Two Charts Feeding You Dangerous ‘Fake News’

Even those with a passing interest in investing will have heard or been told, ‘in the long term, the share market always goes up.’

No discussion needed. The evidence is in. Accept the statement as fact.

But if you decide to look a little more closely at this ‘statement of fact’, you’ll find the data has been ‘cherry picked’ to support the ‘fact’.

In support of the industry’s claim you’ll be presented with one of two charts…or perhaps both.

The first chart usually dates back to 1900 (or thereabouts). The Great Depression, the ’87 crash, the dotcom bust and the GFC are but mere speed humps in the road to lasting riches.

That’s great news if you have an investment horizon of 120 years AND (this is a big ‘and’) the 21st Century is going to be a repeat of the 20th Century.

Will global population quadruple?

Will global debt continue to rise exponentially?

Will we see another generation of ‘boomers’?

If the same dynamics that created the phenomenal market performance of the 20th Century are not present in the 21st Century, then please tell me how we can create the same outcome.

Past performance (and especially long, long term past performance) is totally irrelevant to your particular situation.

You want to know is the share market going up when YOU will be invested…over the next decade or two or three.

That’s when the industry trots out the second chart.

The one that conveniently starts in 1980.

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A 38-Year Track Record

Surely a 38-year track record is sufficient to convince you of the long term wealth creation powers of the share market?

Yes 38-years is a long time.

But again, you have to look at the conditions that created that period of exceptional performance.

Over this period, the market has delivered an average return of 12% per annum…a return that’s well above the historical average.

Have you asked yourself how has this been achieved, or just accept on face-value that this is normal?

I can assure you, it is not normal.

The past four decades have been an extraordinary period in financial markets.

The task we have is to decide whether the conditions (that produced this exceptional level of return) still exist or has the world changed and the market will be subject to different driving forces.

Household debt has risen three-fold since 1980 — from 40% of GDP to around 120%.

Graph of Household GDP

Source: Trading Economics

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When you consider Australia’s GDP in 1980 was $150 billion — at 40% of GDP, household debt was $60 billion.

Today our GDP is $1.6 trillion.

In dollar terms, our household debt has grown from $60 billion to $1,920 billion — a phenomenal 3200% increase over the past 38 years.

Did all these extra money (created from the fractional banking system) floating around in the system find its way to the corporate bottom line…which in turn boosted share prices?

You bet it did.

That’s the past. What we’re concerned about is the future.

Therefore, if rising debt levels contributed to rising share prices, we have to make a judgement call on where household debt levels are going to in the coming decades.

Will debt levels in dollar terms rise by another 3200% over the next 38-years?


But I wouldn’t bet on it…for one simple reason. 

Falling Interest Rates the Big Enabler

The big enabler for debt expansion over the past four decades has been falling interest rates.

Can interest rates fall to the same degree in the future?

No way.

In fact, even with the lowest rates in history, we’re told more households are experiencing mortgage stress.

The GFC was a warning about having too much debt in the system.

That warning was ignored.

Therefore, the system has another much larger too-big-to-ignore warning lying in wait for us.

The higher probability in the coming decades is for debt levels (as a % of GDP) to stagnate or even, fall.

The other fact that’s ignored in the 12% per annum declaration, is the price/earnings expansion over this period.

The P/E is the multiple applied to those corporate earnings that’ve been fattened up by the household debt binge.

The reason this crucial piece of information is ignored is because the industry is ignorant to the impact of PE expansion and contraction on share valuations. In all my years in the investment industry, not once was it ever mentioned.

In 1980, the All Ords was trading on a P/E of 6-times. Today it is around 18-times. (A 300% increase.)

Grab a compound calculator and check these numbers for yourself.

A company earning $1 million x P/E of 6 = $6 million

A company earning $1 million x P/E of 18 = $18 million

The rate of compound growth (from $6 million to $18 million) over a 38 year period = 3% per annum.

Without P/E expansion, the annual average return would have been 9% per annum.

But that’s the past…

Is the Future Going to Replicate the Past?

If the future is going to replicate the past, then over the next 38-years, the market P/E ratio must expand from 18-times to 54-times. (Another 300% increase.)

What are the chances of that happening?

Highly unlikely.

And if it does, it’ll be completely unsustainable.

When we put the two factors together — earnings being boosted by debt levels expanding by another 3200% and the All Ords P/E ratio going to 54-times — what are the odds of the future being a repeat of the past?

Would you bet your retirement on that outcome?

Personally, I wouldn’t.

When you take an objective view of market history — the good and bad times — you’ll see the market has extended periods when it charges ahead (bull), and extended periods when it claws (bear) back some of those excessive gains.

That’s the natural order of markets. Two steps forward and one back.

What’s important for YOU, is where we are in the market cycle NOW.

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Forget about the past. That’s irrelevant. You can only ‘make or break’ your capital base on future outcomes.

This chart clearly defines the two step forward, one step back process the US share market has been subjected to since 1900.

Graph of Household GDP

Source: Crestmont Research

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There are lengthy periods when the market simply runs up and down on the spot…the red bars.

If you happen to be retiring during one of these red (secular bear market) periods, then it is going to be cold comfort when your financial planner tells you ‘in the long term the share market goes up’.

Your capital could be so depleted that when the prosperous green (secular bull market) period arrives, you have precious little left to participate in the rising market.

In my opinion, the next decade is going to be vastly different to the one we have recently experienced.

Debt contraction is going to replace debt expansion. The sluggish economic performance — due to less credit in the system — will weigh heavily on social mood. People become more conservative…PE ratios shrink to reflect the lack of optimism about the future.

Stagnating or falling earnings multiplied by a single figure PE, means future share returns take a step or two backwards.

Never has there been a more important time to take notice of the warning ‘Past returns are NO guide to future returns’.

When you understand how the market’s stellar performance has been achieved, you see that the industry’s claims do NOT add up.

Forget about ‘in the long term markets go up’…it’s fake news that’s not relevant to your personal situation.

In the near term, the numbers and history strongly support an argument for the markets going down, down and down some more’.


Vern Gowdie
Editor, Markets & Money

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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