The 2000s were a pretty good decade for Bears. The Standard and Poor’s 500 Index is down 24% in nominal terms from December 1999 or approximately 30% when dividends and inflation are taken into account. Four of the years were Bear triumphs – 2000, 2001, 2002, and 2008. It’s the best Bear decade since the 1930s (which had five Bear years) though only relatively high dividend yields pulled the inflationary 1970s above it in real terms. Nevertheless, as the calendar stands ready to flip another digit, it seems a priori unlikely that the Bears could achieve two winning decades in a row – after all that has never happened in the history of the New York Stock Exchange. However, to a suitably Bearish prognosticator the 2010s may be ready to set this new record.
In one of the earliest of these columns, on December 27, 2000, I remarked that the 1990s had been a terrible decade for Bears, with only one Bear victory (a feeble 4% drop in the S&P500 index) followed by a string of nine successive enervating defeats. I did however suggest that 2000 was a modest Bear victory and, given the altitude of the market, others would undoubtedly follow. Indeed I called for 2001 to be a “Super Bowl for Bears” defined as a year in which the index declined 25%. There had at that stage only been one such since 1950 (in 1974). In the event my Super Bowl prognostication missed being borne out – I had to wait until 2008 for that Bear triumph, although in 2008 it was achieved with quite a lot to spare, the index ending the year down 37%.
In 2000, I also recognized that a major sea-change was at hand in the US economy. In a piece on Sewell Avery, the former CEO of the just-bankrupt Montgomery Ward who had been famous for refusing to expand after World War II because the Great Depression might return, I wrote “Sewell Avery was right. Just 46 years too early”—he had been forced into retirement in 1954, at the age of 82.
The following year, in an E-Christmas Carol, the Ghost of Christmas Yet to Come showed Scrooge a grim vision of 2024, in which two decades of recession had ensued, and the Dow Jones Industrial Index closed 2024 below its level in December 1999.
In the middle years of this decade, these two prognostications would have seemed the purest fantasy, as the US economy appeared to grow well beyond its 2000 level and the stock market soared into new uplands. In 2008, we were not so sure. Actually, in December of that year I found the general atmosphere so suicidal that I ventured on a little uplift, suggesting that the recession would be over by mid 2009 and that at least a modest stock market boomlet seemed likely. I also forecast however that inflation would be running at 10% by June 2010, a prediction which currently seems a little premature.
I think there’s little question that something has changed in the US economy, for the worse. Two questions do however remain: when it changed, and whether the economic unpleasantness is permanent.
The general view appears to be that the adverse change in the US economy happened in 2007-08, and was caused largely by greed on Wall Street, although some add ineptitude in the government and the Fed to the list of causes. I think that’s wrong. I believe I was correct in December 2000 when I intuited that a Sewell Avery world of slow if any growth and considerable economic difficulty was returning. The consumption and housing bubbles of 2002-07 merely severed to disguise this problem. Looking back from 2009, when investors have lost money over the last decade and unemployment is at 10% (and at 16.7% on its broadest definition) it is clear that the entire decade of the 2000s has been economically a miserable period in the US (though not in many other countries, particularly China and India — we should never forget that.)
Monetarists like myself will argue that the deterioration in US economic performance owed a lot to the monetary distortions engineered by Alan Greenspan and Ben Bernanke, and that those distortions can be traced back to a Greenspan Humphrey-Hawkins testimony to Congress in February 1995, at which he announced, elliptically as always, that he was embarking on a program of faster monetary growth. The succession of bubbles, in stocks, housing and now commodities, and the relentless decrease in emerging market capital costs, causing an astonishing boom in those countries and a corresponding drain of US manufacturing to them, all began with that fateful decision.
Turning now to the future, it seems pretty clear that the unpleasant changes in the US economy have not yet finished playing themselves out. In particular, the following further nasty things seem likely to happen:
First, the unwinding of the current monetary stimulus will cause all kinds of trouble, and take several years. The excess reserves in US banks now total over $1.2 trillion, and at some stage the banks will want to do something stupid with that money. Since the Bernanke Fed is incapable of raising interest rates to proper levels except at gunpoint, we’re likely to see inflation embed itself in the US economy at worrying levels before Fed policy even begins to remove it. As a corollary, commodity and energy prices will be allowed to rise to levels that provide huge windfalls to some of the world’s nastiest regimes, impoverishing the American people (and the hard-working British, European, Chinese, Indian and other people who don’t live off unearned commodity income).
Second, the unwinding of the current fiscal stimulus will also take several years, and will involve an equally unpleasant process. The US economy has never been subjected to budget deficits of 10% of Gross Domestic Product in peacetime, and there’s no reason to suppose it will benefit from them. Further, the current President and Congress have policy ambitions that will permanently increase the presence of government in the US economy, lowering its long-term growth rate and making it uncompetitive against less overburdened polities.
As country after country in Europe has shown over the past 40 years, sharp increase in government’s share of the economy depress growth rates both short-term, as government sucks resources out of the productive sector and long-term, as the size of the productive sector in relation to the economy is permanently decreased. What’s more, the US government at all levels is far more corrupt than that of Germany or Scandinavia, for example, so its drag on resources will be correspondingly greater.
Third, the drainage of economic activity that was in any case bound to happen as the Internet and modern telecommunications reduced by an order of magnitude the costs of manufacturing in a location distant from the market, has been exacerbated by a decade and a half of super-low interest rates and bubbly global stock markets. That has sped the transfer of economic activity to low wage countries. It has also almost certainly made US wage levels very uncompetitive on a global basis, probably by as much as 25-30%.
Fourth, through fifteen years in which rent seeking was encouraged, the US and British financial systems have developed oversized trading operations that are largely parasitic on the economy as a whole. That will eventually correct itself, or if necessary be corrected by legislation, but its correction will itself impose costs on the system.
Finally, US corporate earnings appear to have peaked in 2006, and have declined substantially since. The stock market at its current levels is pricing stocks as though earnings will quickly return to and surpass 2006 levels. That is very unlikely, since those levels represented a record share of profits in GDP. It is much more likely that earnings will revert closer to their average historic levels in terms of GDP, in which case the stock market will inevitably fall.
For the above reasons, the stock market is likely to be in difficulty for at least the next 5-7 years. Were the question whether at the end of 2014 stocks would be lower than today, one could be pretty sure that the answer would be yes, probably by a considerable margin. By 2019 the position is a little less clear, because with good policy and a following wind the US economy could by then have re-emerged into a period of substantial economic growth.
However, looking at the pattern after 1929, the last comparable point of market overvaluation to 1999-2000, one can postulate that by 2019 the stock market will still be in the doldrums, lower than today. In 1949 the US economy was in a healthy state, having shown considerable growth for several years after World War II. Output was far above 1929 levels in terms of real GDP and real GDP per capita, and was embarking on a period of unprecedented growth in productivity and living standards. Yet the stock market was still in the doldrums, with the Dow Jones index at the end of 1949 at 200, 55% of its 1929 peak and with price-earnings ratios at record low levels, as neither institutional nor retail investors had any confidence in stocks.
If we are optimistic, we can imagine that in December 2019 the stock market will still be lower than today, but that the US economy will already be in good shape, while the market itself will be poised to embark on two decades of a roaring bull market.
But meanwhile, the next decade still looks like a good one for the Bears.
(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that, in the long ’90s boom, the proportion of “sell” recommendations put out by Wall Street houses declined from 9 percent of all research reports to 1 percent and has only modestly rebounded since. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)