The Economy…where are we going?
There are two primary drivers that we need to be worried about. These are explored below.
1. Recent Fiscal and Monetary Policy.
The first of these drivers is the recent borrowing and spending policies of governments over the last ten years which have flooded economies with borrowed money, and the recent super low interest rate policies of central banks over the same period of time. The result of these policies has been a glut of cash that has caused asset bubbles in equities and real estate worldwide, and especially in North America. This glut of cash has not appeared in higher prices as reflected in inflation numbers because these assets are not included in regular inflation tracking.
These bubbles will collapse, as they always do following a spate of free and easy money. I would estimate a 60% decline in the TSX and S&P 500 within two years, and a minimum 40% decline in the average value of real estate in the major cities in Canada – Vancouver and Toronto especially – within five years. (Note – real estate prices collapse rather slowly and painfully – starting in the early 1990s, when the late 1980’s bubble started to collapse, real estate prices in Toronto dropped for six straight years and did not recover on a nominal basis until 2002.)
The signs of this impending equities market collapse are clear.
The stock markets declined markedly last year about this time signalling the start of the end of this cycle. In early 2018, these markets entered the “crisis” phase that marks any asset bubble, which sees wild price swings up and down as smart money gets out of a given market, and dumb money jumps in to take advantage of “the entry point from these great low prices!” The US markets rose after this, but they were only kept afloat after spring 2018, by Trump’s corporate tax cuts which allowed US companies to repatriate hundreds of billions of dollars from overseas, most of which went into stock buy-backs.
In fact, last year represented the absolute peak of stock buy-backs in US history - the total was a staggering $1.1 Trillion - with these buy-backs supporting equity prices through to the reporting season started in October, 2018. At that time, further buy-backs were suspended owing to a black out period around corporate reporting, and the result was a late 2018 stock market collapse absent this artificial support – the second major price pull-back in less than 8 months. The key take away here is that institutions and individuals in the USA were mostly selling equities last year, not buying. This selling is going to accelerate this year.
It is now early April 2019, and the next corporate reporting season has begun. Within two weeks, over 80% of companies on the S&P 500 will be forbidden to buy-back their stocks owing to another black out period. Expect another significant stock market pull-back, as the late asset bubble pendulum continues to swing, heading toward the last phase which is collapse.
The housing market has also started to show the inevitable signs of impending collapse. In Toronto, there have been massive price swings for two years now, representing movements of upwards of 19% between top and bottom in just a nine month period from March, 2018, to December, 2019. This is not normal. Price swings like this are – again - classic signs that an asset class has entered the “crisis” phase of a bubble, which again is highlighted by wild price swings. The next phase is collapse, which I think will likely be occasioned by any general slow-down in the economy, which with the inversion of the yield curve in the USA last week, could start late this year.
(Note – All bubbles have five phases – the Initiation of a new round of asset price appreciation occasioned by a change in an asset, like a change in interest rates increasing affordability; the Build-up phase when people with any cash start to get in; the Euphoria stage when prices get dislocated from reality; the Crisis phase when the original investors take profits and get out, causing wild price swings as other investors dive in thinking they are getting a great deal; and Collapse when it becomes clear to everyone that prices do not reflect underlying value, and most investors who can try to get out.)
What is going to happen rather soon isn’t that hard to understand. These assets saw mass price appreciation owing to the flooding of economies with borrowed cash by governments, and the lowest interest rates in recorded human history between 2008 – 2016, and now that rates are rising and the free money that drove that price appreciation is drying up, prices are starting to fall and they will then collapse. It is an iron law of economics – lose money causes bubbles that then collapse. We have never had looser money in the economy than we had over the past decade, and we have never been more indebted than we are right now.
But who cares? Will everything not just revert back to normal after a while? After all, don’t equities markets always recover?
Well, perhaps no.
Professional financial advisers are geared to tell you to stay in the market, because in the long run everything recovers and all will be well. Normally, this is accurate and they truly believe this, but what they almost never discuss is the question of what is the “long run” for you, and what would happen to your retirement plans if during your own personal long run we went into an historic asset valuation stagnation?
Are these periods unusual? Well, what if we just had such a period of price stagnation and no one talked about it?
The S&P 500 peaked on an inflation adjusted basis in 2000, and did not surpass this peak for fifteen years. Not counting dividends, but accounting for inflation, if you bought that market in 2000, you went the equivalent of almost half of your work life with no real equity asset appreciation whatsoever. If you stayed in, you would be up 30% today – but we are at the end of a bubble. Can your own personal long run take another fifteen years of stagnation, or are you ready to get used to saying “Do you want fries with that?” as part of tour retirement planning?
This brings us to us to the second different but related driver.
2. Demographics.
The Boomers are retiring.
See here for the drag that they will have on the economy as they go from spending a working income at 100% to a retirement income of perhaps 50% - 60% of income.
http://mewetree.blogspot.com/2018/12/baby-boomers-are-drag.html
See here for the implications of the Boomers refusing to live on only 50% - 60% of their previous working income, as they take on reverse mortgages, and essentially eat society’s seed corn so they can complete their lives living above their means, and leaving their debt to everyone who follows.
http://mewetree.blogspot.com/2019/02/the-liquidation-generation.html
To conclude, the fact that Boomers are retiring in droves means a 10 to 20 year drag on economic growth as they reduce their consumption in retirement. At the same time, the fact that they will mortgage their real estate assets in order to continue to live large means long term price stagnation in housing as they pass away, leaving debt ridden assets to their progeny that will be dumped on the market suppressing prices for perhaps a decade or more. Both suggest that the next recovery from recession will not be normal.
3. Conclusion – Welcome to Japan.
The next recession is coming. Leaving aside the impact of the Boomers, the fact is that irresponsible fiscal policy choices by government mean that they have little room left to borrow and spend their way out of the next recession. As well, irresponsible monetary policy decisions by central banks in leaving rates too low for too long means that they have little room to cut rates in order to stimulate borrowing and spending in the economy to jump start the economy.
In essence, governments and central banks loved Keynes so much over the last decade that they essentially killed him.
With asset bubbles in equities and housing, and with the impact of the Boomers, we are to a great extent similar to the situation that Japan was in around 1989. Very loose money in that country in the mid-1980s caused massive asset bubbles in real estate and equities.
When the Japanese central bank started to tighten in the early 1990s, the entire edifice collapsed – equity prices in that country NEVER RECOVERED from this collapse! (The Nikkei hit 38,000 in 1990, and fell to 19,000 within months. It has never been much above 22,000 since, so that if you bought that market in 1990, you have been underwater by 50% for almost 30 years.)
As well, real estate prices in Japan collapsed in 1992 and only recovered to nominal values in 2018 – it took 26 years! It is worth noting that Japanese Boomers started retiring in the mid-1990s…the drag that we are starting to experience hit them a decade earlier than us.
The implications of this are dire indeed. No one in North America is ready for a Japanese-style asset price stagnation lasting literally decades. Almost everyone believes that this time will be different so that we will either avoid any negative impacts from a recession, or that if we are impacted, will recover quickly and all will be well.
No we won’t, because we have never had a fiscal and monetary policy tool box that is more empty before, and we have never faced a situation where by 2030, about 1/3 of the population will be retired, with these people never having actually lived within their means and congenitally predisposed to spending the cash of the generations to come.
I am short the Canadian banks, and the S&P 500 (HFD and HIU on the TSX). I have been short and I have been wrong for two and a half years. I am staying short. If I thought my wife would agree to sell our house, I would put it on the market today.
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