By Pam Martens and Russ Martens: March 24, 2020 ~
The chart that tells you how all of today’s economic troubles are going to end is not the bar graph of new deaths from coronavirus in Italy versus deaths in the U.S. It’s the chart that shows the number of potential deaths among the banks and insurance companies that have gorged themselves on risky derivatives and serve as counterparties to each other in a daisy chain of financial contagion.
The chart above is why the Federal Reserve is throwing unprecedented sums of money in all directions on Wall Street. Because despite being a primary regulator to these massive bank holding companies, the Fed has no idea who is actually in trouble on derivative trades, other than looking at a chart like the one above.
The chart above also justifies the Democrats refusing to sign off on the fiscal stimulus legislation that would have given U.S. Treasury Secretary Steve Mnuchin a $500 billion slush fund where the names of the recipients of bailouts could be withheld from the public.
In January 2007, prior to the last financial crisis, Citigroup’s stock was trading at the split-adjusted level of $550 a share. At yesterday’s stock market close, Citigroup’s stock price was $35.39. If you are a long-term shareholder in Citigroup, you’re still down 94 percent on your principal, not including dividends. After receiving the largest taxpayer and Federal Reserve bailout in banking history during the Wall Street financial crash of 2007 to 2010, Citigroup did a 1-for-10 reverse stock split to dress up its share price. In other words, if you owned 100 shares of Citigroup previously, you now owned just 10 shares at the adjusted price. If Citigroup had not done that, you would have seen a closing price yesterday of $3.54 cents instead of $35.39.
Citigroup is not alone in loading up on derivatives again. Together with JPMorgan Chase, Morgan Stanley, Goldman Sachs and Bank of America, these five bank holding companies now control a notional (face amount) of derivatives amounting to $230 trillion, representing 85 percent of all derivatives held by U.S. banks.
And their counterparties are just as questionable as they were at the peak of the crisis in 2008, which led to the biggest Wall Street bailout in U.S. history.
The 2017 Financial Stability Report from the Office of Financial Research (whose budget and staff have now been gutted by the Trump administration) included this cautionary text:
“…some of the largest insurance companies have extensive financial connections to U.S. G-SIBs [Global Systemically Important Banks] through derivatives. For some insurers, evaluating these connections using public filings is difficult. Insurance holding companies report their total derivatives contracts in consolidated Generally Accepted Accounting Principles (GAAP) filings. Insurers are required to report more extensive details on the derivatives contracts of their insurance company subsidiaries in statutory filings, including data on individual counterparties and derivative contract type. But derivatives can also be held in other affiliates not subject to these statutory disclosures, resulting in substantially less information about some affiliates’ derivatives than required in insurers’ statutory filings.”
Insurance counterparties named in the report were Lincoln National Corp., Ameriprise Financial, Prudential Financial, Voya Financial and (wait for it), AIG, the insurance company that blew itself up with Wall Street derivatives in September 2008 and required a $185 billion bailout – with more than half of that sum going out its backdoor to pay off Wall Street and foreign global banks that had saddled it with derivatives that were structured bets that things would blow up. (Some of those funds were also used to settle securities lending programs with Wall Street banks and hedge funds.)
“At the end of 2015, U.S. life insurers’ derivatives exposure, as reported in statutory filings, totaled $2 trillion in notional value. This $2 trillion does not include derivative contracts held in affiliated reinsurers, non-insurance affiliates, and parent companies that do not have to file statutory statements. Details on these entities’ derivatives positions are not publicly available.”
The report further indicates that a dangerous interconnectedness with a high potential for contagion has grown between U.S. life insurers and Wall Street banks:
“According to statutory data on insurance company legal entities, nine large U.S. and European banks are counterparties to about 60 percent of U.S. life insurers’ $2 trillion in notional derivatives. These data show that despite central clearing, derivatives interconnectedness between the U.S. life insurance industry and banks remains substantial.”
Deutsche Bank, whose share price has been regularly setting historic lows, is one of the European banks that is heavily intertwined with Wall Street’s derivatives. (See related article below.)
As Treasury Secretary Steve Mnuchin repeats ad nauseum that this is a health crisis not a financial crisis, just remember when the financial crisis actually started: September 17, 2019 – five months before the first death from coronavirus in the U.S. (See our more than five dozen articles on this latest financial crisis here.)
The ‘Small’ Business Administration is now bigger than Walmart
As you’ve probably already heard, the US government unleashed a giant tsunami of money on Friday, passing a $2 trillion stimulus bill to help boost the economy during the Covid pandemic.
