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NOVEMBER 2018 : ISSUE 16
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4 Inside This Issue
42 Economic Collapse BY P.J. O'ROURKE
BY STEVEN LONGENECKER
6 Letter From the Editor BY P.J. O'ROURKE
46 Getting Ready for the Next Bear Market BY DR. RICHARD SMITH 52 Post-Apocalyptic Movies BY JOHN PODHORETZ 58 Be Afraid of the Scaremongers! BY JOHN TIERNEY
Editor in Chief: P.J. O’Rourke Editorial Director: Carli Flippen Publisher: Steven Longenecker Assistant Managing Editors:
10 What Moved the Market
12 What Could Possibly Go Wrong?
Chris Gaarde, Laura Greaver Creative Director: Erica Wood Contributing Editors: Geoffrey Norman, John Podhoretz, Brunello Rosa, Nouriel Roubini, Buck Sexton, Dr. Steve Sjuggerud, Dr. Richard Smith, John Tierney, Matt Weinschenk Newswire Editors: Scott Garliss, John Gillin, Greg Diamond Cartoon Director: Frank Stansberry General Manager: Jamison Miller Advertising: Sam DeCroes, Jared Kelly, Jill Peterson Editorial feedback: feedback@ americanconsequences.com
14 From Our Inbox
16 Don't Be the Dumb Money BY DR. STEVE SJUGGERUD
66 The Debt Bomb BY OUR CRO X
22 The Makings of a 2020 Recession and Financial Crisis BY NOURIEL ROUBINI AND BRUNELLO ROSA
72 Read This
COMPILED BYSTEVEN LONGENECKER AND P.J. O'ROURKE
26 Bad Investment Advice BY P.J. O'ROURKE
74 The Final Word
BY BUCK SEXTON
28 Fear & Greed
78 Featured Contributors
34 But My Pension!
BY GEOFFREY NORMAN
American Consequences 3
INSIDE THIS ISSUE
I n a few short months, the longest-running bull market ever will turn 10 years old. And after the recent market volatility, we wouldn’t blame you for being skeptical on stocks. As we’ve mentioned when we talked about the Melt Up – what goes up eventually comes down. So, should you be worried? And will this running bull get pushed over the edge? Editor in Chief P.J. O’Rourke shows us that no matter who’s in office, politics and finance mix like oil and water. And he tells us what he’d do in case of complete economic collapse (run in circles and tear his hair out). He also offers up his best bad investment advice. Angel investors, take note! Financial analyst Dr. Steve Sjuggerud looks back at the last time stocks seemed too expensive to keep going up. He shows why valuations can’t kill bull markets and why you must stay long... for now. John Podhoretz digs into America’s obsession with post-apocalyptic films and reviews some of the best and worst. And contrarian journalist John Tierney explores some of the ways the world might end... and tells us which worries could blow up and which worries we should blow off. Author Geoffrey Norman reports on the pension crisis in Chicago. No surprise, a federal bailout will only make things worse.
And our man on the inside, Chief Risk Officer X , warns us of a “debt bomb” you might be overlooking in the markets. Analyst Matt Weinschenk shares a valuable lesson he learned in the last financial crisis and why it’s still relevant today. And Nouriel Roubini and Brunello Rosa delve into 10 reasons why 2020 could mark the beginning of the next financial crisis. Don’t miss Dr. Richard Smith ’s take on how having the right tools and “mental capital” can lead to market gains... even in the face of a bear market. Finally, former CIA analyst Buck Sexton tells us what the 2018 midterm results mean for President Donald Trump and the remainder of his term. Enjoy the issue. And tell us what you think at firstname.lastname@example.org. Regards, Steven Longenecker Publisher, American Consequences
It’s true that markets love certainty of any kind, no matter what... then this confirms a suspicion I’ve had for a long time... Markets are insane.
4 November 2018
From Editor in Chief P.J. O’Rourke
BURYING OUR HEAD IN THE SAND WON'T MAKE THE MIDTERM RESULTS GO AWAY
6 November 2018
LETTER FROM THE EDITOR
CLICK HERE TO READ THEWEB VERSION
American Consequences 7
LETTER FROM THE EDITOR
“If we weren't all crazy, we would go insane.” Jimmy Buffett
The theme of this issue is disaster. In America there is one permanent, continuing, endless disaster – politics. And, thanks to politics, we just had a disastrous midterm election.
