I was born in 1981.. and then stocks went on an unprecedented 38+ year secular bull market rally. Coincidence? I think not. Let’s look at what this nearly 40 year bull market looks like on a chart.
For most people 60 and under, the chart above represents the only financial landscape they’ve experienced. It’s hard not to be conditioned to be an optimist and perma-bull if this chart is all you know. If you’ve been buying stocks over the past 40 years, especially on the dips, your retirement account is looking very healthy at this point in time. You’ve been rewarded greatly for trusting the system, why should you start to doubt it now?
If you weren’t around for the inflationary turbulence of the 1970’s, hopefully you’re at least aware of it and understand that times do change. Tough times smooth out and recover and good times reverse sooner or later. Every bubble in history has been accompanied by a mantra which more or less goes something like this, “This time it’s different.” If you understand that (and the history of every single bubble (hint: they all pop eventually)) you should see all sorts of red flags going off when you hear so many people buy into the notion that the Fed has created a new norm where bear markets and financial calamities are a thing of the past. Nothing lasts forever but the longer something stays the same, the more complacent people become.. and that complacency is what sows the seeds for the next inevitable paradigm shift.
On the surface it’s hard to complain about where we sit. Stocks just keep going up, inflation (by official government metrics) seems to be under control, and our standard of living is at an all time high. Productivity has been spiking steadily for decades (dating back much further back than 1980) and technology has given us creature comforts a person from 1980 could never imagine. There’s just one problem.. and it’s a big one. We haven’t truly earned all of these accolades and accomplishments, we’ve simple borrowed them from the future and it all has to be paid back in one form or another (plus interest). Explain.
The chart below highlights a major issue that underscores the reality of what’s actually been taking place over the last 40 years, contrary to what the soaring indexes seem to indicate. Despite a raging stock market and a seemingly booming economy, the average U.S. worker has experienced only very minor real wage growth over the past four decades. While stock indexes are up 1,000%+ since 1980, the bottom 90% of U.S. workers are looking at only a 15% increase in real wage growth (as of 2013).
You’ll also notice that during that same period, the top 1% has experienced quite a bit more real wage growth than the bottom 90% have. That seems like it might be important.
Historically a strong stock market correlates with a booming economy, significant real wage growth, and a healthy uptrend in personal savings. It makes sense. A society that makes/sells a lot of stuff -> brings home better wages -> and is able to save more as a result of the surplus. Whether you’re an individual, a family, a business or a government, that logic applies. Produce more than you consume, save the difference, let compound interest work it’s magic and retire comfortably one day. Where are you going with this?
This is what makes our current secular bull market ‘unique’. Not only is it unprecedented in duration, but it also correlates with the exact opposite characteristics that a bull market historically tends to exhibit. As a society the U.S. has been manufacturing and producing less and less, our real wages have stagnated terribly and we’re saving less than ever.. I mean can you blame us? Interests rates are so damn low, why in the world would anyone put any money in savings account? *Light bulb goes on*
So how does a stock market go on a nearly 40 year tear while the underlying economy’s manufacturing and production goes down, real wages stagnate, and the population’s savings decline? The chart above answers all. Interest rates. Setting interest rates is a complex process that historically we’ve let the free market determine, but we’re blessed with something even better than the free market – the Federal Reserve. The chart above shows the Fed Funds Rate dating back to 1980, and the trend is the polar opposite of the stock market. Because that’s how it works. You make it cheaper to borrow money, you lower the incentive to save money (savings accounts pay less), you encourage speculation. To put it another way, the lower interest rates go, the more you encourage borrowing and the less you encourage saving. And this has been the trend since 1980. Steadily making it cheaper to borrow money, steadily buying and propping up asset prices. Those two go hand in hand. Now it’s all making sense.
There are certain immutable laws of nature in the universe and they apply in one form or another to everything, even the stock market. One law has to do with something that is unsustainable in nature – it has to end. It’s unsustainable. We don’t need to do anything other than keeping doing what we’re doing and that will be more than enough to spell it’s demise. In this case, it’s not going to end well. The reason you can’t borrow your way to prosperity is because eventually your debt to income ratio (or debt to GDP ratio in the case of governments) blows up and you can’t service the debt anymore, ie you can’t even pay the minimum interest payments and you damn sure aren’t ever paying off the debt itself.