Let’s put that number in context:
$2 trillion is more than it cost to wage 18+ years of war in Afghanistan and Iraq.
It’s nearly THREE times the size of the bailout from 2008.
It exceeds ALL corporate and individual income tax revenue collected by the IRS last year
We are clearly living in unprecedented times… and this bailout is equally unprecedented.
Among the bailout’s many provisions (which go on for more than EIGHT HUNDRED pages!) is a whopping $350 billion to the Small Businesses Administration.
The Small Business Administration is ordinarily a tiny federal agency. But this funding exceeds the budgets of the Army and Navy COMBINED. It’s 8x the size of the United States Marine Corps. It’s more than the entire market capitalization of Walmart.
You get the idea. The SBA just became one of the biggest organizations in the world.
Now, in normal times, the SBA’s mission is to help startups and small businesses obtain bank loans; it’s usually pretty difficult for a startup to borrow money from a bank loan because the business is too risky, and banks don’t want to lend.
So the SBA’s role is to provide a guarantee for the loan. They’re essentially telling the bank that if the business fails and doesn’t pay back the loan, the federal government (i.e. American taxpayers) will make up some of the difference.
This guarantee doesn’t make a small business loan risk-free for banks-- there are still things that can go wrong. But the guarantee helps reduce the risk.
But typically, in order to receive an SBA guarantee, business owners have to provide their own ‘personal guarantee’ to the government. In other words, if the business owner defaults, the government can seize their assets in order to recover loan losses.
That’s the way SBA loans normally work. But these times are not normal.
According to this new bailout legislation, “no personal guarantee shall be required,” and the government “shall have no recourse against any individual shareholder, member, or partner . . . for nonpayment”.
In other words, the legislation implies that these loans don’t have to be paid back.
Moreover, the law also states that “no collateral shall be required for the covered loan.”
So you don’t even need any assets to qualify. In fact you need barely anything to qualify… except a pulse.
According to the legislation, “any business concern, nonprofit organization, veterans organization, or Tribal business. . . shall be eligible to receive a covered loan” as long as you have fewer than 500 employees.
Honestly the only real requirement is that you have to keep paying your employees. That’s the entire point of the legislation-- lawmakers wanted to provide funds so that small businesses could continue paying workers.
The maximum loan amount is equal to your payroll costs over the last 12 months multiplied by 2.5.
*Payroll costs include salaries, wages, and payments paid to employees and independent contractors, including yourself, up to $100,000 each. It also includes medical insurance payments, retirement benefits, state/local tax, and payments for sick leave, family leave, or vacation.
*Payroll costs do NOT include federal income or unemployment tax withholdings, or compensation for employees based outside of the United States.
So if you had, say, $400,000 of qualifying payroll costs over the past year, your maximum loan amount is $1 million.
And the maximum interest rate (according to the legislation) is just 4%.
Now, I’m sure that plenty of people will use these loans as intended-- to stay in business, continue paying workers, etc. And eventually they’ll do the honorable thing-- pay the loans back, with interest.
But let’s be honest. Countless people are going to completely abuse this. They’ll borrow as much money as they can with absolutely no intention of paying back a single penny.
This means there’s going to be a ton of loan losses.
Remember-- banks are the ones who will be making these loans, using their depositors’ money. YOUR money.
And even with the SBA guarantee, there are still things that can go wrong. If the paperwork was wrong, if the loan wasn’t made in the prescribed way, if the business didn’t actually qualify, etc. the banks can still suffer losses.
(Taxpayers will obviously suffer huge losses as well.)
But despite these risks, the legislation specifically tells banks that “a covered loan shall receive a risk weight of zero percent.”
Translation: banks should count these small business loans as ‘risk free’ even though there’s a strong chance that tons of people will never pay them back.
The legislation also says that banks “shall not be required to comply” with accounting rules that require them to disclose when their loans go bad.
So the government is essentially telling banks to make loans to everyone, with no personal guarantee, no recourse, and no collateral… and to maintain these loans on their books as risk free. And even when these loans default, to continue reporting them as risk-free.
What could possibly go wrong???
It’s clearly a great time to be a borrower. That’s one thing we learn from bailouts—they’re always going to take care of people in debt, and help people go into more debt.
But it’s more concerning to be a depositor.
Even with the SBA guarantee, it’s obvious that banks are riskier than they want you to believe.
