The successive new record highs on Wall Street over the past ten years have motivated us to set down our underlying philosophy and understanding of where the stock markets of the world are, in the context of where they have been in the past. Obviously, where they are is a moveable feast especially since the corona pandemic, but we believe that, without the framework that we set out here, it is difficult to make sense out of what is happening in the markets day to day.
Prior to the current bear trend, the S&P500 index was making a new series of record highs and was clearly in a massive bull trend which began in March 2009 and which we believe continues today despite various corrections and the current downward trend. To get a good understanding of what this means and how it came about, you need to first understand the long-term context of exactly where the world economy and more particularly, the US economy, is in relation to its history. Without this deeper understanding, you will be as confused as most economists and analysts seem to be in the face of the relentless and apparently unstoppable upward trend on Wall Street, before the corona pandemic.
Firstly, we need to go back to the crash of 1929 and the great depression. What few people still remember is that that crash was actually anticipated and predicted by a Russian economist, Nikolai Kondratiev, in his book “The Major Economic Cycles” which was published 4 years before the 1929 crash in 1925. What Kondratiev said was that roughly every 54 years there would be a collapse of commodity prices in the world economy. He traced this cycle back 300 years, but it had already been recorded thousands of years earlier on the Hamurabi stele (a stone onto which the leader Hamurabi etched his laws) which dates from 1770 BCE. This 3700-year-old stele talks about periodic economic booms and busts known as “Jubilees” which come roughly every 50 years. This idea is echoed in the Old Testament in the book of Leviticus (25, 8-13).
We believe that this historical cycle corresponds to the economically active life-span of man. In other words, you become economically active in your early twenties and you cease to be economically active in your middle to late seventies. So there is roughly 54 years during which your economic decisions will influence the economy and the markets.
Everyone who experienced the 1929 great depression first hand took away from it a deep and immovable fear of debt. They avoided credit cards, trade accounts and overdrafts – in both their personal and business lives. The impact of this over the next 50 years was enormous.
But by 1987 the influence of this generation was waning rapidly. Those that were still alive were in their middle of late seventies and as their influence faded, so debt levels began to creep up again – personal debt, business debt, international trade debt and government debt.
Kondratiev’s commodity price cycle is really a cycle of debt clean-outs. It is just most visible in the prices of commodities. It seems that every generation has to learn for itself that debt levels cannot keep going up forever.
At some point the piper always has to be paid.
After the 1929 crash and during the Great Depression, John Maynard Keynes published his book “The General Theory of Employment Interest and Money”. In this book he argued that the Federal Reserve Bank had adopted exactly the wrong approach after the collapse of Wall Street in October 1929. He argued that instead of adopting a “tight” monetary policy, what they should have done was to inject additional funds into the economy to compensate for the wipe-out of wealth on the stock market. The tight monetary policy they adopted, said Keynes, caused the cycle of bank collapses and unemployment that came to be known as the Great Depression of the 1930’s.
Fast forward to 1987, Ronald Reagan is a second-term Republican President and in October of that year the S&P500 index falls 23% in a single day. This is more than double the first-day fall on “Black Monday” (that was 9% on 28th October 1929). The Republicans very much wanted to win the election in 1988 and so they called in their recently appointed Governor of the Federal Reserve Bank, Alan Greenspan.
Greenspan was an avid student of John Maynard Keynes and he told Reagan that he knew exactly what to do to avert another Great Depression. What he did was to gather the leaders of the G7 (the seven largest economies in the world at the time) and persuade them that they had to pump money into their economies to compensate for the collapse of their stock markets. They did exactly that – and the results were nothing short of spectacular. The stock market stopped falling in March of 1988 and, 23 months after the 1987 crash, it reached a new all-time record high.
So successful was this cash-injection policy that Greenspan repeated it at every stock market bear trend for the next 19 years that he was Governor, and his successors (Ben Bernanke and then Janet Yellen) continued in a similar manner. The problem is that in the 1980’s it took an injection of tens of billions of dollars to turn the world economy around. In the 1990’s it was hundreds of billions and in the “noughties” (i.e. 2000 to 2010), following the “sub-prime” crisis, it was trillions. In other words, each successive cycle required a more and more powerful stimulation to avoid the inevitable, periodic debt clean-out that Kondratiev observed and wrote about.
And debt levels went higher and higher. The US government debt was $3,5 trillion in October 1987. Today it is over $23,5 trillion. If you really want to scare yourself witless go to the web site: http://www.usdebtclock.org/
In 2008, following the sub-prime crisis, the Federal Reserve Bank of America, in its efforts to stimulate the economy, just ran out of money. But that was no problem. Taking a leaf out of Robert Mugabe’s book, they began to print money. They literally created massive quantities of money out of nothing and injected it into the US economy. Other economies followed suit. Europe is still printing and injecting tens of billions of euros a month into its economy. Altogether the central banks of the world have created and injected well over US$12,5 trillion into the world economy.
This creation of money (known euphemistically as “quantitative easing”), combined with holding interest rates at close to zero percent for at least 8 years, was finally having the desired effect of pushing the US economy (and other economies) into a boom. At last, scared consumers and businesses were spending again. Up to now they had been sitting on cash, hoarding it in case things got bad again. It has been estimated that the non-financial companies of the world alone were sitting on about US$7 trillion. In South Africa alone non-financial companies are currently hoarding about R750 billion.
