Sudden Collapse — or Slow, Painful Retreat?
Days yield to weeks, weeks to months, months to years… and we yet await the collapse.
The time of reckoning — as always — is on the knees of the inscrutable gods.
We know only that it will end.
In thundering collapse, blinding blaze of glory — or slow, agonized retreat?
That is the question that creases our brow today… and slumps our shoulders.
U.S. Household Wealth Rises to Record Heights Relative to GDP
The United States presently bounces along within the largest wealth bubble in 75 years — if we stack household wealth against GDP.
That is, if we compare paper wealth with the economic conditions supporting it.
The reasons become quickly apparent…
The United States housing market floats at record heights.
Our minions inform us that median listing prices crested $300,000 last month — a record — and a 7.2% increase from last March.
And after December’s terrible trouncing, the stock market is back to within some 1% of its peak.
Precisely how far has household wealth run out ahead of GDP?
Analyst Jesse Colombo of Real Investment Advice:
U.S. household wealth recently hit a record of 535% of the GDP, while the historic average since 1952 is 384%.
That is, today’s household wealth to GDP ratio rises some 50% above the post-WWII average.
Today’s household wealth-to-GDP ratio exceeds the Himalayan levels during 1999 and 2006 — shortly before two dreadful pummelings:
Colombo, pursuing the trail of logic to its sad but inevitable conclusion:
When U.S. household wealth reaches an extreme relative to the underlying economy or GDP… a mean reversion or a correction is in the cards.
And given the preposterous proportions of today’s ratio…
We expect a “mean reversion or a correction” that could collapse the very walls of Jericho, that could shake and stagger the cosmos.
But not immediately, says Larry Fink, BlackRock CEO.
Should You Prepare for a “Melt-up?”
Markets must first pass through a final glorious phase of extreme incandescence:
“We have a risk of a melt-up, not a meltdown here,” insists this Fink.
We have reckoned about a possible melt-up in the past.
In reminder, a melt-up is that delirious terminal phase of bull markets when stocks burn white-hot — before burning up.
A melt-up obtains once fear gives way… the bears give up… and the crowd gives in.
The same crowd ultimately gives back — grandly, gorgeously, royally.
But what a show while it rages!
Some of the market’s wildest gains occur in melt-up phase.
The stock market nearly doubled in the 18 months prior to October 1929’s infamous “Black Tuesday”
The Nasdaq likewise roared 200% in the 18 months before the dot-com fever peaked in March 2000.
Why is Mr. Fink yelling about a melt-up now?
After all, investors remain hagridden by ongoing trade wars, clamorings of a global slowdown… and recession.
And stocks have yet to recapture their lofty heights from October last.
Record amounts of fretful cash thus sit idle, waiting, watching.
Despite where the markets are in equities, we have not seen money being put to work. We have record amounts of money in cash. We still see outflows in retail, in equities and in institutions.
So again we ask… why a melt-up?
“More Dovish than Ever”
This fellow’s answer:
Because central banks are presently “more dovish than ever.”
Markets will continue rising on their white, peaceful wings.
Investors, fearful of missing out, will return in flocks… and the record amounts of sidelined cash will come hemorrhaging onto Wall Street.
The up-melting will ensue.
But like ancient Icarus who flew too close to the sun, markets will ultimately come crashing earthward, as they did in 1929, 2001… and 2008.
And so you have the case for the melt-up — before the meltdown.
A 25% Loss of Household Wealth
Would today’s record household wealth melt away with a stock market meltdown?
The previous two collapses — in 2001 and 2008 — left household worth roughly 400% of GDP.
Assume a similar carnage.
Thus United States household wealth would plummet some 25% from today’s levels.
If the wreckage exceeded the prior two episodes… household worth would plunge further still.
In which assets might you seek refuge?
Very few, alas.
The Federal Reserve’s low rates have piled investors into the same crowded boats, all packed to suffocation, all growning under the human cargo.
You may attempt to transfer ships — but you would merely be changing ships on a falling tide.
Explains Eugene Steuerle of the Tax Policy Center:
“[Fed policy] means it’s harder today to diversify against a downturn that can hit almost all markets.”
A Slow Motion Collapse?
But must markets collapse so spectacularly to sink investors?
No, says Steuerle:
We’re not off the hook, however, should the bubble fail to burst or should peak valuations decline only gradually… Either way, rates of returns on assets likely will remain significantly lower than in the past, creating its own set of risks [to] investments, especially those dependent upon returns extrapolated naively from the recent past.
This fellow speaks of valuations.
We have recently documented how stock market valuations presently rise to record heights — some 20% above their previous dot-com peaks nearly two decades past.
Valuations also meet or exceed 1929’s airy heights.
Meantime, the underlying economy limps along at perhaps 2% growth. And it may langush at 2% — or lower — for the future that is foreseeable.
So we ask:
Whence cometh the growth to justify today’s infinitely swollen valuations?
It is as if markets expect unbroken strings of lovely bumper crops ahead… but the actual outlook promises drought.
Meantime, Bridgewater Associates warns that stocks may be at or near “peak” profit margins:
We think there is a decent chance that we are at a major turning point for corporate margins, and if that is correct, U.S. equities have a major valuation problem… it will be hard for companies to maintain the current level of profitability over the coming decade, let alone increase the margins further from here.
Without increasing profit margins, concludes Bridgewater, today’s markets would sag 40% beneath present levels.
A 12-year Journey to Nowhere
John Hussman of the eponymous Hussman Investment Trust — a smart cookie — has sweated through the reams of historical data.
His conclusion, based on current valuations?
We’re now looking at “structural” GDP growth of only about 1.6% annually. That’s the real GDP growth we’re likely to observe in the coming years…
At current valuation extremes… [investors’] actual basis of wealth — the likely future stream of cash flows that will be delivered into their hands over time — is the smallest amount, relative to those “paper prices” since the 1929 and 2000 extremes.
Incidentally, Hussman projects the stock market will deliver zero real returns – or negative real returns – over the next 12 years.
That means you may run in place for the next 12 years… or worse.
Can you afford to run in place for the next 12 years, or worse?
Sudden collapse, meltdown after melt-up, 12-years upon the hamster wheel — we do not know how it will end. Or when.
But to reiterate… we know only that it will.
Managing editor, The Daily Reckoning