Honestly the only real requirement is that you have to keep paying your employees. That’s the entire point of the legislation-- lawmakers wanted to provide funds so that small businesses could continue paying workers.
With so many "corporations" nothing but an empty shell and a few token employees pedaling the Chinese made crap will they qualify?
Until they are able to get more crap to sell they are dead in the water. If everyone understand there is a cost to cheap will they try to buy better quality?
Will corps be forced to bring mfg back to the US or even North America?
You are correct, Scorpio. This rally may push the SPX to 2800 where Bearish resistance pressure will be applied. Note that the Bearish Signal Reversed pattern DID issue a sell signal at 2250, under its Bullish support line turning the trend bearish.
US power sector coal stockpiles total 134 million st in January: EIA
US stockpiles reach 26-month high
Subbituminous days of burn reach 120
Houston — US power sector coal stockpiles totaled 134 million st in January, up 4.6% on month and 35.2% on year, US Energy Information Administration data showed Tuesday.
From January 2019, stockpiles showed the largest year-on-year build since August 2009. US stocks also reached their highest point since November 2017.
From the five-year average for the month of January, which was 144 million st, stocks were at a deficit of 6.9%, the smallest since April 2017.
Bituminous stockpiles totaled about 56.3 million in January, up 2.1% from December and up 39.2% from the year-ago month.
Bituminous stocks were also at a 6.9% deficit from the five-year average of 60.4 million st for January.
Days of burn, according to EIA data, were 137 days in January, up 17 from December and up 47 days from the year-ago month. Additionally bituminous stockpiles reached its peak, for the second consecutive month, since S&P Global Platts began reporting the data in 2009.
The five-year average for January is 88 days of burn.
December subbituminous stockpiles totaled 74.6 million st, up 6.5% from the month before and up 33.4% from the year-ago month.
From the five-year average of 79.6 million st, subbituminous stocks were at a deficit of 6.4%.
Days of burn for subbituminous coal were 120 days, up 23 from December and up 12 days from the year-ago month. The five-year average for the month is 93 days. Days of burn also reached a peak, according to available data.
Lignite stocks totaled 3.3 million st in January, up 5.9% from the previous month. Stocks were up 14.7% from the year-ago month.
The piles are full at about 200 million. I've never seen them above that level that I can recall. I used to watch this stuff much closer but I had access to better sources back then. I think the stockpiles are a good barometer for how the economy is doing but with coal falling by the wayside and nat gas being consumed for power like never before it's probably not a great indicator. The generators might burn some just to comply with contracts written last year but at this point I think they would prefer to burn gas. I'm curious as to how much electricity is being sent down the lines with so many businesses closed over the beer virus. Are people couped up inside the house taking up the slack? I doubt it. the EIA numbers will look interesting a couple of quarters from now.
That was fast! Wells Fargo already ran out of money for small businesses
I think one of the funniest movies of the 1980s was Brewster’s Millions.
In the movie, Richard Pryor plays Monty Brewster, a minor league baseball player who finds out that he is in line to inherit a vast $300 million fortune.
In order to inherit the money, though, Brewster must spend $30 million over the next 30 days… and if he fails to do so, he forfeits the entire inheritance.
Part of the terms of his inheritance were that Brewster couldn’t buy assets. He couldn’t just acquire a bunch of real estate or expensive paintings. He had to spend the money, not invest it.
$30 million is a ton of money, especially in 1985 when Brewster’s Millions was released. And the movie is a hilarious account of how difficult it was for Richard Pryor’s character to spend so much money so quickly.
Amazingly enough, the US federal government is starting to realize this too.
Ten days ago they passed the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act with the aim of putting cash in people’s pockets.
As I wrote to you a week ago, the law includes $350 billion in emergency funding for small businesses. It’s specifically aimed at helping entrepreneurs retain and pay their employees.
A week and a half later, the government seems to have realized just how difficult it is to give away $350 billion to tens of millions of businesses.
Sure, the Defense Department blows hundreds of billions of dollars all the time. They make it look easy. But they’re acquiring really expensive stuff-- bombs, aircraft carriers, fighter jets, etc.
But similar to Brewster’s Millions, the Small Business Administration isn’t buying anything. They have to spend the money, sprinkling hundreds of billions of dollars across the economy as quickly as possible.
And to make matters even more difficult, they’re spending it in very small chunks as low as $10,000 each.
So the government and the banks are scrambling right now trying to figure out how to get this money into the economy, and fast.
Meanwhile, demand is incredibly high from small business owners who are looking to get a piece of that $350 billion.
