The topic for our debate is ‘Will the US share market suffer a 70% correction (or more) in the near term?’
The negative team — Greg — stated in the 14 January 2021 issue of The Rum Rebellion:
‘Vern Gowdie has been regaling you with stories of fear and loathing about the stock market’s ridiculous valuation.’
The affirmative team — me — offers this rebuttal to that statement…
I have been warning you with facts and logic about the stock market’s ridiculous valuation.
In support of my ‘facts and logic’ claim, I offer you this table from Crescat Capital.
15 different valuation metrics, have the S&P 500 Index redlining in the HISTORICAL percentile:
Source: Crescat Capital
Are the valuation metrics — based on almost 150 years of US market history — regaling us with a story of ‘fear and loathing’ OR sounding a warning based on ‘fact and logic’?
If this valuation dashboard had only two, three or even six of the metrics flashing red, then I concede a compelling case for fear and loathing could be made.
The outcome will be unlike any other…
But all 15 metrics signalling dangerous conditions ahead? Well, I’ll let you decide.
Madam Chairperson, as the first (second and last) speaker for the affirmative side, I’d like to outline the facts and logic supporting my case for why the situation we face today is unlike anything we’ve experienced in our lifetimes.
Therefore, it’s my contention, the outcome is probably going to be unlike anything we’ve ever encountered before.
- Interest rates — the go-to weapon of central banks — are close to zero or negative. Prior to the tech wreck, US rates were 6.5% and before the GFC, 5.0%. What’s left to fight the next recession/depression? Negative rates? These have not worked in Europe or Japan. In fact, sub-zero rates have been detrimental to the banking sector.
- Valuations — all 15 of them — are at or almost at historic extremes. Can they push higher? Absolutely. But how much higher? And, unless the laws of gravity have been rendered obsolete, it’s worth remembering the old saying…the higher you climb, the harder you fall.
- Global debt (the driver of economic growth over the past four decades) is at a record high…and with each passing day, continues to climb. Can this continue? Yes. But history again is unequivocal…800 years of recorded debt bubbles ALWAYS end with a debt crisis. The pattern never fails.
- Central banks are going to print money in an attempt to inflate away the debt. True. But will they succeed? Maybe. But what happens if household/corporate/sovereign defaults and debt restructurings begin in earnest before inflation arrives? Confidence (along with a serious amount of money) will be lost. And a society lacking confidence spends and saves differently to one brimming with self-assurance.
- The ease with which US corporate debt has been obtained in recent years has eroded the credit quality of bond offerings. Zombie companies (around 20% globally) continue tapping yield-starved investors to stay alive. The pyramid of global debt is getting higher on a crumbling base. Perhaps, this new world of financial engineering can prevent what civil engineers cannot…the collapse of a structure built on deteriorating foundations. If they can’t, then the zombies become corpses…meaning investors in these corporate cadavers have invested ‘dead money’.
- The (so far) irrefutable law of markets is ‘high valuations equal low future returns’ and ‘low valuations equal high future returns’. The evidence supporting this law is in the following chart:
Source: Advisor Perspectives
- The lower the Cyclically Adjusted PE (CAPE or Shiller) ratio (horizontal index), the higher the actual 10-year rate of return. The current CAPE ratio is…34.4x. If the forecasting model remains somewhat accurate, then, over the next decade, the S&P 500 might return 2% per annum plus dividends. The unknown is how will that 2% per annum over the next decade be achieved?…will it be from…a 70% fall followed by a 240% recovery OR a further 50% gain followed by a 30% fall?
- The ongoing impact of COVID-19 has weakened underlying global economic conditions. The longer the disruption, the greater the damage. How long before pre-COVID-19 activity resumes? GDP growth numbers based on handing out stimulus cheques are meaningless. Real economic activity is what ultimately generates real earnings.
Why would this bubb e
- Current US margin debt (borrowing to invest in shares) far exceeds that of previous market peaks in 2000 and 2007. Leveraged faith in the US market has never been higher. Prior episodes of irrational exuberance did not end well. Perhaps, it’ll end differently this time…or, perhaps not.
- The world is older (maybe not wiser) than it was a decade ago. Ageing Western world boomers are moving into a different phase of life. Even in China, the average age is rising. Ageing populations tend not to borrow and spend to the same extent as more youthful demographics.
- Speaking of the Middle Kingdom, according to Ray Dalio (founder of Bridgewater Associates) China is an empire in ascendency. Whereas the US is in the throes of decline.
Source: Ray Dalio
Ray Dalio’s extensive research on the rise and fall of empires, led him to this observation (emphasis added):
‘…going from one extreme to another in a long cycle has been the norm, not the exception—that it is a very rare country in a very rare century that doesn’t have at least one boom/harmonious/prosperous period and one depression/civil war/revolution, so we should expect both.
‘Yet, I saw how most people thought, and still think, that it is implausible that they will experience a period that is more opposite than similar to that which they have experienced.’
Madam Chairperson, we contend that history, in its simplest form, is nothing more than human nature on a very long replay loop. Maybe the US will be one of those very rare countries in a very rare century that after a prolonged boom, does not experience a depression/civil war/revolution.
- The divide between the ‘haves’ and ‘have nots’ is now equal to or greater than that which existed at the end of the Roaring Twenties. That gap was narrowed considerably by…yes, you guessed it…depression and war.
Our rebuttal continues tomorrow when we challenge the affirmative side’s notion of ‘relative’ returns and ‘real’ assets.
But for now, I’ll leave you with this to ponder.
We know (as fact) the previous Fed-engineered bubbles (dotcom and US housing) ended badly…wiping out years of gains.
Why will the current (and arguably, much larger) bubble be spared from the same fate?
Why will it succeed, where the others failed?
Editor, The Rum Rebellion