s Aftershock subscribers, you will be familiar with some of the themes we introduce in the new edition. But we thought we’d give you a small sneak peek into the new first chapter to answer an important question: Has the Aftershock Been Canceled? As we write this second edition of The Aftershock Investor in mid- 2013, U.S. stock markets have hit new highs, real estate prices are rising, and the economic cheerleaders are declaring once again that all is well or will be soon. The economy is in recovery and the coming Aftershock, our critics say, has been canceled. How wonderful that would be if it were only true. But nothing has happened to change our minds about our earlier forecasts. In fact, current events fall in line pretty well with our previous analysis and predictions, dating back to our earliest books, America’s Bubble Economy in 2006 and the first edition of Aftershock in 2009. From the beginning, we said that in order to keep the stock, real estate, private debt, and consumer spending bubbles going, the government would inflate two more bubbles—the dollar and the federal debt bubbles—through massive money printing and massive money borrowing. That is the only way to keep this temporary bubble party going, and the government is doing all it can to keep pumping helium into the balloons so they don’t fully fall. With the national debt now nearly $17 trillion and the Federal Reserve flooding the economy with $85 billion in newly printed money every month (at the time of this writing), our predictions are looking pretty spot-on. The chapter proceeds to lay out our case in some detail. But in this newsletter we will give you a brief rundown of the reasons why we can say with confidence that the Aftershock has not been canceled. Really, it all comes down to one basic truth: The recovery is 100 percent fake! While many people may claim we are better off since 2008, the reality is that this recovery has not been driven by permanent increases in productivity, but instead by artificial, temporary government stimulus—first and foremost, money printing. To understand just how closely correlated the stock market rise and money printing have been over the last few years, look at the comparison between the growth in the monetary base and growth in the S&P 500. So what’s the problem? If money printing is working to boost the stock market, why question it? The answer, of course, is inflation. Money printing always leads to inflation, and inflation kills bubble economies. And while our detractors like to point out that inflation remains low, the truth is that all is not as it seems. If This Recovery Is Real, Why Is Government Borrowing Outpacing GDP Growth? While many people seem to cheer every little positive sign of growth in the economy (and ignore or downplay any negative news), what’s really astonishing is just how little growth in the economy we’ve seen in spite of all the government intervention. Between 2008 and 2013, the cumulative increase in GDP in the United States was $2.8 trillion. Over the same period, government borrowing increased $4.7 trillion. In other words, government borrowing is greatly outpacing GDP growth. That’s a whole lot of borrowing for just a little bit of growth. If This Recovery Is Real, Why Are Stock Prices Growing Faster than Company Earnings? … A big reason for the stock market’s record numbers recently is investors’ outlandish expectations for future earnings. According to FactSet, industry analysts expect record earnings for the Standard & Poor’s (S&P) 500 in the last two quarters of 2013. In fact, projections for the fourth quarter of 2013 are more than 15 percent above the fourth quarter of 2012. That would be an impressive rise for any period, and a great reason for people to want to own stock in these companies––if it actually happens. Given that S&P 500 earnings grew less than 3 percent from the fourth quarter of 2011 to the fourth quarter of 2012, 15 percent growth would be a tall order for the fourth quarter of 2013. Revenue growth is also pretty poor. S&P revenues have been growing at only 1 to 2 percent for most of 2013. This is no surprise given that U.S. GDP growth will only be 2 percent for 2013 and most major world markets aren’t growing much faster. Despite this, the market is apparently expecting an enormous jump in revenues (which drive company earnings and stock prices) in the second half of 2013. … If This Recovery Is Real, Why Is the Global Economy Slowing? … In Europe, the north is in recession, while the south is in depression. Unemployment numbers in Spain, Italy, and Greece are staggering. In the north, even Germany is suffering from a slowdown, with big companies like Daimler abandoning their profit forecasts due to falling demand. France and the United Kingdom, Europe’s second- and third-largest economies, are flirting with recession. And the Netherlands, a traditionally strong economy, is on the verge of economic crisis. China, the engine many thought would pull the rest of the world out of this mess, is experiencing a slowdown in growth even by its own admission. The truth is likely even worse than the Chinese government lets on, as the enormous construction bubble that was built up in response to the 2008 financial crisis is becoming increasingly unsustainable. A 60 Minutes report in March 2013 showed entire cities being built—high-rise luxury condominiums, expansive malls—with no one living in them. So much for the world’s growth engine. … This is important because the global slowdown has a direct