Some bank websites have crashed. Others simply put a page up saying “We’re sorry, we’re unable to process your request.”
Wells Fargo (of course it had to be Wells Fargo…) announced yesterday on Twitter that they had already “reached lending capacity” for small businesses under this program, and they subsequently took down the application form.
Then the Federal Reserve reacted by announcing a new facility to ‘buy’ small business loans from the banks, which gives banks like Wells Fargo more ammunition to keep lending.
The problem, of course, is that a good chunk of these loans will never be repaid. Ever.
As I explained last week, Congress set up these loans to be “forgivable”. They’re non-recourse loans, and no personal guarantee is required. So a small business owner can take the money, never pay a penny back, and there will be no consequences (as long as the money was used for its intended purpose.)
But based on yesterday’s announcement, a ton of these loans will end up being owned by the Federal Reserve.
Bear in mind that the Federal Reserve’s total capital is just $38 billion. So $350 billion worth of small business loans (or even just a fraction of the $350 billion) would completely dwarf the Fed’s capital.
In other words, widespread loan defaults could easily wipe out the Fed’s capital, rendering the largest and most important central bank in the world insolvent.
Of course the federal government is supposed to guarantee these loans… so if a borrower defaults, the Small Business Administration will make the lender (or the Fed) whole.
But the federal government itself is insolvent! Think about it-- just to be able to make this $350 billion loan guarantee, the US government has to borrow money from… the Federal Reserve!
It’s mind boggling when you think about it: the Federal Reserve prints money and loans it to the US government, so that the US government can financially guarantee the Federal Reserve.
The Secret History Of A 70% Market Loss - What A Secular Bear Market In The 2020s Could Look Like
By Daniel R. Amerman, CFA
Can the U.S. economy actually be turned on and off like a light switch? What are the implications for investors if it can't?
The shutdown of much of the American economy in response to the COVID-19 pandemic has already created what is by far the single largest increase in unemployment in U.S. history in such a short period of time.
We are experiencing two quite distinct but interrelated forms of supply shortages that may just in their early stages. One is the combined result of the collective (and very short-sighted) decision to make much of the world's supply chain dependent on one nation, that of communist China, even while slashing the supply of inventory down to "just in time" levels, with no room for error.
All else being equal - shortages usually translate to inflation, and major exogenous supply shocks can lead to rapid inflation. And if when the system rebuilds, for at least a few years things like national security and robust supply chains are taken into account, rather than a pure focus on fragile efficiency to the exclusion of all else, well, that also leads to higher prices, which also leads to inflation.
The other major issue is that the economic shutdown has cut off the production of goods of many kinds in the U.S. In most areas, simply going to the grocery store is already enough to see both shortages, and soaring prices. A current example is eggs having gone up to $5 a dozen locally, a 400% increase over the usual sales price in February - and they are still getting harder to find. The number of items with shortfalls and the degree of the increases are likely to be increasing in the weeks ahead.
Now, many of the specifics remain to be determined, and many arguments can be made. The problem is that we are still falling, fast, and until the medical reversal happens and economic stability is reached, no one knows had bad it will be at that point.
For those expecting a very profitable market rebound as a near certainty in the next 1-3 years - well, maybe. Watch the Federal Reserve. But absent extraordinary interventions ( a certainty) and assuming that they succeed (far from a certainty), we have a very good example of long term stock market performance with a far lesser supply shock, and less unemployment.
This analysis is part of a series of related analyses, which support a book that is in the process of being written. Some key chapters from the book and an overview of the series are linked here.
How Inflation Hid A 70% Market Loss: 1968-1982
The danger is that history shows us is that once control is lost - it is very hard to bring inflation back under control, and it can be very hard to bring unemployment under control. The U.S. is currently creating a simply unprecedented combination of production shutdown and staggering job losses. Can a switch simply be flipped, and both just return to normal?
There is no example of this switch being flipped and a swift return to the prior situation - because this situation has never happened, and it is pure speculation to say it would. However, history in the modern era in the United States does contain a very good example of what can happen to long term investment returns when control has been lost over inflation and employment. Consider the following graph.
As shown in the yellow/orange, the Dow Jones Industrial Average reached 919 in May of 1968, and by August of 1982, had fallen to a level of 777, for a loss of 15%.
Many investors recall this "Lost Decade" for the stock market when the market stayed flat to somewhat down - moving sideways but never persistently up, and what is seen in yellow is consistent with that market perception. It also looks obvious that this overall flat market with a great deal of volatility would have generated some really good opportunities for astute market timers.
