It was a time of prosperity, or so it seemed.
There was plenty of money around. People had the latest gadgets, went on long vacations and had flashy new cars.
It was also a time of debt. Credit was easy to access.
And then came the crash…
The Fed decreased interest rates and started money printing. It created a boom in asset prices.
But while asset prices were rising, wages weren’t.
It started to create a wedge between the haves and the have nots.
While the above may look a lot like the last decade, I am actually describing the Roaring Twenties and ‘30s. These are almost 100 years apart, but there are a lot of similarities between the two periods.
History doesn’t repeat itself but it often rhymes said Mark Twain.
The ‘30s ended in a devastating world war, something most didn’t expect. The same way many didn’t anticipate the massive crash of 1929.
There is the tendency to project the present into the future when making decisions. The propensity to think that recent events are likely to repeat themselves.
In other words, that things won’t change.
I read something very interesting on this this week from Ray Dalio, founder of hedge fund Bridgewater Associates.
He wrote about ‘paradigm shifts’. Paradigms are a length of period in which markets work in a certain way. They seem to happen more or less in decades.
People get used to this. So much so that they think it will never change.
But this leads to excesses, which becomes unsustainable.
And, as Dalio said here is where the danger lies in:
‘At the end of each decade, most investors expected the next decade to be similar to the prior decade, but because of the previously described process of excesses leading to excesses and undulations, the subsequent decades were more opposite than similar to the ones that preceded them. As a result, market movements due to these paradigm shifts typically were very large and unexpected and caused great shifts in wealth […]
‘In paradigm shifts, most people get caught overextended doing something overly popular and get really hurt.’
These paradigm shifts can be real wealth killers.
According to Dalio, the last paradigm shift was in 2008.
Since then, the last decade has been one of extremes.
One of lows: Low inflation…low interest rates…low wage growth…low volatility.
And record highs…
High asset prices…high debt…high risk.
A great time for investors, and a bad time for savers.
We have seen asset inflation, which increases inequality. And growth, or rather fake growth.
If you have any doubts about how bogus this growth has been let me show you something else from Dalio’s post.
The graph below shows how the US stock market could look like if there hadn’t been so much stimulus.
The blue line shows the actual evolution of the US stock market till today.
The red line shows you what it would have looked like without low interest rates. The amber line shows where it would be assuming there had been no margin expansions, the grey no tax cuts and the dotted blue line without any share buybacks, which prop up share prices.
|Source: Ray Dalio Linked In|
The blue dotted line is where Bridgewater assumes the US stock market would be today if there hadn’t been so much intervention. Quite a distance below from the blue solid line…
Lower Interest Rates and More Stimuli
The US Federal Reserve is meeting next week, and it is widely expected they will be lowering interest rates, even though the economy is supposedly doing well…
The European Central Bank is also looking at more stimuli.
And in Australia, the Reserve Bank is talking about expecting an ‘extended period of low interest rates’.
There is the assumption that with interest rate cuts we will continue to see the same story play out.
That is, lower interest rates, and higher asset prices. And they probably will for a while. Yet the question is, how much longer?
These stimuli become less effective with time.
We are already seeing that with housing here in Australia.
A binge on debt has increased property prices. So much so that asset prices have become detached from salaries. Even with the recent falls property prices still look high.
And with the stagnant salaries and a dim outlook for the future there is less incentive to get in.
We are quickly reaching the end of the line with low rates and this ‘paradigm’. It could be why gold is starting to move. You can read more about it here.
What happens next?
What will happen with these massive amounts of debt?
Will inflation edge higher or will we see deflation? Deflation is starting to look more likely to me.
But no one really knows.
Things are changing. And I get it, change can be daunting.
Yet getting ready for change will be imperative in preserving your wealth.
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