Why We’d Welcome a Depression

DUBLIN – Dow down 252 on Wednesday – or 1.5%. Chevron, Apple, and Goldman Sachs leading the retreat. The press blamed China, North Korea, oil, and “geopolitical concerns.”

So far this year, the Dow has lost 3% of its value [ed. note: as of Thursday’s close it has lost a little over 5%]. Let’s see… We believe it is headed for a 50% loss. So, at this rate… we’ll be there by June!

A less than joyous start to the new year: the DJIA has so far delivered its worst first trading week since at least 1900. That’s the year 1900 in case you were wondering – click to enlarge.

Readers frequently accuse us of being “negative” or “depressing.” Yesterday, one even charged us with fanning the fires of fear and fright to sell newsletter services. We deny it. Fear doesn’t sell financial services.

Ask Goldman. Wall Street sells greed, not fear. It promises profits, not losses. It offers dreams of wealth, not nightmares of poverty. Besides, when you see prices falling, you just go to cash. You don’t need expensive trading advice.

At the Diary, we monger neither fear nor greed. Our only mission is to try – feebly… humbly… uncertainly – to connect the dots. Of course, the dots are many… and they are everywhere. Like a Rorschach test, we risk seeing only what we want to see. But you can’t see anything if you don’t look. So, we squint… we strain our eyes. And what do we see? A top! And then what?

A secular downturn, when stocks will go down – or nowhere – for the next 10 years. If we’re right, a lot of fortunes, jobs, reputations, and mojos will be lost. Defaults, depressions, disruptions, deflation – we’ll probably see a little of them (or a lot!).

Many dear readers find this unappealing; and they mistrust our motives. They seem to think that because we see clouds on the horizon, we must want it to rain!

But wait… They are right. That is the pattern we’ve been looking for!

This parched earth needs a good soaking… and a healthy wash. But if readers think this is “negative,” they should blame themselves, not us. They are looking at the glass as half empty; we only see the part that is full of St. Emilion Grand Cru 2006.

Debt and Claptrap

Look on the bright side: If we’re right, you’ll get a lot more for your money in the stock market 10 years from now. Not only that, but also much of the debt and claptrap that now strangles the system will have been purged.

Greenspan, Bernanke, and Yellen will finally be regarded as the rascals and flimflam artists they really are. Businesses that should have gone bust in 2008 will finally hit the wall. And the speculators, bankers, and bamboozlers who should have been bankrupted in the last crisis will finally get what’s coming to them in the next one.

All the major central planning charlatans in one place. Ms. Yellen looks slightly worried, which she has every reason to be. Alan Greenspan looks like he would like to run away at the earliest opportunity. Mr. Bernanke’s self-satisfied grin can be explained by his timely exit from the job as central planning head honcho and the new and far better paid job offers he has accepted since then.

Photo credit: Federal Reserve Board

Yes, some investors will feel the pain. The economy will suffer. It will be bent by bitter fate and outrageous fortune…but into a better shape! A stock market correction is not something to be feared. It is something to look forward to… something to be embraced, like a plumber who has come to unclog your bathroom drains.

It may get messy; but what a relief it will be to have the toilet working again. We saw a headline from our colleagues at Casey Research yesterday (our old friend Doug Casey’s outfit). It recommended that investors short – that is, bet against – U.S. stocks.

That will probably turn out to be good advice. But it suggests a level of confidence we don’t have. Getting out is good enough for us.

Cash Is (Still) King

But get out of stocks and into what? Cash, dear reader… cash. No financial services needed. Cash is king now. And it will be until we come to the next major pivot point. Study those dots…

The Fed has favored easy credit for at least the last 20 years – quickly cutting rates in the face of even the smallest signs of adversity and dragging its feet when it was time to raise them. Each time a contraction of credit begins, the Fed reacts with even lower short-term interest rates. And each time it drops the price of credit… it creates another bubble.

The Nasdaq bubble in the late 1990s… the housing bubble that followed… and now the nascent bubble in student debt, corporate debt, sovereign debt… and a small group of tech stocks that has raised U.S. stock market indexes to rare and dangerous highs.

And now, the Fed imagines that it is going to return to “normal”! That was the way the dots looked when 2015 adjourned. In 2016, there are new dots appearing… and old patterns are coming into sharper focus. What do we see now?

Uh-oh… As we reported yesterday, Nobel prize winner Robert Shiller’s cyclically adjusted price-to-earnings ratio – or CAPE ratio – tries to get a truer picture of value by looking at the average of the past 10 years of earnings and adjusting for inflation.

Real S&P 500 (adjusted by CPI) and the P/E 10 (or CAPE) since 1871. No matter how one looks at it, the stock market is in the upper 10% range of historical valuations. In short, it is extremely overvalued – click to enlarge.

And by this measure, only three times in the last 135 years has the S&P 500 been more expensive – in 1929, 2000, and 2007. All three times were followed by major market crashes.

Some excitement is coming… Stay tuned.

Charts by stockcharts, Doug Short/advisorperspectives

Image captions by PT

The above article originally appeared at the Diary of a Rogue Economist, written for Bonner & Partners. Bill Bonner founded Agora, Inc in 1978. It has since grown into one of the largest independent newsletter publishing companies in the world. He has also written three New York Times bestselling books, Financial Reckoning Day, Empire of Debt and Mobs, Messiahs and Markets.