However, reality is that a 15% loss in a long-term sideways market isn't what happened at all, not when we look at what a dollar would buy. That is, in 1982 the US dollar was only worth 35 cents compared to what it would have bought in 1968, because the dollar had lost 65% of its value to inflation.
As shown in blue in the graph, when we adjust the August, 1982 Dow index of 777 to account for a dollar being worth 35 cents, then the real value of the Dow drops to 274. So when we consider the purchasing power of the dollar, then our stock portfolio wasn't flat, not even remotely close. Instead, it had dropped by a staggering 70% in fourteen years, from 919 to 274.
Now while this 70% decline in the value of what our assets would buy for us was entirely real, to this day many of us don't realize just how bad it was. That is because inflation in prices was hiding deflation in investment values. The 65% plunge in the value of the dollar "hid" the 70% plunge in the value of stocks, with most of the surface value of the Dow index by 1982 consisting of dollars that were worth far less than what they had been before.
Those 14 years are the best modern era example we have of what happens when control is lost over both inflation and employment at the same time. There were no magic switches involved that swiftly brought everything back under control - the government and Fed were trying everything they could, and there were still many painful years until stability for prices and jobs were regained.
Indeed, this secular bear market and staggering 70% real loss could be called the only example for what happens when a situation even vaguely like this occurs. There is zero precedent for a fast restart - and while arguments can be made for that, these arguments have to be seen for what they are at this stage - theory and speculation.
It's not that a fast restart can't happen, nobody knows at this stage as the shutdowns continue. But to act as if a fast restart is the most likely course and a reasonable and prudent person can therefore confidently invest on that basis - is arguably a bit on the absurd side, particularly for someone in retirement or nearing retirement and who is supposed to be investing conservatively with the body of their savings.
Three False Peaks & Inflation Hiding Deflation
Even though long-term asset deflation of 70% (in real terms) was the result of persistent high unemployment coupled with inflation, many investors and newspaper readers of a certain age may not remember the 1970s that way at all. Instead they may recall three powerful bull markets when the Dow repeatedly flirted with the "magical" 1,000 mark. Each surge filled innumerable financial columns with the hopes that the good times and a long term bull market had returned again, with those hopes being quickly dashed as the market repeatedly proved unable to sustain itself above the 1,000 level.
Perceptions don't change reality, however, which is that there never were three bull markets, but rather only an inflationary illusion fooling the public. Indeed when we look closely, instead of seeing three peaks, we will see three historical object lessons in how destroying the value of money can hide the destruction of the value of assets - and repeatedly fool the headline writers along with much of the investing public.
The cold reality of the Dow adjusted for inflation is shown in blue. There aren't three interim peaks, but merely a market moving steadily and powerfully down.
The "bull market" that peaked in January of 1973 when the Dow hit 1,047 - was in a reality a fall to Dow 848 (asset deflation in inflation-adjusted terms), that was masked by the dollar being worth only 81 cents when compared to May of 1968 (monetary inflation). Inflation had created an almost 200 point illusion in the Dow.
The "bull market" that peaked in September of 1976 at 1,014, really represented the Dow falling by over 300 points - translating to asset deflation of 34% - which was hidden from savers by the illusory profit created as a result of the dollar dropping in value by 40% (monetary inflation).
The cruelest illusion of all was the "bull market" of April of 1981, when the Dow finally reached 1,024. Because the real value of the market had fallen to 399, and a 57% destruction of the purchasing power of investor assets was being entirely hidden by the 61% destruction of the value of investor dollars.
Fully understanding this relationship of simultaneous monetary inflation and asset deflation is absolutely essential for financial survival, because there is a reasonable chance that we may all be seeing the greatest "bull market" in stocks that we have ever seen in the 2020s - but it won't necessarily work the way investors today think it will.
(We will use "monetary inflation" interchangeably with "price inflation" herein.)
Three Wealth Destroyers vs "Perfect Timing"
In my opinion, the greatest threat to long-term and retirement investors is the wealth-destroying triple combination of monetary inflation, asset deflation, and inflation taxes.
One of the most common investor approaches to a truly difficult market is to attempt to "outrun" the problems. Just make better decisions than the rest of the public, and make so much money that the problems can be overcome and wealth kept intact.
How well does that work in practice and just how good do you (or your financial advisor) have to be?