Here’s one last chart which highlights how the average U.S. citizen has been blessed with a steadily increasing standard of living while their real wages have stagnated. They’ve spent their savings and have borrowed more than ever.
Starting right around the time that the Fed started to hammer interest rates lower, the percentage of personal income saved started to dive while the percentage of debt service to personal income started to climb. The spike in debt service relative to personal income may not seem like a huge spike, but with interest rates falling so dramatically, that percentage would fall dramatically as well if the amount of debt stayed consistent. Lower interest rates means lower monthly payments, so the fact that the debt service percentage actually spiked under those conditions shows you just how how much the amount of debt had to have gone up. Around 2008 that percentage dropped significantly thanks to the Fed lowering interest rates to nearly zero, which in turn lowered rates across the boards, yet in spite of all time low interest rates the debt service percentage still stayed at 10%. Imagine what happens when interest rates start to go up. But but but, the Fed will never let that happen!
While the picture here can either be a duck or a rabbit depending on how you look at it, our markets can’t actually be both healthy/strong and vulnerable/precariously weak. It amazes me that the financial world as a whole can’t see that the 40 year trend in interest rates has everything to do with the booming asset prices (not just stocks but also real estate and bonds) over the same period, or if they can see it they’re not letting on. If you’re in the camp that believes that the Fed can indefinitely hold down interest rates while simultaneously staving off any currency crisis then you’re officially a “This time it’s different.” bubble blower. This time is never different, a bubble is always a bubble, and a low cost of borrowing is the ultimate fuel for speculation.
Let’s try to wrap this up. The inflation scare of the 1970s forced the Fed to raise interest rates to defend the strength of the dollar. The high interest rates resulted in a strong dollar and a strong economy, but it also gave the Fed a lot of ammo to fight off any recessions. As soon as a recession reared it’s head, the Fed reacted by cutting interest rates. *Note to the Fed, recessions are a normal, necessary and perfectly healthy part of the business cycle.* Every time they tried to raise rates back up (once the recession was ‘over’), the rate hikes would tighten up the financial markets and the Fed would panic and cut rates again. Over the years the cycle not only continued but it became exacerbated to the point where the market’s hiccups became more and more extreme and then so did the extent of the rate cuts. This cycle climaxed during the 2008 financial crash and subsequent rate cuts down to near zero. To steal Peter Schiff’s analogy, this is synonymous with a junky requiring more and more heroin for their addiction.
Over the years the booming stock market (and advancements in technology) helped to cover up an otherwise stagnant and slowing economy and the perpetually lower interest rates also made it cheaper for households to borrow more money and live above their means. The Fed’s policies have clearly harmed the bottom 90% by hurting their real wage growth, made it more expensive to buy a home or real estate, discouraged responsible saving and encouraged risky speculating – propping up assets thus immensely benefiting the 1% who own most of those assets, and now have us in quite the pickle.
So here we sit, with a precariously bloated stock market (as well as most asset classes on the planet), massive amounts of debt (personal, state, federal and business), and basically an entire system completely hooked and dependent on low interest rates. Nothing about any of this is either healthy or sustainable. An unsustainable trajectory combined with a complacent population is a recipe for disaster.
For those that believe that this time truly is different, and that the Fed will save us with it’s omnipotence and omniscience, let me remind you of how well they spotted and were prepared for the 2008 great recession and financial crash.
I don’t know how this all plays out, I just know there’s a major problem here. Does the fed try to keep rates low indefinitely ultimately bringing about hyper inflation and a currency crisis as a result or do they defend the dollar by raising rates and sinking asset prices in the process? They’re stuck between a rock and a hard place and whatever their ultimate intentions are, they’re not revealing their hand. They’re still playing up the guise of pretending that they can have it both ways but it’s impossible. However, what I do know is that there is a major paradigm shift coming and things will begin to change immensely as we transition out of this financial landscape we’ve all become conditioned to believe is the new norm.
The game plan for the past 40 years will not work over the next 40 years. Navigating a paradigm shift of this extent requires being aware, alert and observant as well as thinking outside of the box. The Fed will not only fail to alert us to the next financial crisis (maintaining their perfect track record) but they’ll also be entirely responsible for it. The silver lining? Financial paradigm shifts offer golden opportunities for life changing fortunes to be made if you’re on the right side of history. Do you have a plan? I’ve got mine.
Check back for part 2 for some info on how I plan to turn shit into shinola.