After a good fright two weeks ago, investors are comfortable again. They’ve learned their lesson: whenever the stock market goes down, just stay calm; it will always come back.
So here is our prediction: the next time it won’t. The next bear market will last at least 10 years…and probably 20. Why? Debt and demography.
Our old friend, now deceased, Dr Kurt Richebächer spelled it out for us years ago:
‘You can’t build lasting stock market gains or solid GDP growth on debt. Because debt cannot expand forever. Sooner or later, it must stabilise and then it must contract. When that happens, all the positive features of debt become negative features.
‘Instead of borrowing and spending more, people must spend less and pay off past debt. Instead of adding to corporate sales and profits, they subtract from them. Instead of driving up asset prices, they push them down.‘
Borrowed money has an almost magical effect on the way up. It comes out of nowhere…so there is no labour cost to offset against it. It goes almost directly into corporate profits.
But on the way down Dr Jekyll becomes Mr Hyde. Debt has a maniacal effect when it goes into contraction mode. Jobs and wages go down as spending slows…making it harder than ever to pay debt…forcing households to make cuts far beyond what they would have had to do in the good times before.
The effect is biblical. And symmetrical. As ye sow so shall ye reap. Borrow a lot of money and you will have to repay a lot. Enjoy a big debt-financed boom…and you will suffer a big debt-driven bust. The bigger the boom, the bigger the bust.
Where are we now? Not far from an all-time high in debt…and stock prices. Investors are confident. If prices should go down, don’t worry Janet Yellen has their backs.
We bring this up because an end to the deleveraging cycle has been widely reported. Households must borrow to spend more. Because their wages and salaries are still crawling along the floor.
And if they do get in a borrowing mood, it would have a powerful and magical effect. Consumer incomes and spending are roughly 6 times as much as corporate earnings. So, a rise in the consumer’s willingness to borrow and spend could be important…at least for a while. Corporate earnings – already at record highs – could go even higher!
But wait. It would take some pretty strong magic to get corporate earnings and stock prices to go higher. How many more rabbits does Ms Yellen have in that hat?
By our count, not many. The Fed has tried QE. They’ve tried ZIRP. And now what? Nominal rates can’t go below zero. And QE doesn’t seem to do more than to get them down on the floor.
That leaves jawboning…or ‘forward guidance’, as the Fed calls it. But everyone knows ‘forward guidance’ is no guidance at all. The Fed tells us it can change its mind at any time.
So, unless the consumers really are ready to bugaloo…we are still in a deleveraging episode…still with a long way to go down. Debt is still in its Mr Hyde phase. And there’s not much the Fed can do about it.
How about demographics?
Oh la la. There are a number of studies linking demography to stock market P/Es. The results are what you would expect. When people prepare for retirement, they buy stocks. When they retire, they sell stocks.
As more and more people retire, more and more stocks are sold. P/Es go down in – at least according to the studies – a predictable pattern.
And here’s where the grim news comes. According to the latest study we saw, the expected effect on stock prices of demographics will be about MINUS 15% per year…over the next 10 years.
Debt and demographics cannot be QE-ed or ZIRP-ed away. They are both long-term trends. And they’ll pull down stock prices for at least a decade.
Prepare for it.