Life cycle. Political cycle. Emotional cycle.
Everything goes around. That’s how life works.
Good times. Not-so-good times. Bad times.
Rarely, if ever, is life one smooth ride.
The longer you live, the more perspective you gain.
You learn to appreciate the good times because you know they won’t last.
Hopefully the same applies to the bad times. You have to endure the difficult times, holding onto the belief of ‘this too shall pass’.
The same philosophy holds true for investment markets.
There are good and bad times.
Yet, investment and economic analysis is permanently positive.
There is never any downside.
Markets will always go higher.
Growth will always be stronger.
These gilded forecasts are repeatedly at odds with what history tells us.
Busts follow booms. That’s the natural order of the market’s life.
Cycles have two phases…up AND down.
However, self-interest (from politicians, central banks and financial institutions) prevents any serious discussion being had about the extent of the inevitable ‘downside’ risk.
Instead, the public is given the ‘mushroom treatment’. And in fairness to the ‘mushroom feeders’, the public really don’t want to be told to conduct their affairs prudently.
We have grown accustomed to living beyond our means and expecting more of the same.
But it hasn’t always been like this.
The following chart puts the latest period of prosperity into historical context.
Since 1921 — nearly a century ago — there has been three distinct ‘boom and bust’ cycles in the US share market.
And let’s face it, whatever happens in the US markets, good or bad, is reflected around the world.
The three cycles are…
1921 to 1948 — dotted green line
1948 to 1982 — dotted red line
1982 to Present — blue line
Source: Macro Trends
[Click to enlarge]
The chart plots the performance (vertical scale) of each cycle — from up to down — and the duration (horizontal scale) of the cycle.
To help you interpret the important message in this graph, let’s look at the ‘dotted green line’: the 1921 to 1948 cycle.
In duration it lasted around 330 months.
During the ‘up’ phase of this, the Dow produced a 500% return in the first 100 months…this was the Roaring Twenties. After peaking at 500%, the ‘down’ phase of the cycle – The Great Depression followed by WWII – took back the majority of those gains.
By the end of the cycle, the Dow had returned 150% over a 330-month period.
The next cycle – 1948 to 1982 – lasted a lot longer and delivered a higher rate of return…around 400% over a 400-month period.
But, you’ll note the same pattern of the previous cycle. The Dow rising to 500% in the ‘up’ phase and then surrendering some of those gains in the ‘down’ phase.
And that brings us to the current cycle — 1982 to present. In duration and performance, it’s without precedent.
More than 35-years of out-performance (and the economic flow on effects of this) has conditioned us to believe that this is normal. When in fact it’s highly abnormal.
What’s behind this extraordinary period of performance?
The greatest build-up of debt in history…over US$230 trillion.
All that borrowed money had to find a home somewhere in the economy and financial markets. And this chart is simply a reflection of that fact.
We have lived through an extraordinary ‘up’ phase of the cycle…and unfortunately, this sustained period of false prosperity has been mistaken for a permanent reality.
Nothing could be further from the truth.
If you place any belief in the adage, ‘the higher you climb, the harder you fall’, then the downside of this current cycle is going to be extremely painful for far longer than anyone is expecting.
On the cusp of the down phase
After more than 35 years, it’s easy to understand why there’s a widespread belief in ‘the good times’ lasting indefinitely.
But we know from our life experience, that this is simply not true. The cycle turns.
And I have the feeling we are on the cusp of a massive downturn…the likes of which we have never seen before.
The Fed’s determination to continue with the flawed ‘wealth effect’ theory, has created the ‘everything bubble’.
Property prices, share prices, crypto madness, art works…everything that can be lifted higher by greed and cheap money, has been.
When this bubble bursts, it’ll be like no other in its breadth and reach of devastation.
The epicenter of this pending collapse will be Wall Street.
As we saw in early February, when the US market wobbles, the whole world gets a case of the quivers.
The following table is a list of 20 valuation measures used to evaluate the whether the US share market is under, fairly or overvalued.
Source: CMG Wealth
[Click to enlarge]
Red lights are flashing everywhere.
For Lost in Space fans, these readings are the equivalent of, ‘Danger, Will Robinson’.
Get out now before the whole thing explodes.
One valuation measure not listed in the table, is the ‘Buffett Indicator’.
Buffett famously said the ratio of the country’s share market capitalisation (total value of share market) to the overall GDP (economic output) of the country is, ‘Probably the best single measure of where valuations stand at any given moment.’
The theory is that the share market cannot be valued (at least not indefinitely) at a higher level than the economy supporting it.
Where’s the Buffett Indicator today?
Source: Advisor Perspectives
[Click to enlarge]
This is the second highest reading since 1950.
The all-time high was reached at the height of the dotcom boom…and we know how that ended.
The Buffett Indicator is telling us, ‘More danger, Will Robinson’.
Could all these warning signals be behind Buffett’s increasing cash position?
Investor’s Business Daily 27 December 2017 published an article titled:
‘What Will Berkshire’s Buffett Do With $109 Billion? (Hint: No Bitcoin)’
Here’s an extract (emphasis is mine):
‘As investors and Warren Buffett followers ponder what Berkshire Hathaway (BRKB) will do with its swelling, record-high pile of cash, analysts say options include a major acquisition, buying more stocks like Apple (AAPL), doing nothing, or even a first-ever dividend.
‘The holding company held $109.3 billion in cash and equivalents at the end of the third quarter and will grow by some $3 billion more in December thanks to a bet on the burger business years ago. The record cash hoard is more than five times the $20 billion that CEO Buffett likes to keep on hand, and many shareholders want to see Berkshire put the money to greater work.
‘Buffett even acknowledged to Berkshire shareholders in May that it had been a while since he had pressed his “foot to the floor” on an acquisition, and rued keeping so much cash just lying around. But he said the question is: “Are we going to be able to deploy it?”’
When you see far more risk than reward, the preferred position is cash.
You may not like earning ‘sweet nothing’ on your money, but it’s far better than losing 50, 60, 70 or 80% of your capital…and that’s the sort of carnage we’re going to see in the ‘down’ phase of this cycle.
The signs are pointing to an imminent rotation from good to bad times.
If you wait for all 20 valuation measures to flash red and the Buffet Indicator to go even higher before taking defensive action, it’ll be far too late.
The cycle will have turned, and your capital will be in for a very steep descent.
There’s another market adage that’s worth remembering — ‘it’s better to be out too early, than to be a day late.’
Editor, The Gowdie Letter