It really baffles me. We know that change is a constant. Yet, we act as if the current constants will never change.
What has been, will continue to be so. But that’s not true. Nothing stays the same.
Golf clubs once brimmed with members. Not anymore. Now the road bike takes pride and place in the garage…while golf bags gather dust.
Things cycle (no pun intended) in and out of our lives. The wheels of change can sometimes turn slowly and it’s only with hindsight you identify the shift in trend.
‘Nothing lasts forever. I think that’s the easiest lesson we all learn the hardest way.’
Why should we have to learn the hard way? Why not open our eyes and minds up to the possibility of there being a change in trend? Complacency. That’s why.
It’s far easier to project the present into the future. Doing so requires little thought or imagination.
Google’s dictionary definition of extrapolation:
‘…the action of estimating or concluding something by assuming that existing trends will continue or a current method will remain applicable.’
Extrapolating past trends into the future assumes ‘something lasts forever’. If the 20th century taught us anything, it’s that nothing last forever. Employment. Education. Family structures. Housing. Banking. Communication. Transportation. Medical. Sport. Attitudes to sexuality.
These facets (and many more) of society are nothing like that of my grandfather’s era. Times change. Nothing stays the same.
In financial markets, the failure to acknowledge the reality of this absolute fact is best captured by the ‘it’s different this time’ mentality.
Investors buy into the belief that an upward trend can continue indefinitely. That, somehow, times won’t change. Yet we know they do. Therein lies the danger of extrapolation. That ill-conceived notion of ‘what has been, will continue to be so’.
At best, this reasoning is faith based, at worst, it’s stupidity borne from arrogance and/or ignorance.
Our future is going to be a product of prevailing conditions
The failure to ask the most basic of questions is why investors are destined to learn the hard way. Have you considered whether the conditions that created the current trend are still in existence today?
Compare the pair…
The dynamics that existed in the 1980s all combined to create the economic and asset market momentum we’ve experienced over the past 40 years.
Those dynamics no longer exist…they’ve changed. Therefore, it stands to reason, our future is going to be a product of prevailing — not past — conditions.
Where to from here? Is the question I’ve been pondering for some time now.
My gut is telling me we’re on the cusp of enormous change and upheaval. There’s nothing scientific about this approach. It’s based on nothing more than the dual premise of everything has its limits and if something cannot continue, then it won’t.
Understanding where we’ve come from, can help us figure out where we might be going to. The 20th century can be divided into two distinct periods, pre and post 1950.
The first half was beset with economic upheaval — panic of 1901; panic of 1907; 1920–21 Depression and the 1930s Great Depression.
There were two world wars. Resulting in the needless slaughter of millions of people.
In spite of these periods of extreme hardship, the spirit of human endeavour prevailed. The seeds of growth — that flourished in the second half of the 20th century — were sown prior to 1950.
The earlier part of the 20th century gave us:
- Mechanisation — greater productivity.
- Medication — improved healthcare.
- Sanitation — lower child mortality rates.
- Population — a fourfold increase from 1.5 billion in 1900 to 6.1 billion in 2000.
- Financialisation — The Federal Reserve was legislated into existence in 1913.
- Education — literacy and numeracy became core subjects.
- Inflation — inflation eroded the buying power of US$1 of in 1900 to around five cents in 2000.
The combination of all these factors was truly transformational. After 1950, economic growth blossomed like never before. More productivity. More consumers. Better living conditions. Higher education standards. Greater access to finance. Business prospered. Government revenues increased. Households felt wealthier.
However, as is the way of life, not everything goes smoothly all the time. The economy faltered badly in the 1970s. It was a particularly difficult decade. Removal of the gold standard. Oil crises. Inflation rising in excess of 13%. Interest rates topping at 18%.
The upheaval in the 1970s, resulted in the low base from which we started in 1980. Proving, once again, that things change.
Taming inflation in the early 1980s resulted in falling interest rates. Cheaper lines of credit began to flow more freely to a generation of eager baby boomer consumers.
Asset values (shares and property) floated much higher on this new tide of seemingly unlimited credit.
The lower rates went, the higher debt levels went. That’s been the trend for so long we think it’s permanent.
Where to from now?
With interest rates at historic lows and lacklustre wage growth, can households continue to accumulate debt at past take-up rates? Unlikely.
The latest data on mortgage stress — and this is before we go into a recession — makes for sobering reading…stress levels keep rising.
Source: Digital Finance Analytics
With hindsight we can clearly identify the conditions that existed in 1980 that set us up for an extended period of growth. Unfortunately you don’t make money with hindsight. You need foresight.
Things were so bad in the late 1970s, BusinessWeek ran this cover in August 1979:
While that cover may seem laughable now — because we know things changed — is it any more laughable than the current mantra of…equities forever?
In early October 1929, Yale economist Irving Fisher made that mistake when he said ‘stock prices have reached what looks like a permanently high plateau’. A few weeks later, things changed for the worse.
The best way I know how to give you foresight is to show you this chart of the US share market’s MAPE (Margin Adjusted PE Ratio). The model takes the Shiller PE 10 and adjusts corporate earnings for a reversion to the mean of profit margins.
It has proved to be a highly accurate predictor of future market returns. Look at the rise in the multiple since the low point of 1980:
Source: Hussman Strategic Advisors
That multiple expansion has been a significant driver in the performance of shares over the past 40 years.
Can that upward trend continue indefinitely or will it change? And if/when it does change, will it be a repeat of 1929?
How people can blithely ignore what’s staring them in the face truly mystifies me. Ironically, it could be because some things actually don’t change…our failure to recognise that nothing lasts forever.