Gualfin (“End of the Road”), Argentina

Dear Diary,

First, this flash update. The Dow lost 142 points yesterday, which, in today’s volatile market, is no big deal.

Nevertheless, our proprietary short-term stock market indicator has turned starkly negative, as shown below:

Yes, the near-term outlook is darkening. Our model suggests a MINUS 6.4% return from the stock market over the next 94 days. Take warning.

As to the long-term outlook

The Longest, Deepest Depression in US History

Yesterday’s good news was that there will be no 25-year recession. “We should be so lucky,” is the way a New Yorker might react. Because the bad news is much worse.

The logic of the “long depression” is simple. Aging populations, debt, zombification – all of which slow growth.

How many old people and zombies do you need before an economy comes to a halt?

Nobody knows. But the drag from debt is observable and calculable.

Over the last three decades, approximately $33 trillion in excess debt has been contracted – above and beyond the traditional ratio to income – in America alone. And growth rates have fallen in half.

That’s because dollars that would otherwise support current spending are instead used to pay for past spending. Our old debts have to be retired with current income.

The money doesn’t disappear, of course. Some goes to creditors who spend it. Some comes back as capital investment, which is a form of spending. But as credit shrinks, generally, so does the economy.

And that brings us to the impossible situation we’re in now.

In order to get back to a healthy ratio – say approximately $1.50 worth of debt for every $1 in income – you’d need to erase all that excess that has already been contracted. In other words, you’d have to take $1 trillion out of the consumer economy every year for the next 33 years.

It would be the longest and deepest depression in US history.

A Credit Crisis, Complete with Howling, Whining, Finger-Pointing

Take a trillion out of the US economy and you have a 4% decline in GDP. Then, as the economy declines, the remaining debt burden becomes even heavier.

Try to pay down debt and it becomes harder and harder to pay down. You stop buying in order to save money. Your local merchants lose sales. Then they try to cut expenses, and you lose your job.

In other words, no “steady state slump” is possible.

When the credit cycle turns, it will not be a gentle slope, but a catastrophic cliff… a credit crisis, complete with howling, whining, finger-pointing… and more clumsy rescue efforts from the feds.

As we said yesterday, there are two solutions to a debt crisis. Inflation or deflation.

Central banks can cause asset price inflation. But it is not always as easy as it looks. Consumer price inflation requires the willing cooperation of households.

With little borrowing and spending from the household sector, credit remains in the banks and the financial sector. Asset prices soar. Consumer prices barely move.

US consumer price inflation over the last 12 months, for example, was approximately zero.

The assumption behind the “long depression” hypothesis is that central banks cannot or will not be able to cause an acceptable or desirable level of consumer price inflation. As a result, the economy will be stuck with low inflation, low (sometimes negative) growth and low bond yields.

But what about deflation? If inflation won’t reduce debt, why not let deflation do the job?

More tomorrow

Regards,

Signature

Bill


 

Market Insight:

A Question About “Buy Up To” Prices

by Chris Hunter, Editor-in-Chief, Bonner & Partners

Publisher’s Note: Market Insight editor Chris Hunter is on vacation this week. In the meantime, we’d like to share a particularly interesting question about “buy up to” prices from one of Braden Copeland’s Building Wealth subscribers. The following is excerpted from the most recent Building Wealth Q&A, which is published the fourth Thursday of every month.

*** Subscriber Edad A. writes in:

Hi Braden, My name is Edad, emailing you from England. I love reading your reports and updates. A quick question for you: If a stock goes slightly above the recommended price, would you still recommend people buy it if it has potential long-term growth? For example, using Jack Henry & Associates as an example: It’s gone up 25% since you recommended it. Would you still recommend people buy it or is it too late?

Look forward to your response.

Kindest regards, Edad A.

Braden’s comment: Greetings over in England, Edad. I’m glad to know you are enjoying the reports and updates.

A few days after you wrote in, I addressed the idea of paying up a little for Jack Henry & Associates (NASDAQ:JKHY), or any stock, in my April portfolio review. Here is what I wrote (emphasis added):

JKHY already has been successful for us. And I expect the success to continue. Currently, its shares, near $70, are trading above the “buy up to” price of $63. This translates into an EV/EBITDA ratio of 12 for the stock, using a trailing 12-month EBITDA of $428.7 million and 81.6 million shares outstanding. (Multiply 12 by $428.7 and divide by 81.6 to get to the $63.)

EV is short for “Enterprise Value.” This is the total debt of the company less any cash, plus the market value, or market cap, of the stock (its price multiplied by the number of shares outstanding). Think of the EV as the price you’d pay to buy all of the shares of a company and pay off its debts. JKHY, by the way, has essentially zero debt. EBITDA is short for earnings before interest, taxes, debt service and amortization.

For JKHY, a price that translates into an EV/EBITDA ratio of 12, as I explained in the issue last year, is a reasonable price to pay. You don’t want to pay much more. Remember, no matter how good the business, if you pay too much for its stock, you could end up making a terrible investment.

As JKHY’s EBITDA continues to increase in the coming quarters, which I expect, I’ll continue to raise the “buy up to” price. Meantime, if you don’t own JKHY, sit tight. And, by all means, should JKHY stock drop below $63 in a broad market sell-off… buy it!

I keep my eye on “buy up to” prices for all of our positions and raise them as business conditions warrant. What I don’t do, though, is raise them as market conditions warrant. In other words, I don’t raise the “buy up to” prices just because the market is pushing the price of shares higher after we’re in. That’s just a really good recipe for us to get burned.

If you find this frustrating, you’re not alone. Playing this game of investing right requires patience and a bit of wise discretion. Few market participants are long on these traits. Of course, this is why few market participants are long on realizing lasting gains either.

Stay the course, Edad. Rest assured we’ll get there.