To answer that question, we will go back in history and assume that through the use of a time machine (or peerless skill, or uncanny luck) we did a perfect job of long-term market timing during an environment of asset deflation and monetary inflation.
Aided by this time machine, we put every dollar we had into the market on May 26, 1970, when the Dow closed at 631. What makes this day remarkable is that 631 is the lowest level the Dow index closed at between November 20, 1962 and September 12, 1974. It was the single cheapest day to buy stocks over an almost 12 year time period, and at the time, the lowest that stock prices had been at in more than 7 years. Perfection.
Subject to the conditions that 1) as long-term investors we need to be in the market ten or more years, and 2) that we want to stay within the 1968 - 1982 period of sustained asset deflation and high monetary inflation, we instruct our time machine to find the best possible place to sell. This turns out to be April 27, 1981, when the Dow closed at 1,024.
April 27, 1981 was the single highest close for the Dow index between January 22, 1973 and October 19th, 1982. So we buy in on the exact day with the lowest stock prices in an almost 12 year period, and we sell everything out on the exact day with the highest prices over an almost a ten year period. Double perfection!
So then, how did we do? As shown in the following graph, which begins on our purchase date and ends on our sale date - our time machine allowed us to get the best possible results in a thoroughly bad market. If our returns had exactly tracked the Dow between when we bought and sold, our perfect timing would have taken us from 631 to 1024, for a 62% price gain in the midst of one of the worst markets in memory.
A whopping profit indeed! Before we adjust for inflation, that is, so let's do that. A dollar on our sale date in April of 1981 was only worth 43 cents compared to what it was worth on our purchase date in 1970. When we adjust for what our assets will buy for us - we have Dow 440, not Dow 1024. So even the absolutely perfect timing delivered by our time machine leads to a 30% asset deflation loss in real terms, not a 62% gain.
The Internal Revenue Service did not "see" these losses, however. To the contrary, it was quite impressed by our remarkable investment prowess. Moreover, taxes were higher back then (when we confine ourselves to federal income tax rates, even after the tax hikes at the end of 2012, we are still at a relatively low level now compared to much of the modern era). Assuming we were in the highest income tax bracket, and traded often enough to pay ordinary income tax rates, then given that the average top income tax rate over that period was 68%, this means that we would have paid out 267 in taxes on our 393 gain.
These taxes on effectively non-existent income are known to economists as "inflation taxes", and they can be devastating.
Subtracting out real taxes on imaginary income leaves us with Dow 757 in after-tax terms, and Dow 325 in after-inflation and after-tax terms. Thus, even with our quite unrealistic assumption of absolutely perfect market timing - which allowed us to radically outperform almost every other investor in the nation - we still lost almost half (48%) of the purchasing power of our net worth.
Lessons Learned & Implications For Today
The most important takeaway from our time machine scenario is not about 1970 or 1981, but about what investors face today.
History does show what can happen next for an entire nation with a deeply troubled economy. For more than a decade, the markets and investor wealth can be dominated by the deadly combination of:
1) a crippling destruction of the purchasing power of investment assets;
2) a masking of this asset deflation by the destruction of the purchasing power of money; and
3) this masking then generating illusionary "profits", upon which taxes have to be paid, which then compounds the damage.
Moreover, history shows us quite clearly that when all three of these major wealth destroyers are working together in the real world - conventional investing methods cannot withstand the destruction of investor wealth that occurs across the nation and over the long term. Even when we used the extraordinary assumption of perfection in timing - there was still a crippling asset price loss in real terms. Of course, real world investors who didn't have the benefit of assumed perfect timing lost even more money.
Secular bear markets are entirely real - they are the reality of history, and what we just reviewed is only one example. It is the idea of a bear market being a brief and reliable buying opportunity that is myth, over the long term.
As shown in the graph above of expansions and recessions from Chapter 2 - when we look back over time, what we had been living in could in some ways be called the aberrant exception. Recessions always happen, given enough time.
From a long term perspective - the so-called "once in a lifetime" recession associated with the financial crisis of 2008 was not actually all that unusual or all that bad, as can be seen when we look at the frequency and size of the yellow bars on the left side of the graph. People who think it was something incredibly unusual, just don't know long term economic history (and most don't).
We were at record stock highs, in no small part due to heavy-handed interventions by the Fed, keeping interest rates at historically abnormal lows even before the swift recent return to 0%. We are currently in the process of taking it on the chin with one of the heaviest economic blows that we have ever seen, and we are still in the early stages at this point. We simply don't know how long it will last, or whether there will be a second wave and a second shutdown, as China appears to currently be experiencing in at least some provinces. Japan is also experiencing a second wave after good control with the first wave, and it is taking bigger measures to contain this second wave.