What should we do about it? Maybe we should do what the Dow Jones Industrial Average did the day after the election and go crazy... It closed up 545 points. I know... I know... Markets always go up after every midterm election. Supposedly this is because markets love certainty, even if the certainty is lousy. Which this midterm election certainly was – sending the socialist swineherds to tend the capitalist pigs in Congress. If it’s true that markets love certainty of any kind, no matter what... then this confirms a suspicion I’ve had for a long time... Markets are insane . I mean, personally, I’d rather have a little hopeful uncertainty instead of a hopeless sure thing. I’d rather have my doctor say, “Maybe this is serious” than “You’ll be dead in a week.” Which is how I feel after the campaign season we’ve been through. We have two political parties in America, each worse than the other. One party thinks it’s in favor of business and economic growth. It’s not thinking very hard. The GOP has done nothing about the nation’s burgeoning debt and deficit. If Republicans were financial advisers, they’d take a look at
your huge credit-card bills, delinquent car loan, and outsized mortgage debt and tell you to quit making loan payments and go on a spending spree. You’d say, “But I’ll lose the house!” And Republicans would say, “Heck, we lost the House. So what?” The other party is convinced that everything is free. Health care is free. College tuition is free. Parental leave is free. Not that parents need it, since daycare is also free. Democrats should go into a butcher shop and announce that beef is free... and get clocked on the head by a butcher wielding a frozen rib roast. (Except Democrats will ban meat because animals are free, too.) Meanwhile, Republicans claim that free trade isn’t free and costs too much and this means war. Because... the way to deal with the giant Walmart that is China is to burn it down and get swell bargains afterward at the fire sale. Which makes Democrats scared that real war will break out and, when the world is destroyed by nuclear holocaust, women and minorities will be hardest hit. But, Republicans say, what we really should panic about is thousands of jobless Hondurans and Guatemalans invading our
8 November 2018
southern border. Never mind that with the current unemployment rate, I can’t find anybody to mow my lawn, not even for $18 an hour. So, privately, I’m thinking of the Hondurans and Guatemalans as “The March for Yard Care.” And what’s worst of all about these two political parties is that on Tuesday, November 6 both of them won. Now we’ve got a Saphead Senate and a House of Fools. And what’s worst of all about these two political parties is that on Tuesday, November 6 both of them won. “ One chamber of Congress will be carting tax cuts to hell while the other is letting expenditures ascend into heaven. The House will squat like a toad on deregulation while the Senate confirms lizards and snakes to head regulatory agencies. Progressives will subpoena everyone in America who wears a necktie. Conservatives will console each of them with a large defense contract. One side will hobble businesses. The other will hamstring consumers. Liberals will kiss the ass of our enemies. Reactionaries will piss off our allies. The left will imagine new grievances for minorities. The right will fantasize about old majority prejudices. Democrats will lead the bull into the china shop. Republicans will pack the dog with the cat. Refereeing this hard-fought, down-to-the- wire, tied 1-1 in extra innings contest between asshats is... President Trump.
Let us not get ourselves all a-twitter – so to speak – about what we think of President Trump. Whether you approve, or grudgingly approve, or disapprove, or abhor him with bells on... whatever you think of President Trump, he’s not exactly the person you’d pick as an umpire. If the 116th Congress were the World Series and Trump was the umpire, he’d send both teams to the showers so that he could be the pitcher and the batter and throw every strike and hit every home run... And he’d also want to be the only hot dog vendor in the stadium. This game is not going to end well. Which is why – history of post-midterm market upticks notwithstanding – I was surprised when the Dow went up 545 points. On the other hand... “Crazy” is not the same as “wrong.” Perhaps markets were trying – in their own crazy way – to tell politics something on November 7. This is what I’d like to think the markets were attempting to say in their delirious ravings: We’re the economy! We’re the grown-ups here! We pay the bills! We’re the parents and you political parties are the quarreling teenage kids. We’re sick of you two fighting all the time. You’re making a mess! You’re in the way! We’ve got jobs, we’ve got work to do, we’ve got businesses to run! If you’re going to fight, take your stupid fight somewhere else, someplace nobody cares about, a place that’s already wrecked – like Washington! And not only are we kicking you out, you’re grounded until 2020!
American Consequences 9
THE BIGGEST STORIES THAT MATTERED FOR THE MARKET LAST MONTH
WHAT MOVED THE MARKET
The likelihood of a Democratic House and Republican Senate had already been taken into account. There was also rare cause for celebration when China announced it may cut its light- vehicle import tax by half, providing a boost to the battered industrial sector. Market corrections can be vicious, but the economy remains strong and there are no major economic headwinds in the foreseeable future. October was an awful month for investors, but no different than the volatility we experienced in February. Markets can’t go up in straight lines. Be patient. We’re not in a bear market yet. The Federal Reserve made its footsteps heard once more... On November 8, the Federal Open Market Committee released its policy announcement, leaving the federal funds rate in the range of 2% to 2.25% (as expected). THE FEDWEIGHS IN
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THEWORST MONTH FOR STOCKS SINCE THE FINANCIAL CRISIS Weak growth, tariffs, and political conflict in the EU sent global equities into a free fall for most of October. While Prime Minister Theresa May fought to draft a Brexit deal in the British Parliament, the Italian Ministry of Economy and Finance pushed back on the EU’s demand that Italy’s deficit budget include less spending. Aside from the obvious risks of overspending and implementing sweeping social programs during a deficit, there is fear that other members may follow suit, creating more economic conflict in the region. Meanwhile, EU bellwether Germany reported its worst quarterly growth in five-and-a- half years. Investors didn’t fare much better in U.S. markets, either. Oversupply, tariffs, competition, and loss of momentum combined to cause many familiar names to sell off on the month. Earnings from Netflix,
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Google, Facebook, and Amazon were on target, but lower than expected, and Amazon’s downbeat fourth-quarter outlook put the FAANG trade into a tailspin. The S&P 500 Index was also down 6.94% for the month. The November midterms caused some concern, but the results had little effect on the markets.
