January 2013 issue
A new breed of the “irrational exuberance” once lamented by Alan Greenspan may have taken hold in recent weeks as the S&P rose to multi-year highs last Friday despite so many headwinds that have been evident for years. The bulls are gloating and the bears are licking their wounds. So what is really happening?
To me one thing is clear- investors, citizens, and consumers all seem to agree that our enormous debt levels just don’t matter one bit. Despite all the grumbling and headlines we see each day relating to the exploding deficits, there is no passion on behalf of the American public to reduce government debt or its freebies. The recent agreement reached in the 13th hour near on New Years Day sets forth a plan that allows for only tiny gains in tax revenues but maintains runaway spending and nets us another $4 trillion in deficits in the next few years.
Yet stock markets around the world have rallied because another temporary disaster seemingly has been averted. It seems to me that something quite perverse has taken hold in the psyche of today’s investor. Above all, investors loves debt more than growth or fiscal sanity. They are convinced it’s foolish to bet against a system that rewards deficit spending without limits so they are “all in” with risk and reach for yield like never and to hell with the risk. They seem content to ride each asset bubble, smug in knowing they can just cap hop off the train in time before it crashes. Stock prices are inflating right along with debt levels- but can it last?
I believe the current market sentiment is long on hype and short on wisdom. The prevailing worldview in recent years is that the combined aggregate fiscal and monetary stimulus tools will always be sufficient to overcome any weakness in our economy in the near to intermediate term. Here I disagree strongly because I advocate that under the K-Wave theory that efficiency and dysfunction do matter and by natural law must be remedied through the market forces. But since the global financial crisis the prevailing market sentiment disagrees with this core theorem because their belief is “In the Fed we do trust” above the natural laws of the universe. I am wary of any mantra’s that put money changers ahead of nature so color me skeptical that the Fed can keep this up for much longer. We must keep in mins that since the march 2009 lows the stock rally has added over $10 trillion in wealth but that is exceeded by the increase in fiscal and monetary stimulus over the same period. Ultimately that debt has to be repaid at interest rates likely to be much higher than current rates.
A formidable storm has been brewing for decades relating to global aggregate debt levels that is now approaching a tipping point. Soon it will become evident to investors that the current interest rates for debt across the board are far too low and that risk has been severely mis-priced for many years as investors have been chasing yield without proper considerations for the inherent risk. Just days ago new all-time highs were eclipsed in the riskiest of assets such as small caps and junk bonds despite the risk underlying those assets. Such a distortion of risk in the pricing of asset valuations can only occur when extraordinary influences are at work in the capital markets. To date, I would estimate those forces to have accrued to over $30 trillion in global aggregate fiscal and monetary stimulus in the past few years years and this fact has no doubt served to numb investors to the most obvious land mines in plain sight. This would include the exploding fiscal and monetary deficits among sovereign fiscal governments in the Western world (US, UK, Japan, etc). The aggregate effect of this doubling and tripling down of debt in such a short span means that the global capital markets are in for quite a wild ride in the next few years. I expect several crashes coupled with a few large counter rallies too.
One thing is sure- the age of unsustainable debt is over and the age of austerity has already arrived. It will be mitigated eventually through the wonderful advancements in technology and human innovation on display to us across the board but we must realize that in the 2013-2016 period we ‘re experiencing both the tail end of the last K-Wave cycle (1949-2105) and most notably the last quadrant of that cycle (2000-2016, the winter phase). Yet we are also likely seeing first hand the initial stages of the next K-Wave spring cycle (2015-2030) that is sure to be marked by dramatic advancements in technology and human innovation of that technology. It can be argued that this has already begun and thus the pivot has already begun from into the cycles in 2015.
The years from 2013-2016 are the inflection point of the K-Wave cycle where debt must be purged and the floodgates of innovation of the spring cycle must be released. Who will accomplish this necessary feat? A brand new Treasury Secretary? A lame duck President who has no passion at all for fiscal restraint? The leaders of a Congress now sporting all-time lows (9%) approval ratings? No, it’s more likely that pure market forces will be the final arbiter that purges the excesses of this credit cycle. The current long wave cycle began in 1949 and has become over extended through excessive support from the easy credit policies of global central banks, especially in the past thirty years. Can’t imagine this purge will be too pretty.
Investors will be faced with a dilemma in the near to intermediate term- stay the course and hope corporate profits can remain at all-time highs or flee the markets because the headwinds from the aggregate global debt are so daunting they render most everything else irrelevant. To advocates of long wave economic theory such as myself, the latter argument supercedes the former. It renders other meaningful measures to be distant cousins of relevance such as PE multiples, book value, GPP growth, etc. Any investment today in most paper assets (stocks and bonds) is a pure play that could be upended in a big way by any revolution in the appetite for debt. Such a revolution is fully expected to happen as a hallmark of our K-Wave theory.
Other signs point to a potential collapse in stocks for 2012. Investor sentiment and margin balances are at pre-crash highs. Given the recent highs we have front loaded most of the gains coming from the hype of QE and may have exhausted marginal buyers of stocks. I suspect investors are sure to be disappointed with the trajectory of future monetary and fiscal stimulus over the next several years because we have just accrued too much debt already.
It will be quite a tough feat to break though the 2007 all-time highs of 1565 on the S&P or the Dow high of 14,200 or so. There have been a few times since the fall of 2010 that the markets were set to crash (May 2010 flash crash, August 2010 and August 2011) but each time disaster was avoided through unprecedented and incredibly spectacular and dangerous intervention by global central banks, namely the Fed and the ECB. Each time the same thing occurred- the policy measures were decisive and quelled market fears for a brief period but these measures never solved the structural maladies inherently at the root of the problem. They only offered a solution (debt) to solve the same problem (debt). Any fool knows that won’t work yet the markets are placated for the time being.
But the canons of K-Wave theory hold that soon enough a tipping point will be reached that will mark the end of an era of easy money that has fueled our economy and asset bubbles for so long. Never mind the drumbeat of headlines touting new multi-year highs in the market. The primary long wave count still sports an ending diagonal pattern that suggests that once this tipping point is reached the markets will fall much further and much faster than most think.