The Dow fell 26 points on Friday. Gold rose a few bucks. Nothing important.
After a good fright two weeks ago, investors in US stocks are comfortable again. They’ve learned their lesson: Whenever the stock market goes down, 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 the late 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 stabilize 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 labor 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, not to worry: Janet Yellen has their backs.
We bring this up because an end to the de-leveraging 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 six 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. US corporate earnings 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. And it has tried ZIRP. Now what? Nominal rates can’t go below zero. And QE isn’t exactly causing consumer price inflation to take off.
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!
How about demographics?
Ooh 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. That P/Es go down – at least according to the studies – is 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 percentage points… 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.
What Last Week’s Big Renminbi Move Means for China Bulls
From the desk of Chris Hunter, Editor-in-Chief, Bonner & Partners
While Bill contemplates the future of US stock market investors… we continue to look further afield to the emerging markets, where both Bill and I are bullish over the long term.
Much of the fate of the emerging markets rests on China. And although the Chinese stock market is tempting from a value perspective, worrying signs of a slowdown there continue to emerge.
First, a word on the value picture.
At writing, the Chinese stock market trades on a trailing P/E of 6.6 and a dividend yield of 3.1% versus a trailing P/E of 17.9 and a dividend yield of 2.3% for the S&P 500.
That’s a steep discount. And it definitely puts the Middle Kingdom on our value radar.
The question is how deserved it is, based on what may be coming down the pike in terms of economic growth.
The following chart shows the big spike in the renminbi versus the dollar this month.
During the last three trading sessions of last week, the renminbi dropped by about 1.3% versus the buck – its biggest three-day fall since 2011. And the Chinese currency is now 0.6% weaker versus the dollar than it was at the start of the year.
This may seem like small beer… especially given the wild swings in other emerging market currencies, such as the Argentine peso. But a move of this magnitude in the carefully managed renminbi is highly unusual.
It’s no coincidence that last week, HSBC’s so-called “flash index” of manufacturing activity fell to its lowest level in seven months – a big depreciation in the renminbi provides support for China’s exporters.
Most investors think a rise in the renminbi versus the dollar is a one-way bet. That’s because China needs a stronger currency to encourage domestic consumption… part of its big plan to rebalance the economy away from cheap exports and toward higher domestic spending.
Last week’s big move in the renminbi signals that this transition may prove more fraught than the China bulls would like to believe. Chinese stocks may get even cheaper still, before they start to close out their discount to the S&P 500.