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The committee noted continued economic strength and appeared to be on track to raise rates to 2.25% to 2.5% in December. (There were also concerns about tariff and trade policy, although the official data
10 November 2018
EDITORS John Gillin Greg Diamond Scott Garliss
But that all changed with the current Fed chairman, Jerome Powell... In an interviewwith NPR in late October, Powell said we’re a long way from neutral, contradicting the claims made by Fed officials earlier in the month. The interview threw some markets into further chaos, as many feared a higher neutral rate would foster too much growth. During the tenures of Fed chairs Janet Yellen and Ben Bernanke, the market had come to expect the Fed to stay on-message. Since becoming chairman, however, Powell has been repeatedly off-message with the rest of the group. He has come across as decidedly hawkish, and his talk of higher rates worries many analysts. Add tax cuts to the mix, as mentioned by President Trump, and the Fed may need to extend rate hikes further.
have seen little impact.) Despite pushback from President Donald Trump and theWhite House, the rate increase was expected and many analysts anticipate another hike in March. So the question is, what happens in June? Currently, the Fed’s dot plot chart – which indicates the future path of interest rates – is calling for three rate hikes next year. (Earlier this year, it called for two.) So, if we see a “pause” in June, that would imply rate hikes are still coming in September and December of next year. The main factor here is the Fed’s “neutral” rate target, which neither helps nor hurts the economy. Until the beginning of October, the market was certain that the Fed’s neutral target was 2.75% to 3%... A range that happens to fall in the window of the March rate hike, but only if current Fed policy remains on
With the Democrats taking control of the House, additional tax cuts are unlikely. And expect more volatility as both sides draw lines in the sand and kick that sand in each other’s faces.
track. The market based this expectation on the comments of several regional Fed governors, and there’s also been a call to lower the neutral target to 2.5% to 2.75%. Overall, the Fed and its governors seemed to agree.
Add tax cuts to the mix, as mentioned by President Trump, and the Fed may need to extend rate hikes further.
American Consequences 11
WHAT COULD POSSIBLY GO WRONG?
Financial follies and disaster in the making
market’s performance is based on logic and reason. Stocks move up or down based on quantitative data like fundamentals – how the actual companies behind them are doing –
Volatility shakes up the markets...
After months without so much as a 2% decline, volatility returned with a vengeance in October. Since then, we’ve seen the S&P 500, the Dow, and other markets seesaw into chaos while the media stokes fears of a looming bear market. Many folks – typically those who are new to investing – seem to believe that if they can just figure out what “caused” the market to fall on any given day, they’ll eventually be able to avoid market corrections altogether. And it’s not just investors... The mainstream media is more than happy to speculate, offering up unrelated reasons for nearly every turn in the market. Of course, these folks are almost always off the mark. Legendary value investor Ben Graham liked to say that in the long run, the market is a weighing machine ... But in the short run, it’s a voting machine . In other words, over long periods of time, the
and the relative value of other assets. But in the short run, the market’s
performance is based largely on emotion . This means there’s no way to know exactly how the market will react to the news on any given day. Worse, it’s often not even clear what news the market is reacting to in the first place. Occasionally, there may appear to be a single reason for the market’s moves. Sometimes, there’s no news at all. And you can often point to countless potential causes. The latter is certainly the case right now... The broader market averages are all lower today... There is no one defined reason why, but rather a number of things going on. Earnings in general weren’t great, Brexit negotiations continue to weigh on the UK and EU, and we’re still experiencing fallout from
12 November 2018
the China-U.S. trade war, to name a few. But it’s important to keep a few things in mind... First, none of this “news” is new. The market has known about all of these problems for some time, which means it has likely already discounted them. More important, none of these “reasons” have altered the longer-term picture to date. For now, the most reliable measures of economic and market health continue to tell us that the risks of a bear market or recession remain low today. That said, corporate and subprime consumer debt continues to balloon, and nearly half of Americans don’t have the cash for a $400 emergency. Bull or bear market, subprime borrowers and heavily leveraged corporations will have to face reality. These debts will still come due, and with them will be a wave of bankruptcies, defaults, and even more borrowing. Since 1946, there have been exactly 18 midterm elections in the United States. And according to research published in Forbes , the broad U.S. markets were higher 12 months later after every single one... and the average gain was an impressive 17%. In short, since the end of World War II, it simply hasn’t mattered which political party controlled the White House or Congress prior to the election, or which party controlled them after. Stocks moved sharply higher after every single one. But there is one potential caveat... Although Republicans have kept control Do the midterms matter?
of the Senate, Democrats have retaken the House of Representatives. Why does this matter? According to a note from Nautilus Investment Research, we’ve seen this exact scenario play out in two previous midterm elections. These were in 1910 and 1930, during the presidencies of William Taft and Herbert Hoover, respectively. And both were followed by less-than-stellar years for stocks. Following the 1910 election, stocks fell 5.5% over the next year. In 1930 – which admittedly was in the middle of the Great Depression – stocks plunged more than 40% over the next 12 months. Of course, this is an extremely limited sample size. The reality is, politics matter far less to the markets over the long run than most people think. If anything, so-called “gridlock” – when no one party holds the presidency, Senate, and the House – has often been considered a bullish rather than bearish development. It meant the government would have a more difficult time interfering in the economy. However, the market has risen significantly over the past two years. Outside of the recent trade war with China, investors have generally cheered the efforts of President Donald Trump and the Republican Congress to cut taxes and ease some of the government’s most onerous regulations. So while it wouldn’t be surprising to see the market give up some gains, history – and gridlock – may give it room to run.
