Sticking With the Basics
What’s new? Nothing much….
Markets still moving up…
Oil rose $2.50 on Friday…to $69. Gold rose $18 to $953. The Dow was up 18 points. And the dollar fell to $1.42 per euro.
And governments are still doing the wrong thing…trying to increase demand. It’s not possible…for reasons we describe below…
Well, it’s August…and we’re on vacation. But just because we’re on vacation doesn’t mean the world stops turning. It just doesn’t turn quite so fast.
“Why don’t you just stop writing for a while?” our mother asked this morning. She is visiting for the summer.
“I don’t know how you write every day anyway. You must say the same thing…”
Richard Russell has given a Dow Theory bull market signal. When you get a signal, he says, you don’t argue with it; you go with it. Stock prices are going up.
We don’t doubt it. The Dow would have to clime to about 10,300 just to give us a classic 50% bounce.
But we are in a depression. We don’t gamble on stocks in a depression. It’s too risky. Instead, we go with the flow. And the flow over the next 10 years or so is probably going to be down.
By our reckoning the Dow hit its high in January of 2000. Adjusted for inflation it’s been running downhill ever since. Investors have made nothing for their trouble. And if we’re right, they won’t make anything in the years ahead either. Instead, they’ll have to wait until stocks are cheap again.
You know, dear reader…investing is really very simple. Buy low. Sell high.
Okay…now that we got that figured out…let’s move on…
Sticking with the basics, what we notice is that stocks, bonds and commodities move in broad patterns that last for many years. Not to put too fine a point on it, but they go up and then they go down. Or vice versa. Just looking at the last 50 years, stocks were very expensive in 1966. Then, they dilly dallied around for a couple of years…and headed down. This bear market continued until August 1982. That was when BusinessWeek magazine declared that stocks were not merely ailing, they were dead: “The Death of Equities” was the cover story that month. Naturally, equities got up from their deathbed the very next month and entered the marathon. They ran for the next 18 years.
Well, you know the rest of the story as well as we do. It’s not complicated. The problem is that it takes patience to see it…to understand it…and to take advantage of it. The way to make money in stocks is to buy them when they are very cheap. But you may have to wait for 15-20 years. They’re not cheap towards the end of the bull cycle. Since you never know exactly when it’s going to end you don’t want to buy anywhere near the top. So you wait…and then stocks keep getting more and more expensive. Finally, the top arrives…and then you have to wait another decade or more until they reach bottom.
“Well, why don’t your write The Daily Reckoning once every 20 years?” mother wanted to know. “Just tell them when to buy…wait 20 years…and then tell them when to sell.”
But we’re going to ignore our dear, sweet momma this morning. She just doesn’t understand the complexity of the financial world!
For the last nine years, stocks have been going down (albeit with a major countertrend to the upside). We’ll probably have to wait another few years before they are cheap enough to buy. And when the end comes, stocks will be very cheap – between 5 to 8 times earnings.
When will that day come? Probably around August 15, 2018. Don’t forget to read The Daily Reckoning that day!
Stock market cycles tend to coincide, more or less, with broad trends in the credit cycle. When people borrow and spend it causes business profits to grow. The businesses then expand; they hire more people; they build more capacity.
Then, when the credit cycle turns, everything goes in the other direction. People stop borrowing and begin paying back. Sales decline. Unemployment grows. Profits fall. Credit contracts.
We are now in the early stages of a major credit contraction. This is not a pause in a credit expansion; it is a change of direction, a credit contraction with all that goes along with it – joblessness, bankruptcies, foreclosures, and so forth.
Bloomberg tells us that the numbers have already been revised – downward. “Worst recession since the Great Depression,” says its headline.
It is the worst recession since the Great Depression because it’s not a recession at all; it’s a depression. And the government is doing its level best to make it a great one.
The key to understanding a depression – or the downswing of the credit cycle – is that demand contracts. Consumers have less to spend. For a very simple reason: they already spent it.
Listen up, because this is important. When you borrow in order to consume, what you are really doing is consuming something today that you would have normally consumed in the future. You spend money you haven’t earned yet on something you’re not really ready to buy. You’ve heard the expression, ‘time is money.’ That’s why borrowing money is really borrowing time. Later, you have to make it up. You have pay off the debt. When you do, you take money out of current consumption; you’ve already consumed it!
This is what economists refer to as “demand destruction.” It’s what happens in a depression. People are replacing what they took from the future. They’re can’t consume because they’ve already spent their money in the last boom. Demand collapses.
We’ve seen that happen in the last two years. Savings rates went from zero to 7%. Sales have declined (the latest revisions show them off more than was previously thought.) Profits are shrinking.
This is, of course, a completely natural and necessary adjustment. You can’t take things from the future without putting them back eventually. The future won’t stand for it. But the feds, in their benighted confusion, fight the problem like a farmer who plows backwards to fool the crows. They think the problem is too little demand. So, they try to add demand…with tax cuts…spending programs…low rates…easy credit…cash for clunkers and other fixes. What do these policies achieve? Do they really increase demand? No, they can’t do that…that would require a richer population with more money to spend. What they try to do is to move demand forward.
The problem, of course, is that too much demand has already been moved forward. But they’re nevertheless trying to steal even more of it…taking away demand that would normally show up two, three, four…ten years from now. That car that you might buy next year, for example. With the ‘cash for clunkers’ program, you might make the purchase now instead of waiting until you actually have the money. Or, that new parking lot behind the town hall. We won’t really need it for a few years, but heck, if they’re giving away money now… Or how about that trip to Europe? With a big tax rebate check, you might decide to take it on your 20th wedding anniversary, rather than wait ’til your 25th.
Real demand increases only when real wages increase. Then, people have more purchasing power. Trying to increase demand by borrowing – or stealing – from the future is a scam at best. Even if it works now, it fails later.
Our gardener, Damien, came over yesterday…carrying a big wheel of cheese and a huge loaf of bread.
“Finally…you are back,” he said.
“Yes, it’s been a long time. But it’s August again…so we’re back…”
We explained how we had followed the annual bicycle migration out of Paris on Friday night. On the last day of July, Parisians load their bicycles on racks behind their cars and head for the country. We followed the bicycles out of town. The highways were jammed…traffic was start and go for hours.
“Look, I was just down in the Auvergne,” Damien continued, “so I brought you some cheese and bread. These are specialties from the region. They’re very good…
“And now that you’re back, let’s celebrate…let’s have a drink. How about some pineau?”
“Sorry Damien,” Elizabeth interrupted. “He’d love to, I’m sure…but he has another engagement. We’re going to the Berry (about 45 minutes East…where Georges Sand lived) to attend a play. Shakespeare…in English.”
“But who’s going to understand it,” Damien wondered. “The French can’t understand Shakespeare…”
“Even native English speakers have a hard time following Shakespeare,” we added.
But there was not time for a drink…we were off to see As You Like It performed at a friends house by an itinerant English group…
And so…the summer vacation begins…
The Daily Reckoning