impact on the U.S. economy and U.S. stocks, particularly those that collectively make up the S&P 500. That’s because in this global economy, no country is an island. Some countries may fare better than others, but trends around the world operate as a large feed-back loop. When the United States falters, the rest of the world slows down. When demand in Europe drops, exports in China drop. When China slows down, Europe sinks further, and other economies can’t keep up their previous pace. Everyone depends on everyone else. We can turn our heads away from bad news all we want, but eventually there will be nowhere to hide. We think we’ve made our case pretty well in this book and elsewhere. But of course, we know many people are still going to be strongly resistant to what we have to say. Even as people continue to struggle, five years removed from the crash of 2008, many will continue to laugh at anyone who suggests the party of the ‘80s, ‘90s and early 2000s is nearly over. That being said, we think many people are beginning to sense that the party is coming to an end. They may be cracking open another bottle of champagne––bought on credit, of course––but there is a growing sense in many circles that it can’t go on forever. It reminds us of another time in history, one that offers a great deal of perspective on our own. 20 or 30 years… that is about the length of the financial memory A couple weeks ago we sent out a link to great episode from PBS’s American Experience about the stock market crash of 1929.* The episode offers an insightful look into the public mentality in the months leading up to the crash, and highlights some exceptional parallels with our situation now. While everyone knows about the crash in October of 1929, not everyone is familiar with the earlier crash that happened in March. That crash was turned around in large part by an advance of $25 million to stock traders by National City Bank (now known as Citibank) chairman Charles Mitchell. The move was hailed at the time, but ultimately just fueled more rampant speculation and led to an even bigger crash later. Sound familiar? In fact, private manipulation was both common and legal at that time. It wasn’t at all unusual for wealthy investors to trade a stock amongst each other in order to push up prices well beyond what the underlying business was worth. Many investors paid no attention to a company’s real value—its assets and earnings—but only saw stocks as pieces of paper that were either going up or down in price. So when the big crash hit in October 1929, few people were troubled when market moguls colluded to try to push prices back up. The American Experience documentary describes the New York trading floor erupting in cheers when Dick Whitney came on the floor calling out huge buy orders at prices well above the current asking price. No one had a problem with manipulation of this sort because no one had experienced the consequences, just like no one in the U.S. today has experienced the consequences of massive government manipulation. If it keeps the market up, it must be a good thing. But there were signs that the party was coming to an end before the 1929 crash. The documentary explains that in the spring of that year, the steel industry was declining, construction had turned sluggish, car sales had dropped, and years of easy credit had left many people deeply in debt. One would have thought that the market would slow down under such conditions, but instead it soared to record heights that summer. People had become inclined to think that prosperity was a God-given right, rather than something that had to be earned through hard work. And why wouldn’t they think that way? For much of the decade, everyone was getting rich in the stock market. Even astrologist Evangeline Adams put out a newsletter offering stock tips based on the zodiac. She had 100,000 subscribers in 1929. Conveniently, the stars always seemed to want people to buy, buy, buy—she would have fit in pretty well among today’s stock analysts. Also, much like today, people paid a price if they questioned the underlying fundamentals of the stock market bubble. Roger Babson was one such person, and in response had people questioning his patriotism. Economist John Kenneth Galbraith explains that people who were cautious about their reputation at that time kept quiet. So, to sum up: 1)The big crash was preceded by a smaller crash, prompting investment magnates to step in and support the market. 2)The stock market was heavily manipulated, much to the delight of investors who wanted to see prices keep rising forever. 3)Sooner or later the manipulators ran out of firepower, forever changing people’s minds about market manipulation—at least that kind of manipulation. 4)Before the big crash, the stock market rose fantastically even when the economy sputtered. 5)Anyone who questioned the virtue of the rising market did so at the expense of their reputation. The parallels between that period and ours are uncanny. So why can’t people see history repeating itself today? John Kenneth Galbraith offers a trenchant insight: There’s nothing unique about this. It is something which happens every 20 or 30 years, because that is about the length of the financial memory. It’s about the length of time that it requires for… a new set of people capable of wonderful self-delusion to come in and imagine that they have a new and wonderful fix on the future.
Posted on: Fri, 27 Sep 2013 22:27:59 +0000
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