American Consequences 13
FROM OUR INBOX
Re: Our Newest Readers Weigh In My first sent to me today. Love the way you write PJ. – Jake M. PJ, I’ve been reading your great works since I was a kid reading National Lampoon ! – Pete H. Looking forward to receiving American Consequences ... Once attended a lecture of yours and chuckled & learned a few things. – Carole B. P.J. O’Rourke comment: Jake, Pete, and Carole, there’s nothing I love more than spontaneous, unsolicited comments like these! (Your checks are in the mail.) Take me off your socialist list immediately. You don’t deserve to live in this country. – June M.C. Unsubscribe now. Don’t need lying conservative [news media] brainwashed by the lying idiot in theWhite House. – Normand A. P.J. O’Rourke comment: June, we’ve been called a lot of things, but never the s-word. Are you sure you didn’t misplace your reading glasses and pick up a copy of The Nation by mistake? And, Normand, we resent your “brainwashed” characterization – we’re as dirty-minded as everyone else. Re: Why I Don’t Vote
human mind maturity, which is around 25. – Jacques B. P.J. O’Rourke comment: Jacques, from my experience, it’s more like 40! Porter is absolutely right. The masses will continue to vote for more and more and more “free stuff” until the only thing free will be the misery brought on by the choices made. There are a host of things wrong when one can’t keep what is rightfully hers/ his... Unfortunately, most will be eaten by the wolves. – C.F.L. P.J. O’Rourke comment: I fear you’re right, C.F.L. But look on the bright side. If we sheep keep getting more and more bloated with short-term self-interest, those wolves are going to have a terrible case of indigestion. I like the wolf and sheep analogy and I think it’s pretty apt, but the wealthy are really just beginning to feel like sheep. The middle class have been feeling it for a long time now. The poor have always felt it, I’m sure. So the question is not who are the sheep... But who are the wolves? In the analogy, it seems to be politicians, who are all similarly hungry for what’s in our wallets. But who are the wolves really working for? – David B. P.J. O’Rourke comment: David, if politicians were merely standard-issue mercenaries, I’d be trying to figure out who they’re working for. But politicians are worse than that. They’re not just greedy for money, they’re greedy
Voting age must be raised to the age of
14 November 2018
for power and domination. The worst thing about a wolf is that it works for itself – and nobody else. The problem with the government is: A government big enough to give you everything you want is also big enough to take everything you have. We have departed from the ideals of small government, maximum freedom, and even the minimum standard of good government... – Penni B. P.J. O’Rourke comment: Penni, this is very much what Senator Barry Goldwater was trying to tell us in his book The Conscience of a Conservative . You’ve gone right to the nub of the message and summarized it beautifully. Thank you! (And, although CoC was written 58 years ago, every alarm that it rings about big government is still an alarm that should be rung today.) With the maker:taker ratio now crossing that crucial midpoint, there is little hope for a turnaround absent an economic collapse Venezuela style. I completely agree with the idea that at least one of the Presidential candidates in 2020 will be farther to the left than anything we have seen since FDR. – Paul M.W. P.J. O’Rourke comment: Paul, there’s an old Irish superstition, “To say it is to summon it.” So for gosh sake, touch wood, spit three times, and hang some garlic on your doorframe!
I think you’re trying to get people not to vote so the socialists can win. NOT HAPPENING. – Lance B. Steven Longenecker comment: I searched our entire American Consequences e-mail inbox to confirm that this is the very first time we’ve been accused of this possible conspiracy. We’re marking it off our BINGO card now. Re: Politics Can’t Mess With the Melt Up Is it wise for those “close to retirement” to be investing at all in volatile investments? Are such “NASDAQ Tech stocks” referred to in the article even suitable for such investors? Such advice directed at that target audience shouldn’t sit comfortably with responsible advisers... – Phelim K. Steven Longenecker comment: Phelim, we would never recommend that anyone take on more risk than they feel will allow them to sleep well at night. We also try to highlight articles from multiple perspectives – for example in this magazine we’re publishing an article by Dr. Steve Sjuggerud expanding on his “Melt Up” theme about how to cash in before the crash as well as an article by Dr. Richard Smith on how to survive the next bear market.
Send us a message, question, or criticism at email@example.com
American Consequences 15
don't be the DUMB MONEY CASH IN ON THE CRASH Here’s another way to think of it...
H ow quickly individual investors forget that stocks go up and down. The famous Dow Jones Industrial Average stock index hit a new all-time high in early October. A week later, the Dow fell more than 800 points. It fell another 500 points the next day. All in all, we had a nearly 1,400-point decline (or a 5%-plus fall) in just two days. I get it – that scared folks. But you’ve got to understand something... Volatility is part of a “Melt Up” in stocks. You can’t have one without the other. You need
If a market has the potential to jump 100% in a year, then of course it can fall 10% along the way. That’s simply how Melt Ups work. It’s the nature of what’s going on right now. Don’t just take my word for it, though... Let me show you. In the final 12 months of the dot-com boom, the Nasdaq fell by roughly 10% or more – five separate times. Take a look at the chart below... As you can see, the last Melt Up was not a one-way move higher.
