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 right now, in the context of where they have been in the past. 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.
The S&P500 index has made a new series of record highs and is clearly in a massive bull trend which began in March 2009 and continues today (although we have been in a correction since 26th January 2018). 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 this relentless and apparently unstoppable upward trend on Wall Street.
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 $20 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 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, is finally having the desired effect of pushing the US economy (and other economies) into a boom. At last, scared consumers and businesses are spending again. Up to now they have 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.
But now, finally, after ten years of the most powerful monetary stimulation in history, the US economy is showing definite signs of life. It is creating between 200 000 and 250 000 new jobs every month and unemployment is at all-time record lows. This is a clear indication that, once again, the mighty US economy is stirring into life.
Of course, smart investors all over the world have known about this for a long time. They knew that, sooner or later, all that cash which was sloshing around in the world’s financial system would begin to be spent. Because of that understanding, they have been bidding the S&P500 (and all stock markets around the world) up since March 2009 in anticipation of the economic boom that is now finally starting to happen.
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 sitting on for the past eight 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, appear to be confused and bewildered by the relentless progress of Wall Street (and all stock markets world-wide). They fearfully describe equities as over-priced and speculate about the top of the market and a new bear trend. They find it more and more difficult to justify the prices at which shares are trading based on the profits of the companies which they represent. That disconnect between earnings and share prices will be a feature of markets during this great bull trend.
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 the S&P500 index is simply discounting what will become, and is now becoming an unprecedented, world-wide economic boom. Already commodity prices from oil and copper to gold and coal are rising. 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.
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 on-going boom in equities – but be ready to defend your assets when the party comes to an end – which it must. Remember,
The piper must always be paid.
To get an up-to-date picture of the state of affairs in the US economy and 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. 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. This prevents them from implementing or supporting policies which will involve pain in the short term, but have long term benefits. This explains why debt levels in America keep on rising.
The US economy is growing very rapidly now, stimulated by a decade of the most stimulatory monetary policy in history. The stock exchange is discounting that growth and future expected growth. So this is a good time to be invested in shares.
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”.