The Dow Jones hits a record high.
The New York Stock Exchange margin debt reaches a record high.
Complacency, as measured by VIX, the fear index, is at an all-time low.
Don’t people realise that when anything market related is prefaced with ‘record’ or ‘all-time’ it’s closer to the end, and NOT the beginning, of a trend?
Haven’t US investors seen the chart below? Or heard the saying ‘a picture paints a thousand words’?
Oh that’s right…’it’s different this time.’
Somehow the same ill-fated stimulus policies that were instrumental in creating the two previous bubbles, are going to achieve a different outcome this time.
Seriously, are people that stupid?
That was a rhetorical question.
For more than 35 years we’ve been conditioned — by self-serving investment industry propaganda — to believe ‘share markets always go up’. The success of this sustained marketing campaign is evident in the chart above. The lemmings just keep coming back.
Well, that claim is going to be severely tested in the not-too-distant future.
The share market has gone up over the very long term — the operative word being ‘has’.
By very long term, I’m talking in excess of 100 years.
However, during this century of ascendancy, there have been periods when major share markets tread water. These flat-lining periods can last up to 20 years.
This inconvenient truth is conveniently airbrushed out of industry marketing material.
And then there are periods, like we’ve seen from the early 1980s to now, when the share market shoots the lights out. It’s this extraordinary period of performance that the industry uses to persuade the masses.
Take a good look at investment industry marketing material…the performance graphs all commence from 1980. They’re clever…cherry-picking the most spectacular performance period in history to build a story around.
However, there’s no dispute that, over the very long term — dating back to 1875 — the share market has ‘gone up’.
Belief systems are established over a long period of time. And more than 140 years of data certainly qualifies as ‘long term’.
But what if there’s a disruptor — like a sustained period of deflation — that meant that what has been is not what is going to be?
What if share markets fail to deliver to the extent we have become accustomed to?
Ridiculous. Not going to happen.
The 20th century was an amazing period in mankind’s development. Mechanisation. Sanitation. Medication. Financialisation. And, finally, population growth.
All these factors contributed to an extraordinary period of growth. The likes of which have never been seen before…and possibly may never been seen again.
As evidenced by the trajectory of the S&P 500 graph, the US share market rode this extraordinary century of prosperity and growth.
But at the very beginning of the 21st century, the market collapsed with the end of the dotcom boom.
The Fed stimulated growth to create the second bubble — the US housing boom.
We know how badly that ended in 2008.
It’s only fitting that the latest asset bubble is the most magnificent that’s ever been blown. A record high followed by a historical collapse. The symmetry is perfect.
Belief systems will be shattered. It’s possible that a generation or more of investors may be so scarred by the experience that they shun the share market.
Extrapolation — projecting the past into the future — is one of the biggest mistakes investors make.
Do you really think the current trajectory of the S&P 500 is going to continue without major disruption? Investors obviously do.
To avoid being part of the herd that gets slaughtered, you need to think for yourself.
In my book — How Much Bull Can Investors Bear? — I dedicate a chapter to why the past is not necessarily going to be like the future. This is an edited extract:
‘Study the past, if you would divine the future.’
‘Extrapolating the past into the future — and believing that what has been will continue to be — is a common mistake.
‘When it comes to investing, if markets have been bad, the general consensus is that they’ll continue to be bad. On the other hand, if markets are on the up and up, this is forecasted to continue…even though markets are becoming more and more overvalued.
‘Extrapolation is not confined to markets.
‘Over a century ago, the world’s major cities had a serious problem — horse dung.
“In 1898, delegates from across the globe gathered in New York City for the world’s first international urban planning conference. One topic dominated the discussion. It was not housing, land use, economic development, or infrastructure. The delegates were driven to desperation by horse manure.”
- Horse Power to Horsepower, by Eric Morris
‘While this seems funny today, back then, mounting piles of horse manure were anything but a laughing matter.
‘For centuries, horses were the mode of transport. As populations grew, so did the number of horses — and the piles of manure…
‘The problem the city’s fathers faced in the late 1800s was not new. In Ancient Rome, Julius Caesar banned horse-drawn carts between dawn and dusk.
‘Between 1800 and 1900, the US population expanded by 30 million. More people meant more trade, which, in turn, meant more horses.
‘The railway did relieve some of the horse-drawn transportation issues. However, within the towns and cities, goods were still delivered by the traditional horse and cart.
‘The first public transport system in New York was the Omnibus (carrying up to 120,000 passengers per day). A bus pulled by a team of horses. If the public commute was not to your liking, personal transportation was still by horse-drawn carriage.
‘In the wide open spaces of Wyoming, the increase in horse numbers was not a problem. There was plenty of space for natural fertiliser out there. However, in densely populated areas like New York, it was a whole different matter.
‘In New York, it was estimated that, on a daily basis, there was 1.8 million kilos of horse dung and 150,000 litres of equine urine to be “handled”.
‘Naturally, all this horse waste became a pedestrian nightmare — especially when it rained. In addition to the obvious issue of dodging the “land mines,” there were serious health issues confronting the city administrators.
‘There is nothing like a dung pile to attract flies. The spread of typhoid and diarrhoea (especially among infants) increased mortality rates.
‘With this brief background, you can see why the 1898 urban planning conference had horse manure as the most pressing topic on its agenda. Apparently the meeting was scheduled to last for 10 days. After three days the meeting was terminated, as no acceptable solution to the problem could be found.
‘The issues associated with too many horses had plagued Rome nearly 2,000 years ago and was such a long established trend that the world’s town planners resigned themselves to it being an unsolvable problem.
‘According to Eric Morris:
“The situation seemed dire. In 1894, the ‘Times’ of London estimated that by 1950 every street in the city would be buried nine feet deep in horse manure. One New York prognosticator of the 1890s concluded that by 1930 the horse droppings would rise to Manhattan’s third-story windows. A public health and sanitation crisis of almost unimaginable dimensions loomed.”
‘Based on the knowledge at the time — population growth and volumes of horse waste — you can appreciate the math behind the forecast of “pavements of poop” piled up to the third floor.
‘These days, the only horse poop in New York is around Central Park, where horse and carriage rides await to take love-struck and nostalgic tourists on an overpriced ride through the park.
‘The “piles of poop” forecast is known as “extrapolation” — taking an established trend and projecting it into the future. The problem with extrapolation is that an unforeseen disruptor can change the trend, making forecasts look silly to future generations.
‘In the case of mounting horse poop as a trend, we know the advent of the combustion engine didn’t just change the trend, it killed it.’
If we replace the extrapolation of ‘horse poop’ with ‘debt levels’, can we realistically expect current record high debt levels to continue growing at the same pace?
Record debt has brought forward an enormous amount of future consumption.
The share market has been a major beneficiary of debt-funded consumption feeding into corporate profits. What if that ‘growth’ model ceases to function? What if consumers change their spending and savings patterns?
This could be the disruptor that turns a 145-year trend — share markets always go up — on its head. This has certainly been Japan’s experience since 1990.
When the proverbial hits the fan, the share market may have an unpleasant odour that lasts for a very long time.
Editor, Markets & Money