By Dr. Steve Sjuggerud
CLICK HERE TO READ THEWEB VERSION
to expect big ups – and big downs (even bigger than we recently experienced) – in the coming months. This should make intuitive sense... After all, a Melt Up is the final blow-off top of a long-term bull market. It’s the glorious, unadulterated boom before the next bust arrives. For this to happen, by definition, prices have to move – a lot.
Nasdaq Composite Index
The Nasdaq fell 10% five times during the last Melt Up
S&P 500 CAPE Ratio 1918-1996
American Consequences 17
And the 10% falls happened quickly – just like the fall we saw last month. They all took place in a month or less. But at the time, they were still painful. At 10%-plus, they each reached the level of a full-blown correction – even worse than the move in early October. Once investors get used to a one-way market, they forget that stocks go down as well as up. If you were invested back in 1999, all five of these moves would have made you question whether staying long stocks was the right choice. But today, nobody remembers any of it. The way most folks talk about the dot-com boom now, you’d think stocks did nothing but soar the entire time... We’ve seen some terrible volatility... But a pullback in stocks does not signal the end of the Melt Up. The Nasdaq more than doubled during the final 12 months of that boom. That’s the part everyone remembers. The reality is, pullbacks and corrections are normal... even during a blow-off top. And if today’s Melt Up plays out anything like the last great Melt Up, then we could see as many as five corrections – worse than what we just went through – before the market peaks. So yes, we’ve seen some terrible volatility... And no, you don’t have to like it. But a pullback in stocks does not signal the end of the Melt Up.
And it’s not the only big issue that folks seem to have with my Melt Up prediction. They raise another big objection, over and over again... The Melt Up skeptics say stocks are too expensive. After all, they say, prices have gone up and up for almost 10 years. They believe stocks HAVE to crash from today’s levels... that prices can’t possibly move higher from here. The funny thing is that folks have had this problem for years. They don’t seem to understand the reality of the situation. Let me explain... HECK NO, STOCKS AREN’T TOO EXPENSIVE TO BOOM One of the biggest mistakes of my career was missing out on the last great Melt Up... At the time, the dot-com boom didn’t make any sense to me. Stocks soared on hype, but the businesses behind them had no real future. I watched friends get “paper rich” in dot-com stock options. And instead of joining the mania, I stood on the sidelines. “It can’t go on any longer,” I told myself. But it did go on longer. I learned an important lesson from that. And in my career, it’s helped me to stand strong in bull markets around the world over the nearly two decades since the dot-com boom. It’s one big reason why I’ve stood strong in this bull market. The lesson has two parts... Just because stocks are expensive, it doesn’t
mean they can’t go much higher. High valuations are a symptom of a stock market peak... But they are not the cause of a stock market peak. Let me walk you through my personal experience with this... By the end of 1994, stocks had gone up for 12 out of the previous 13 years. Said another way, you would have lost money on stocks during only one calendar year since 1981. As you might guess, after that 13-year boom in stocks, measures of valuation showed that stocks were getting expensive. Any rational person in 1994 would think stock prices couldn’t go much higher. But then something irrational happened in 1995. Stocks did go higher... They soared 38%. That drove valuations to crazy heights...
Those two previous peaks were significant – and so were the losses that followed... The Great Depression followed the 1929 peak. And stocks lost a fortune in the 1970s after the late 1960s peak... shedding nearly half their value from 1973 to 1974, adjusted for inflation. So in 1994 and 1995, any rational person would have said that valuations were extreme – hitting levels that had preceded the two greatest stock market busts in the 20th century. Buying then would have seemed foolish... Except it wasn’t. It was exactly what you should have done. After soaring 38% in 1995, stocks jumped 23% in 1996. Astonishingly, that STILL wasn’t the end of it... The market soared another 33% in 1997. -9.7% -10.2% -13.1% -9.8% 5,200 4,700 4,200 3,700 3,200 2,700 2,200 1,700
Nasdaq Composite Index
The Nasdaq fell 10% five times during the last Melt Up
Stocks had only been THAT expensive two times in history – in 1929, and in the late 1960s. You can see this by looking at the cyclically adjusted price-to-earnings (or CAPE) ratio, one of the most popular ways to measure value in the markets over the long term. Take a look at the chart on the right...
S&P 500 CAPE Ratio 1918-1996
Stocks reach extreme valuation levels in 1995
S&P 500 CAPE Ratio 1919-1997
American Consequences 19
Stocks hit all-time expensive levels in 1997
S&P 500 CAPE Ratio 1918-1996
By the end of that year, stocks had become more expensive than at any time in history. Take a look at the top chart below... That was a surely a sell signal – right? Stocks were even more expensive than right before the 1929 peak! In hindsight, it was not a sell signal. Instead, what happened next shocked all rational people...
