Ten years ago this week, this column asked: “Will the Tens be another Bear decade?” predicting that the stock market in late 2019 would be lower than in late 2009. Alas, that prediction was complete rubbish. Yet the column’s economic forecast – that the early years of the Tens would be grim, but improvement would come late in the decade – was quite close. The stock market however let the Bears down, making everybody else richer in the process. So, let us repeat the process for the 2020s, perhaps learning from previous mistakes (you never know)!
Defining a Bear year or decade as one in which the major stock indexes declined over the period, the 2000s, leading up to that column, had indeed been a rare Bear decade. It was the first such decade since the 1930s, with the Standard and Poor’s 500 share index down 24%, or 30% including dividends and inflation between January 2000 and December 2009. Even though in late 2009 stocks appeared high by historical standards, it was thus rash to predict that the 2010s would produce another such “winner.” Yet the quality of economic policymaking was so low, the anti-business popular sentiment so strong and asset prices in general still so inflated through over-expansionary monetary policies, that such a prognostication seemed plausible, if by no means certain. As a Bearish column, it is our job to make Bearish prognostications, so we made one.
As I said, the prediction was spectacularly wrong. The Standard and Poor’s 500 Index was up 189% over the decade to December 2019, an excellent return, though not so stellar as the 1990s 316% or the 1980s 227% (both of which returns were far more assisted by inflation, however). Three of the individual years in the 2010s were Bear years in which the index declined, as distinct from four in the 2000s, two in the 1990s and only one in the 1980s.
Given that the lackluster economic performance of the 2010s, and especially the productivity growth, was far below the ebullience of the 1980s and 1990s, this was an excellent, indeed surprising result. Nominal GDP was up 49% during the decade, so the stock market outperformed by 140 points, compared to a 244 point outperformance in the 1990s, a 116 point outperformance in the 1980s and a 72 point underperformance in the 2000s. Overall, the market has been becoming steadily more over-valued; the question is: will this continue?
One possibility would have the 2020s be an economically grim decade, yet the stock market end up ahead, in nominal terms: if inflation takes off. This is not unlikely. The gold price has once again broken above $1,500, and is up 38% on the decade, after a rise of 275% in the previous decade. Despite clever Millennials’ attempts to distract the world with Bitcoin, gold remains the world’s principal measure of price levels and store of value, with the most serious world players, such as the People’s Bank of China, still devoted to its acquisition. Thus, its continued strength must be a warning signal of inflation ahead.
Monetary policy remains marooned in a swamp of negative real interest rates, even negative nominal rates in some countries, with no apparent willingness to restore sanity. Productivity growth therefore remains meagre, an important Bearish indicator. One possible way out of this position, though one wonders endlessly why it is not happening, is for retail price inflation as distinct from asset price inflation, to take off into the stratosphere. Were this to happen, interest rates even though rising would inevitably lag behind prices as they did in the 1970s, and we would have a decade of declining stock prices in real terms even if through inflation they rose in nominal terms.
It behooves this column however to examine other possibilities, and to take nothing for granted. The fact that retail price inflation has not soared since 2010 would seem an indicator that it may not soar in the 2020s – the inexplicable may remain inexplicable but true. Nevertheless, even without inflation, there are several indicators that the decade may be one in which the last 25 years’ economic malfeasance catch up with us.
The most important of these indicators is the appalling level of outstanding debt, in all three categories, consumer, corporate and government. In the third quarter of 2019, U.S. consumer debt was $13.9 trillion, corporate debt of non-financial corporations was $10.1 trillion and public debt $22.7 trillion, a total of $46.7 trillion or 217% of GDP. Ten years earlier, in the third quarter of 2009, that total had been $30.5 trillion, 209% of GDP. In other words, total debt is now higher than near the peak of the worst financial crisis in memory. In the last ten years, only consumers, with debt up 13%, well below than the 49% growth in nominal GDP, have pulled back owing to the restrictions in the home mortgage market. Corporations have become significantly more profligate and governments have gone bananas.
The deterioration of corporate balance sheets, and of corporate operating statistics in other respects, is also highly concerning. The mania for share repurchases, which goose returns for top management holding stock options but do absolutely nothing for anyone else, has gone altogether too far. The case of Boeing (NYSE:BA) which is running a major international business without any book net worth and thus with infinite leverage, is extreme but there are many companies not too far behind. As Boeing is in the process of demonstrating, once a hiccup occurs in the business or the next general recession arrives, such companies are not long for this world. Given the appallingly high costs of major bankruptcies, they will take a lot of the economy into the grave with them. To prevent this getting worse, we should probably revert to the pre-1982 position, in which stock repurchases were effectively banned.
Second, corporate profitability has run at record levels in this decade; this has resulted from global outsourcing, which has reduced costs more than sale prices, from ultra-low interest rates, which has sharply reduced the cost of corporate capital and from short-term-itis in corporate management, which has prioritized short term boosts in profits over long term gains from technological investment. Corporate investment is running at half its level of the 1990s despite high profits, while new company formation is way down on its levels of 40 years ago. These high profits are artificial, and their elimination will hit stock prices and cause endless trouble.
The deep malaise in the corporate sector will emerge into the open in the 2020s, probably via a wave of bankruptcies of major multinational corporations whose capital bases have become inadequate to withstand a downturn. Being big companies with vast teams of lobbyists, they will naturally demand bailouts from the Federal government, but will then discover that Federal borrowing capacity is nothing like as robust as they thought.
For the last 30 years, by the Basel regulations, banks have been managed on the assumption that government debt of OECD governments is wholly without risk, so they have thus been able to leverage it infinitely. This is only profitable if they incur an interest rate mismatch, generally with their assets far longer than their liabilities. The risk to the banks in doing this (since long-term bonds decline when rates rise) has been hidden by two factors: the continual decline in rates, almost without pause, that has taken place since 1981, and the use (and opacity) of vast heavily-traded derivatives portfolios. The assumptions underlying bank risk management were proved to be hopelessly in error in 2007-08; most banks were bailed out then but have not corrected the flaws in their risk management systems. Consequently, the collapse of several major corporations will be followed by the collapse of the global banking system; bailouts will be impossible because there will be no creditworthy entity left to do the bailing.
Beyond the rational risks to the economy and the market outlined above, there are irrational ones. Environmental regulation already went far enough during the Obama administration to have a severe retardant effect on the U.S. economy, while regulation in general appears to be having a similar deadening effect in the EU currently. There are two political trends in particular which could crash the market before 2029. One we can define as Corbynism/Sandersism: the attempt by a truly leftist government in a major country to reintroduce elements of the command economy. The other we can define as Gretaism, after the Swedish teenage climate change activist Greta Thunberg; this would involve introducing climate change regulations so severe that economic progress became impossible. In either of these cases, the steady progress in living standards we have seen since the Industrial Revolution would go into reverse; presumably the stock market would follow.
Whether a full Armageddon of today’s crony capitalism occurs before 2030 is uncertain; I have previously suggested a date as late as 2040. It will however involve a series of foreshocks, some of which will inevitably occur within the next decade. Absent hyperinflation, those foreshocks will make the currently overvalued U.S. stock market trade very much lower at the end of 2029, making the 2020s a true Bear decade like the 2000s.
(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 the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. 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.)