It is also worth noting as seen in the secular bear stock markets of the early 1900s, the 1930s and the 1970s - both recessions and bear market downturns can occur in waves as well. Setting aside the specifics of pandemics occurring in waves (the second wave of the Spanish flu pandemic was by far the worst), new lows in secular bear markets could almost be called the rule rather than the exception, when new bottoms are set in waves that can occur years apart.
We can very much hope for a fast recovery, and I very much do. But, the idea that history shows that we can treat this as a reliable buying opportunity with a bounce back in the next few years - is based on an almost complete misunderstanding of actual financial history.
Consistent & Long Term Cycles, Not One-Off Front End Events
Particularly for someone who is retired or near retirement at this stage - if we are indeed entering a secular bear market for stocks, then instead of being a short term deviation, the current bear market and recession could become dominant events over an entire retirement. Now, that doesn't mean "end of the world" or "doom & gloom", but for many people this could be a very good time for a complete reassessment of assumptions and planning.
The above graph is from Chapter 19 (link here), and it shows the rolling advantages to investing in stocks or gold on a two year, inflation-adjusted price basis. The yellow areas are advantage to gold, the green areas are advantage to stocks.
Two particular items to note: during the horrific time for stocks during the 1970s as covered in this analysis, look at the spectacular height of the spikes upwards for the contracyclical asset class of gold. Then examine the yellow area in the 2000 to 2012 era, and the twin stock market blows of the collapse of the tech stock bubble and the financial crisis of 2008.
Whether someone was in stocks or gold was of extraordinary importance during each secular bear market in stocks, and each secular bear market in gold.
What is even more important as covered in the linked analysis, is the consistency of the advantages. Those are rolling two year comparisons, so the initial advantage to gold over stocks is gone within two years of the first start of the bear market. Yet, the rolling ongoing advantage of gold over stocks just rolls on and on, as the secular bull market of contracyclical asset of gold continues year after year, even as the secular bear market for stocks rolls on year after year.
What history clearly and convincingly shows us is that when a turn occurs - it isn't just the front-end surprise and transition that matters. The great majority of the relative advantage of gold to stocks in the yellow graph area occurs long after the initial shock and change, just as the great majority of the rolling relative advantage of stocks to gold in the green area just goes and goes. These are long term relationships, the front end just sets the stage.
So, when we look at the advantage of being in gold over stocks on an inflation-adjusted price basis, most of the 12 to 1 advantage of the 1970s occurred years after the initial stock bear market. Even as most of the cumulative 325 to 1 advantage over the first 30 years, for those who pivoted from gold to stocks in 1980, was accrued long after 1980.
One way of adapting to a potential secular bear market in stocks is to go all in - sell all stocks, buy all gold, and patiently buy and hold for many years, before trying to identify the next secular bull market in stocks. What history shows us is that if someone had done that successfully over the last 50 years - they would have done spectacularly well.
But that said - there is no need to do anything that radical. All we have to do is recognize the compelling historical relationship between the contracyclical assets, allow for the reasonable possibility that we are entering a secular bear market in stocks that could dominate the next ten or more years - and consider whether we are set up for that? (An alternative way of asking the question is whether someone is so sure that we are not entering a long term bear market for stocks that they are willing to bet their standard of living and security in retirement upon it?)
How many retirement strategies are set up to handle a true secular bear market for equities, where stock prices could be lower in inflation-adjusted terms in ten years than they are today? This is a fascinating question because the usual answer is to simply assume the possibility away, as in reasonable people don't think that.
However, what actual history (which can be a very different thing from prevailing market paradigms) shows us, as captured in the green and yellow graph above, is that more than 40% of the last 50 years were secular cycles of relatively poor performance for stock prices on an inflation-adjusted price basis, where gold did better on a relative basis, year after year after year.
If that perspective can be accepted at all - what actually happened - then there is a strong case not for panicking, not for necessarily selling all stocks, but to step back on a very deliberate basis and reassess. If there is a reasonably strong possibility but not yet a certainty that there could be a third round of a secular bear market in stocks, are there ways of significantly reducing risks while hopefully still generating substantial profits on an inflation-adjusted basis over the years?
