The Global Economic Cycle: Speculation, Capitulation, Ruination

You have to speculate to accumulate.

The problem with this old proverb is that by the time it’s being peppered into the sales pitch of stockbrokers/financial planners/real estate agents/crypto promoters, markets offer the least opportunity to accumulate.

Speculation only ever happens after a trend is established.

We, the majority, are not emotionally programmed to ‘buy low and sell high’.

The historical trend — ever since Adam played fullback for Jerusalem — is and has been to always buy high and sell low. It’s a pattern that’s as predictable and repeatable as night following day.

The ‘speculate to accumulate’ mantra grows louder the longer we stay in the ‘buy higher’ phase.

This apparent ‘sweet spot’ in markets — the period when you can’t go wrong and easy money is on offer — is what renowned economist Hyman Minsky identified as ‘economic stability breeding instability’.

The longer the period of speculative accumulation goes for, the greater the belief in the permanency of the trend.

The level of risk-taking escalates because there’s this overwhelming confidence in ‘this time it’s different’. It never is.

However, in an era when central bankers are blatantly underwriting asset prices, you can understand why ‘speculate to accumulate’ becomes even more entrenched in the human psyche.

What can wrong?

If there’s a market downturn that warrants being the lead story on the six o’clock news, the Fed will sort it out.

The good folks in the Marriner S Eccles Building (the Fed’s office in Washington) will make your dollar whole again in due course.

You can speculate to accumulate safe in the knowledge that central bankers have your back.

Those who don’t quite buy the ‘Fed is all-powerful’ story remain partially or fully on the sidelines. Observing the market action from a position of safety. Confident that this time is NOT different.

However, the longer the actions continue without any apparent downside, confidence is replaced by doubt.

What if I’m wrong? What if it is different this time? What if we’re in a ‘new’ normal?

What if there isn’t going to be any meaningful correction?

Questions that give rise to the FOMO syndrome — Fear of Missing Out.

When enough people suffer from FOMO, we have capitulation.

Sick and tired of waiting and earning ‘sweet Fanny Adams’ on their money, they surrender.

Can’t beat ‘em…join ‘em.

And in the current environment, who can blame them?

Volatility is almost non-existent.

The global economic outlook is the rosiest it’s been in a long time.

Trump’s tax cuts are going to underpin Corporate America.

Commodity prices have recovered…China is ‘open for business’ again.

According to Bloomberg Market on 30 January 2018 (emphasis is mine):

Record bullish positions are building up across currency, equity and commodity markets as hedge funds and real-money investors dump the dollar and U.S. Treasuries to crowd into risk assets around the world.

Goldman Sachs warns that “extreme” sentiment is propelling global shares to their best start to a year ever, while U.S. government bonds head for their worst on record. Investors are throwing caution to wind to wager more gains are nigh.

John Hussman, a US fund manager, wrote in his 15 January 2018 investor update (emphasis is mine):

Last week, Investors Intelligence reported the most lopsided bullish extreme in over 30 years, with 64.4% of investment advisors bullish and just 13.5% bearish. Likewise, the Daily Sentiment Index for both S&P 500 and Nasdaq futures reached the most extreme levels in their history.

Capitulation is all but complete when you reach the most extreme bullish levels in history. 

What the current bullish extreme tells us is that for every cautious investor, there are five who see an optimistic future.

This 5:1 reading is the highest ‘for and against’ ratio in over 30 years…going right back to that infamous year, 1987.

And this is why optimism abounds:

S&P 500 Daily Price 2019-Present 02-02-2018

Source: Real Investment Advice
[Click to enlarge]

If you follow the dotted red line — the trajectory of the S&P 500 index since the March 2009 low — it’ll tell you the story.

Initially, there’s the gradual increase.

Followed by the steeper (speculate to accumulate) second phase.

Then there’s the almost vertical rise…the capitulation phase.

But we’ve seen this pattern before…the 1922–29 bull market.

1922-29 Bull Market Chart 02-02-2018

Source: Federal Reserve Economic Data
[Click to enlarge]

There are countless charts — Japanese share market from 1980–1990, the Dow from 1983–87, and the NASDAQ from 1995–2000 — where the pattern of behaviour is almost identical.

The timeframe from ‘caution to capitulation’ varies.

However, the stages — based on the change in social mood — remain the same.

What comes next for the global economy?

The following stage is as predictable as it is inevitable…


The above chart shows you what happened to those who bought into the belief that ‘this time is different’.

The first sharp correction was followed by a strong bounce…even back then, the ‘buy the dip’ mentality was at play.

This proved to be nothing more than doubling up on a losing bet.

By the time the market hit its low-point in July 1932, the Dow had lost nearly 90% of its value.

Hardly the outcome that was expected by investors in 1929.

They mistakenly interpreted the almost vertical trajectory as a ‘welcome’ rather than a ‘warning’ sign.

What can we learn from history?

You cannot cure a debt crisis with more debt. It’s illogical. Market extremes are ALWAYS followed by a process of reversion. The more vertical a market climbs, the more dangerous it becomes. The downside descent is far more rapid than the upside ascent.

Here’s my interpretation — based on history — of what the future has in store for us.

First, there is likely to be a sharp downturn. This is going to be explained away — predictably — as the market experiencing a long overdue breather. ‘Buy the dip…normal resumption will continue shortly.’

But why would the market go back to and beyond the level of extreme valuation — from which it fell — on nothing more than ‘buy the dip’? It makes no sense.

The momentum from the ‘buy the dippers’ will turn things around somewhat…temporarily.

Then the bumpy road to destination ‘ruination’ begins in earnest.

When it’s all over, my best case scenario is for the US market to fall 65%; the worst case is a drop of over 80%.

As you can see from the above chart, all the gains (and more) from the 1920s were wiped out in the space of a couple of years.

Gone. Vanished. Not to be seen again for another 20 years.

At present, we’re experiencing only a half of a market cycle…the ‘up’ half.

When this cycle makes a full rotation — through the ‘down’ half — don’t be surprised to see the Dow back to levels first reached in 1995.

‘Impossible. Madness. Not going to happen.’

That’s not what history repeatedly tells us.

If you’re eager to learn how you could avoid the road to ruination, please go here.


Vern Gowdie,
Editor, The Gowdie Letter

Vern Gowdie has been involved in financial planning since 1986. In 1999, Personal Investor magazine ranked Vern as one of Australia’s Top 50 financial planners. His previous firm, Gowdie Financial Planning was recognized in 2004, 2005, 2006 & 2007, by Independent Financial Adviser (IFA) magazine as one of the top five financial planning firms in Australia. He has been writing his 'Big Picture' column for regional newspapers since 2005 and has been a commentator on financial matters for Prime Radio talkback. His contrarian views often place him at odds with the financial planning profession. Vern is is Founder and Chairman of the Gowdie Family Wealth advisory service, a monthly newsletter with a clear aim: to help you build and protect wealth for future generations of your family. He is also editor of The Gowdie Letter, which aims to help you protect and grow your wealth during the great credit contraction. To have Vern’s enlightening market critique and commentary delivered straight to your inbox, take out a free subscription to Markets and Money here. Official websites and financial eletters Vern writes for:

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