Stocks went up – again – in 1998. And once again, it was a BIG gain. The S&P 500 went up 29%. And tech stocks went up even more – the Nasdaq soared 40% in 1998. This is when the last great Melt Up started. Investors who had been skeptics got religion. The late 1990s had taught folks not to worry about high valuations. This time was different, right? 30 25 20 15 10 5
Stocks reach extreme valuation levels in 1995
Animal spirits kicked in. The excitement was palpable. And things got even crazier... In the late 1990s, many of my buddies were leaving their “real” jobs and joining dot-com companies. They got stock options for changing jobs. On paper, they were worth more than I could imagine. And I started to feel like the fool for staying on the sidelines instead of joining them. Stocks just kept going higher... The Nasdaq soared a ridiculous 86% in 1999. Take a look at the bottom chart to the left. What happened
S&P 500 CAPE Ratio 1919-1997
Stocks hit all-time expensive levels in 1997
S&P 500 CAPE Ratio 1920-2000
Stock valuations soared before peaking in 2000
20 November 2018
to valuations before the boom was finally over. They went up further than any rational person would have thought possible... If you were smart enough to know that valuations alone don’t kill bull markets... and if you were bold enough to simply stay on board as the stock market “melted up”... then you would have made an absolute fortune. To be honest with you, I was neither smart enough nor bold enough to do those things... I personally missed out on most of the upside in the late 1990s. And I missed out on basically all of the upside of the dot-com boom in 1999. I didn’t believe in it. It didn’t make rational sense. Stocks were record-expensive, and people were acting completely irrationally. Now, I am older and wiser. (Certainly older... hopefully wiser!) I have stayed on board today’s bull market longer than any other analyst I know. My experience taught me two important lessons... Valuations are high today – but not absolutely crazy based on history. Valuations alone don’t kill bull markets. Most people say that stocks are near record- high valuations. The CAPE ratio is above 30 today, inching back toward the dot-com boom highs. But after my 1990s experience, I look at how stocks soared from similar levels back then. And I believe we could see years of gains before we see true Melt Up valuations.
People are not acting completely irrationally – not yet. They’re worried about valuations. They’re worried about interest rates. They’re worried about trade wars. At some point, they’ll notice that the sky isn’t falling... And they’ll stop worrying. They’ll buy with reckless abandon. Valuations won’t matter one bit. Their only worry will be missing out on the huge gains their friends and family are racking up in the market. As we saw in 1999, that is the hallmark of a true market top. We’re not there yet... Not even close. Today, we have high levels of fear and worry. Prices have pulled back... Volatility has picked up... And we are nowhere near the optimism and excitement that signals the top of the market. That’s why I still urge you to stay long U.S. stocks.
Dr. Steve Sjuggerud holds an MBA and a PhD in finance. He’s worked as a stockbroker, vice president of a global mutual fund, and a hedge-fund manager. His track record has landed him on various television networks including stints on Fox Business News, Bloomberg’s Taking Stock , and CNBC, among others.
American Consequences 21
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THE MAKINGS OFA
RECESSION AND FINANCIAL CRISIS
As we mark the decennial of the collapse of Lehman Brothers, there are still ongoing debates about the causes and consequences of the financial crisis, and whether the lessons needed to prepare for the next one have been absorbed. But looking ahead, the more relevant question is...
What actually will trigger the next global recession and crisis, and when?
The current global expansion will likely continue into next year, given that the U.S. is running large fiscal deficits, China is pursuing loose fiscal and credit policies, and Europe remains on a recovery path. But by 2020, the conditions will be ripe for a financial crisis, followed by a global recession. There are 10 reasons for this: 1. The fiscal-stimulus policies that are currently pushing the annual U.S. growth rate above its 2% potential are unsustainable. By 2020, the stimulus will run out, and a modest fiscal drag will pull growth from 3% to slightly below 2%.