After ten years of the most powerful monetary stimulation in history, the US economy entered a powerful economic boom. It was creating between 200 000 and 250 000 new jobs every month and unemployment was at all-time record lows. This boom was anticipated by investors and drove Wall Street and other world markets to a series of new record highs. By the middle of February 2020, the S&P500 index was trading at record levels and was clearly due for some sort of major correction.
The impact of the coronavirus was completely unexpected. Investors world-wide were caught completely off-guard. None of the usual economic signs of the top of a great bull market were apparent. The world economy was gathering steam and looked to continue upward for some time. This was a true “black-swan event” (N. N. Taleb).
In our view, this means that its progress is likely to be materially different from other previous bear trends. We believe that its impact on the markets will directly reflect the perceived progress of the pandemic itself. While that perception remains universally negative the markets will continue to fall.
To assess the progress of the pandemic we need to look closely at the progress of the virus in the country where it started and where it has had the greatest impact over the longest time period – China. In China more than 80 000 people were confirmed to have contracted the corona virus and as many as 4000 died. But by the middle of March 2020, it was apparent that China was past the worst. The rate of new infections and deaths was dropping rapidly and the government was urging people to go back to work.
If the rest of the world follows the example of China, then we reasonably predict that by the end of 2020 the coronavirus will largely be a spent force. Some countries will fare better than others because of their state of preparedness and the strictness with which they implemented counter measures to prevent the virus from spreading. There is also the probability that there will be a vaccine in production by the end of 2020 or early in 2021.
We believe that these facts will become more apparent to investors by June or July of 2020 and then there should begin a period of bargain-hunting. Shares will see a pause in their relentless downward trends. A period of sideways movement will follow – and then gradually as confidence grows a new upward trend will emerge. We believe that some time, probably early next year, the S&P500 will make another new record high – and this “bear trend” will turn out to be a relatively short, sharp downward trend in the form of a “V” bottom.
After that the great bull market will resume – and probably even gain momentum. We see it as a “bump in the road” – albeit a major bump – of this great bull market.
Once corona is substantially behind us and as people slowly regain their confidence they will spend more and more. That will create even more jobs and bigger profits for companies – who will employ more people and pay those people higher salaries – which will result in even more spending. We believe that the non-financial companies of the world will not only spend the $7 trillion that they have been hoarding for the past eleven years, but they will borrow five times that amount and spend that too. As confidence grows, we will see a series of amazing asset bubbles such as the world has never known before. The Dutch tulip mania of the 1637 and the excesses of the early nineteen-twenties will pale by comparison.
Right now, many analysts, both inside America and outside, have been confused and bewildered by the relentless progress of Wall Street (and all stock markets world-wide). The corona downtrend has come as a relief to them because they were very concerned about a bull market which had gone on for a record 11 years. They were finding it more and more difficult to justify the prices at which shares are trading based on the profits of the companies which they represent.
What is amazing is that none of these analysts appear to have considered the longer-term impact of the unprecedented monetary stimulation that has been applied to the US economy over the past ten years – and to other major economies world-wide. It’s as if they believe that, now that quantitative easing is coming to an end, the trillions that have been injected into the world economy are somehow irrelevant to Wall Street, and other asset markets – a part of history – but they are not.
We believe that Wall Street is far from being at the top of this great bull market. We see it as in the throes of the greatest bull market that the world has ever seen – driven by:
The coronavirus has displaced none of those powerful forces. In fact, corona may well have the effect of accelerating some of these trends.
We believe that the S&P500 index, prior to corona, was simply discounting what will become a world-wide economic boom. Commodity prices from oil and copper to gold and coal were all rising before the pandemic and we believe that trend will continue once the virus has been brought under control. The relatively low oil prices over the past four years have kept a lid on inflation so central banks are still much more interested in pushing growth than defending the purchasing power of their currencies. Indeed, the corona scare has caused the US Federal Reserve Bank to cut rates by 1% and the US government to announce a massive $2 trillion cash injection into their economy.
We suggest that, as a private investor, you need to take this scenario into account in your investment strategy. You need to make money out of the ultimate continuation of the boom in equities. The corona pandemic has given you a unique opportunity to buy high quality shares at a fraction of their value. You must watch closely and pick your moment to buy in.
The piper must always be paid.
To get some perspective on how it arrived in this position, take a little time to watch what Jeff Deist says about it: https://www.youtube.com/watch?v=KIgsmm2uR8M
Jeff Deist’s lecture is important because it draws attention to the idea of “time preference”. People with a short time preference have no patience to build for the future – either their own or that of the country in which they live. People with a long time preference have the patience to postpone gratification and to build capital and savings. Because you are reading this it is fair to assume that you have capital to invest in the share market – which implies that you have a long time preference.
The American democratic system tends to encourage politicians to have a relatively short time preference. They are motivated by the next election and their immediate popularity. Trump is a clear example of this. He is horrified by the corona pandemic because it comes at the worst possible time for him in an election year. He will do everything in his power to mitigate the impact of the downtrend and get the bull trend to resume – but his efforts will probably turn out to be too late. Politicians inevitably fail to implement or support policies which will involve bringing them pain in the short term, but which have long term benefits. This explains why debt levels in America keep on rising.
The US economy was growing very rapidly before corona, stimulated by a decade of the most stimulatory monetary policy in history and we believe it will resume its upward path. The stock exchange will certainly continue discounting that growth once corona is behind us. So this is a good time to be watching closely for a key buying opportunity.
You should bear in mind, however, that eventually the piper must be paid – or as Diest says, “After the party there will be a hangover”. We just think that corona has inserted an interval in the upward progress of markets world-wide, but once corona is behind us, the party will continue for a while longer.