Once the contracyclical relationship is accepted, then three risk-controlled methods of improving returns are 1) using simple annual averages rebalancing techniques that are asset neutral (50% stocks / 50% gold); 2) using tilted (not 50/50) contracyclical ratio strategies to seek gains in the favored class while using the insurance component of the contracyclical asset to greatly reduce asset choice and timing risks, and 3) using secular rebalancing techniques for tilted or neutral contracyclical ratios that improve returns and reduce asset choice risks while neutralizing timing risks.
As can be seen in the purple bar in the graph above (explanation in the analysis link here), just going to a basic 50/50 ratio of the contracyclical assets with annual averages rebalancing would have over the 50 years studied increased total inflation-adjusted price returns by about 50% over either of the individual asset classes of stocks or gold. Sticking to a market neutral 50/50 ratio but going to a more sophisticated rebalancing method specifically designed to benefit from secular cycles for contracyclical assets, would have led to an almost 150% advantage over either underlying asset class on an inflation-adjusted price basis, as can be seen with the blue bar on the right.
A Third Cycle Of Crisis & The Attempted Containment Of Crisis
Will there be a secular bear market? Based on normal history - the answer is probably yes. However, we are not in normal times, nor have we been for some time.
As introduced in Chapter 1 (link here) and developed at length in later chapters, the Federal Reserve's extraordinary and increasing interventions did indeed contain the previous two cycles of crisis. The Federal Reserve followed what could be called a "playbook" in containing the two previous crises - and as anticipated, it is doing the same on an amplified basis with the current crisis.
Four distinct elements that I developed in a series of analyses and chapters well before the Coronavirus pandemic, were to expect when a new recession hit (from any source) a 1-2-3-4 of 1) zero percent interest rates; 2) massive new monetary creation by the Federal Reserve; 3) record long bond prices and profits; and 4) record new deficits, to try to limit the market and economic damage from new recession.
That is exactly what has been happening. The Federal Reserve is following the anticipated playbook, using extraordinary tools to try to contain recession and market damage. The U.S. government is doing the same.
The plunge in the stock market was at least temporarily contained - but it wasn't anything "natural" or something to be expected from a long term study of economic history or stock market history. The markets were very specifically reacting to the forcing rates to zero percent, the announcement of unprecedented monetary creation by the Federal Reserve, and the announcement of unprecedented deficits and stimulus spending by the U.S. government (that are ultimately likely to be funded by Fed monetary creation).
There is no long term stock market history for the Federal Reserve creating money by the trillions to try to contain a crisis - that never happened before 2008. We have no precedent for massive government stimulus spending that is itself funded by central bank monetary creation successfully overriding the economic cycle.
However, it is this actual and promised monetary creation funding of both the Fed's massive interventions, and the government stimulus spending as part of an attempted 3rd cycle of the containment of crisis, that has been actually dominating the markets.
This is all an experiment. The coronavirus pandemic itself was a wild card, but for those who have been paying attention, as explored in advance in the free book, we have known that this extraordinary experiment that would ultimately determine retirement investment results for the nation was on the way.
What is likely to determine whether the stock market goes into a secular bear market or not is the battle between two titanic and unprecedented forces: the recession (or depression) produced by shutdowns associated with the attempted medical containment of the spread of the coronavirus, and the attempted containment of the associated economic and market damage.
There is nothing natural about that battle between two unprecedented containment efforts, one medical and one economic.
If we do recover and rebound within the next 1-3 years - it will be because the extraordinary interventions funded by unprecedented degrees of rapid monetary creation succeed. If so, then as developed at length in the free book, we could indeed eventually see the highest stock, bond and real estate prices to date, not in spite of the coronavirus, but as an eventual result of the extraordinary interventions used to contain the economic damage.
If this unprecedented attempted containment of economic damage fails - perhaps as a result of a potential future breakdown of the containment of the coronavirus and a second wave - then there is a very strong possibility of another secular bear market in stocks, perhaps like the 70% inflation-adjusted loss that was experienced between 1968 and 1982, or perhaps even worse. It should also be noted that using monetary creation to fund massive government spending as the primary tool to contain crisis is a truly incendiary combination for creating inflation potentially worse than the 1970s, if it eventually turns out not to work after all.
We can't know which will prevail at this time. But we can recognize what forces are in play, and watch them carefully, while assessing what the implications are and how this may change our choices. Hopefully this analysis has been helpful for you in that regard.
Curious about what could happen if the CB is allowed to buy up all of the beer virus debt, which is forgivable, and then is pushed over the cliff and dropped like a boulder and then metals are made King again.