2. Because the stimulus was poorly timed, the U.S. economy is now overheating, and inflation is rising above target. The U.S. Federal Reserve will thus continue to raise the federal funds rate from its current 2% to at least 3.5% by 2020, and that will likely push up short- and long-term interest rates, as well as the U.S. dollar. Meanwhile, inflation is also increasing in other key economies, and rising oil prices are contributing additional inflationary pressures. That means the other major central banks will follow the Fed toward monetary-policy normalization, which will reduce global
By Nouriel Roubini and Brunello Rosa
American Consequences 23
liquidity and put upward pressure on interest rates. 3. The Trump administration’s trade disputes with China, Europe, Mexico, Canada, and others will almost certainly escalate, leading to slower growth and higher inflation. 4. Other U.S. policies will continue to add stagflationary pressure, prompting the Fed to raise interest rates higher still. The administration is restricting inward/outward investment and technology transfers, which will disrupt supply chains. It is restricting the immigrants who are needed to maintain growth as the U.S. population ages. It is discouraging investments in the green economy. And it has no infrastructure policy to address supply-side bottlenecks. 5. Growth in the rest of the world will likely slow down – more so as other countries will see fit to retaliate against U.S. protectionism. China must slow its growth to deal with overcapacity and excessive leverage. Otherwise a hard landing will be triggered. And already- fragile emerging markets will continue to feel the pinch from protectionism and tightening monetary conditions in the U.S. 6. Europe, too, will experience slower growth, owing to monetary-policy tightening and trade frictions. Moreover, populist policies in countries such as Italy may lead to an unsustainable debt dynamic within the eurozone. The still-unresolved “doom loop” between governments and banks holding public debt will amplify the existential problems of an incomplete monetary union with inadequate risk-sharing. Under these conditions, another global downturn could
prompt Italy and other countries to exit the eurozone altogether. 7. U.S. and global equity markets are frothy. Price-to-earnings ratios in the U.S. are 50% above the historic average, private- equity valuations have become excessive, and government bonds are too expensive, given their low yields and negative term premia. And high-yield credit is also becoming increasingly expensive now that the U.S. corporate-leverage rate has reached historic highs. The policymakers who must confront the next downturn will have their hands tied while overall debt levels are higher than during the previous crisis. Moreover, the leverage in many emerging markets and some advanced economies is clearly excessive. Commercial and residential real estate is far too expensive in many parts of the world. The emerging-market correction in equities, commodities, and fixed-income holdings will continue as global storm clouds gather. And as forward-looking investors start anticipating a growth slowdown in 2020, markets will reprice risky assets by 2019. 8. Once a correction occurs, the risk of illiquidity and fire sales/undershooting will
will be intolerable in countries with resurgent populist movements and near-insolvent governments. In the U.S. specifically, lawmakers have constrained the ability of the Fed to provide liquidity to non-bank and foreign financial institutions with dollar-denominated liabilities. And in Europe, the rise of populist parties is making it harder to pursue EU-level reforms and create the institutions necessary to combat the next financial crisis and downturn. Unlike in 2008, when governments had the policy tools needed to prevent a free fall, the policymakers who must confront the next downturn will have their hands tied while overall debt levels are higher than during the previous crisis. When it comes, the next crisis and recession could be even more severe and prolonged than the last. © Project Syndicate Nouriel Roubini , a professor at NYU’s Stern School of Business and CEO of Roubini Macro Associates, was Senior Economist for International Affairs in the White House’s Council of Economic Advisers during the Clinton administration. He has worked for the International Monetary Fund, the U.S. Federal Reserve, and the World Bank. Brunello Rosa is co-founder and CEO at Rosa & Roubini Associates and a research associate at the Systemic Risk Centre at the London School of Economics.
become more severe. There are reduced market-making and warehousing activities by broker-dealers. Excessive high-frequency/ algorithmic trading will raise the likelihood of “flash crashes.” And fixed-income instruments have become more concentrated in open-ended exchange-traded and dedicated credit funds. In the case of a risk-off, emerging markets and advanced-economy financial sectors with massive dollar-denominated liabilities will no longer have access to the Fed as a lender of last resort. With inflation rising and policy normalization underway, the backstop that central banks provided during the post-crisis years can no longer be counted on. 9. Trump was already attacking the Fed when the growth rate was recently 4%. Just think about how he will behave in the 2020 election year, when growth likely will have fallen below 1% and job losses emerge. The temptation for Trump to “wag the dog” by manufacturing a foreign-policy crisis will be high, especially if the Democrats retake the House of Representatives this year. 10. Once the perfect storm outlined above occurs, the policy tools for addressing it will be sorely lacking. The space for fiscal stimulus is already limited by massive public debt. The possibility for more unconventional monetary policies will be limited by bloated balance sheets and the lack of headroom to cut policy rates. And financial-sector bailouts
American Consequences 25
INVESTMENT WHY BAD INVESTMENT ADVICE? Plenty of good investment advice is available (much of it right here in this magazine). But do we listen to that good advice? No, usually we don't. Then we feel bad about ourselves. Maybe we need bad investment advice. When we don't listen to bad investment advice, we feel good about ourselves. At least that's P.J.'s reasoning... P.J. is well-known for his bad investment advice (and for feeling good about himself). He has his kids' college savings 529 plans all in General Electric stock and Toys "R" Us bonds. "Sure," says P.J., "they'll be going to Skinhead Barber College – if they're lucky. But this way I'm 'ahead of the curve' as an investor. Sooner or later the bull market is going to crash and everybody will be broke and I'll be able to brag, 'I got in on the ground floor!'" Here are some of the investment ideas P.J. is considering right now. Take a look at them yourself – then run for your life. (Maybe in a pair of WalkShare TM shoes.)
Farmland for the Small Investor American farmland has been an excellent risk-free investment, rising steadily from an average price of $1,340 per acre in 2004 to $3,140 per acre in 2018 with almost no market downturns. However, for the small investor, purchasing farmland presents various difficulties. I've solved them. A 40-pound bag of topsoil sells for $1.29 at Walmart. For only $9 a week, you can build a 7.3 ton "black gold" portfolio in just one year. (Or, better yet, dig in your own back yard for free.) A 40-pound bag of topsoil will cover 12 square feet. There are 43,560 square feet in an acre. You'll be "piling up" enough per annum to cover 4,380 square feet. Start at age 20 and by the time you retire you'll have a valuable 4.5-acre farm. Given the way farmland prices have been going up, you'll be "rolling in clover." Science keeps harnessing the forces of nature – solar, wind, geothermal, and next... gravity! Unlimited clean power will soon be available from the kinetic energy of great big things rolling downhill. After all, America is full of hills and also full of great big things. I've been following patent applications from researchers at the University of GoFundMe and other prestigious educational institutions, and I'm convinced that gravity is where the smart money will "drop." The Next Frontier in Alternative Energy
WalkShare Shoes Just "untie" them with your smartphone app and walk anywhere you want! Leave your WalkShare TM shoes wherever you step out of them! A hot new Silicon Valley start-up is pioneering this novel form of personal transportation, similar to Bird dock-less electric scooters, but without the bothersome electricity or potentially hazardous scooting. Soon to be available in most major cities. Unprecious Non-Metals It's a box of rocks. This commodity – with proven value going back to the great pyramids of ancient Egypt – is trading at such low levels that it has nowhere to go but up!
