real estate reached a peak in March and has been falling since as rates have risen.

Source: Lynette Zang

As I stated in our interview, I fully expect this to also impact rent rates negatively which will directly impact cash flows into the REITs. It is likely we have reached, or will very soon reach, the peak in the REIT markets.

As an example, Toll Brothers have been saying the real estate market is strong and growth will come from Millennials at the same time the insiders are selling out of the stock.

Source: Lynette Zang

Source: Lynette Zang

What the Markets Are Telling Us

It is very clear the insiders are selling out of the market, and the markets themselves are signaling a coming recession. I think it will be worse than that, and based upon un-payable national debts, we will have a currency crisis like what is already being seen in the emerging markets.

Source: Charlie Bilello

There are a very few investments that are set up to take advantage of a market in this position that also have low counterparty risk and no investment vehicle risk. Primarily that is gold and silver in physical form, in your possession.

Lynette and I discussed several types of precious metals ownership in the interview, and how to attend to the various risks of each type of metals investment. I believe investors may be running out of time to get into those markets at today’s depressed prices, have a shrinking window of opportunity.

This is why I will be dedicating a large part of my coverage to gold and silver starting in 2019. The market has been setting up for a bull run in gold and silver during 2018, and I believe the metals will finally start to be unleashed next year.

I will be traveling to Vancouver in January, and Toronto in March, to network with some of the best gold and silver analysts in the market today. I will also be establishing more relationships with precious metals miners and to provide you the insights into the market from the point of exploration to the pouring of the metal bars.