26 November 2018
From P. J. O’Rourke and Henry Smith ADVICE FROMPJ
Inverted Pyramid Scheme Also known as a "Democratic Socialist Ponzi Game" and reputedly the brainchild of Alexandria Ocasio- Cortez. The way an Inverted Pyramid Scheme operates is that you send $10 bills to 10 different people. Each of those people, in turn, sends $10 bills to 10 other people, and so on. This pyramid scheme, like all pyramid schemes, is a rip-off. And you get nothing out of it at all. On the other hand, it only costs you $100, as opposed to the many thousands of dollars that standard pyramid schemes can cost you. I call that a bargain.
Hydro-Electric Cars No need to worry about charging stations
when you carry your own source of renewable, environmentally friendly, carbon-neutral electrical generation with you everywhere you go. A joint venture between the Tennessee Valley Authority and Elon Musk, the new 2020
Beachfront in Greenland Get out in front of the global warming fad and make it work for you! Beautiful Angisorsuaq Island ocean frontage on the calm – not to say frozen solid – Labrador Sea is available for next to nothing... and somewhat less where house lots are under a glacier. Just miles and miles and miles from Greenland's charming capital city of Nuuk, population: none. Premium Bagged Air Drinking bottled water has been all the rage for decades, but what about the air we breathe? It's a trend you won't want to miss. There's a ready-made market for premium bagged air from the freshest places on earth – the mountains, the seashore, forest glades, flowery meadows, brisk autumn breezes, and dewy spring dawns. The owners of France's most famous and iconic brand of naturally carbonated mineral water are rumored to be launching a whole new product line – PerriAir. I'm betting that locally sourced "craft breathers" won't be far behind, making for plenty of "blue sky" investment opportunities (think AWhiff of Brooklyn TM ).
Wetsla TM is scheduled to go on sale next fall.
CounterFeitcoin Some people say cryptocurrency isn't really "real." But this cryptocurrency really, really isn't real... which makes it perfect for buying illegal things on the darknet. Because if you buy something illegally and you really don't pay for it, then it isn't really a crime. Right? I'd tell you more about the initial CounterFeitcoin TM offering but then, of course, I'd have to kill you.
American Consequences 27
By Matt Weinschenk
THE BIGGEST LESSON OF MY INVESTMENT CAREER
I was one of the first people to know that Lehman Brothers would go bust, but I didn’t figure it out for myself.
I was just a 25-year-old kid sitting in the right place at the right time (the 2007 Value Investing Congress in New York City, to be exact). I was in the room when then-regarded short-seller David Einhorn walked the audience through his thesis for why the investment bank would go bust.
Einhorn didn’t regale the audience with a gripping story. He just talked accounting numbers. The shocks had already started to show in the banking system. Lehman looked like it had one of the worst loan portfolios of the banks, but it hadn’t written off any losses yet.
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American Consequences 29
160.0 Several speakers made good cases to buy stocks. After all, these were value investors and you had to have guts and buy when “there is blood in the streets.” They didn’t know it, but the streets were about to get a lot bloodier. See for yourself in the chart below: The blue circle indicates the time of the conference... We were on the precipice of the greatest financial crisis in 60 years. Everyone was worried... But we had no idea how far the market would eventually fall. The S&P 500 was about 6% off its peak. The financial sector had already fallen about 20%. 140.1 120.0 100.0 80.0 Rent Cost Median Household Income learned those two days had nothing to do with what the speakers said on stage, the investments ideas they presented, the charts they shared, or the balance sheets they studied. The mood in the room was fearful yet constructive. Between every session, folks would get on their Blackberries to check in on the stock market. Whoever got an update would yell it out in the hallway.
Something didn’t add up. And Einhorn knew an earthquake was coming. Later, billionaire hedge-fund manager Bill Ackman shared his research on monoline bond insurers. These companies sold insurance on mortgage-backed securities for a few bucks and paid out hundreds if the bonds defaulted. Ackman argued they’d go bust. They had already started to crater, but they went on to lose another 90% within four months.
RENT INCREASES OUTPACED INCOME GROWTH SINCE 2001 2001-2015
They didn’t know it, but the streets were about to get a lot bloodier.
S&P 500 yet. At that conference, I learned the biggest lesson of my investment career... As investment conferences go, the Value Investing Congress represented It was November 2007, and the financial crisis was looming over Wall Street and all of America. But the market hadn’t crashed
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
the best of the best at that time. Every
speaker managed billions of dollars. Even in the crowd, you could find yourself sitting next to hedge- fund royalty. However, what I
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