Dèjá vu All Over Again? (Part 2)
I received a lot of very interesting feedback for my last commentary entitled "Dèjávu all over again," so much so that I decided to share some of it with you in the hopes of elucidating this possibility of a repeat of the 1930s recovery bull market. This inflation-driven recovery rally in the stock and commodity markets from approximately 1933-1937 was known also as the "rich man's rally" since few middle class Americans had enough money at that time to be able to participate in it (as an economic Depression was still in force). This time around, of course, it's much different since there is so much debt-based liquidity that virtually everyone can participate if they so choose (even if it is with borrowed money).
In fact, this is one of the answers I would offer to those who ask me, "How can we have a repeat of 1933-1937 in the financial markets when there was very little public and private debt then compared to now?" Well there's your answer right there - the debt itself allows the recovery bull market to continue. We really don't know the outer limits to which consumer and federal debt can be stretched before it reaches the absolute breaking point. But because there is so much debt today it allows the Fed to expand the money supply to levels unheard of, which in previous decades would have caused a massive hyper-inflation and destroyed the economy. Essentially what is happening is that the Keynesian economists have reached their own version of "Nirvana" where an almost continuous expansion in the money supply can be gotten away with without having to pay severe consequences...at least for a few years longer. Anyone who says that the economy MUST implode now under this heavy strain of debt is really speaking beyond their understanding. Obviously, the Fed has gotten away with what they are doing for the last several years and they will most likely continue to get away with it for at least a few years more until the K-Wave bottom hits with all its force and magnitude. That could be as late as the 2010-2014 time frame.
This brings me to my next point: Where exactly are we in the K-Wave? Is it possible that the majority of K-Wave experts have wrongly assumed the K-Wave "hard down" phase is already upon us when in fact is still a few years off? After all, as its name suggests, the K-Wave is just that -- a wave -- and not a pre-determined cycle with a fixed time frame. Waves, unlike cycles, can be manipulated as to duration (although not as to ultimate effect). The Fed, with all the mighty tools at its disposal (many of which it did not possess during the Great Depression), has been able to artificially extend the K-Wave and keeping it from bottoming when it probably should have bottomed. This point was recent addressed by a gentleman who took the time to reveal some very insightful points in responding to my previous article. He wrote:
"In your article you drew parallels between the '30s [bull market] and the current market. It seems to me the parallel is closer to the '20s market. The 1920-21 recession and subsequent liquidity infusion appears to mirror the 2000-2001 recession and Greenspan's money airlift. If this is true then Ian Gordon's Kondratieff clock is off. We entered winter in 2000 -- just as we entered winter in 1920. The speculative bubble that developed from 1923 to 1929 is most likely the path that these markets will mirror. Remember, the innovative technology of the '20s was automobiles -- here it is broadband. Both create a belief system that allows us to deny the inevitability of a debt implosion and the coming home of financial excess. Look at the charts of the Dow and autos in '20 through '29. They are eerily close to our Dow and the Internet sector in 2000-2002 recession. By default then, the next 5 years should include huge bubbles in financial assets and create the type of euphoria that is necessary to lead to panics."
I'm not sure I agree with his comparison of our time to the 1920s, but he could be right for all we know. Perhaps I'm erring on the side of conservatism when I suggest a repetition of the 1933-1937 recovery bull market in stocks and commodities. Perhaps this gentleman's argument is a lot closer to the truth than many of us would care to admit.
Here's another insightful e-mail in response to my previous article:
"I am somewhat perplexed with the widely held belief by many well-respected analysts that a market collapse is all but imminent. As [one notable analyst] points out in his article, the response of the Fed to any perceived collapse will be a rapid and sudden injection of liquidity. So if that is the case, which I think is already the case and has been for quite some time, then won't the response of the markets be the same as what they have been following the LTCM collapse and Y2K and 9/11?
"These analysts appear to be a little contradictory. Hasn't the case been that since LTCM, liquidity injection has had an inflationary effect on the market and real estate in general, and that this excessive liquidity is now rolling over into commodities and Gold?"
Let me interrupt this reader's comment right there to answer his questions: Yes and yes! You've hit the nail on the head, dear reader, and this is the point I was trying to drive home in the previous article, namely, following every great market decline the Fed always infuses massive amounts of liquidity into the market in attempting to stimulate a recovery. In turn, this expansion in money supply finds its way into all sorts of areas like stocks, commodities and real estate...just like it did in the 1930s! He continues:
"Why is it that so many analysts are so market bearish give what has transpired since LTCM? Once again, are they failing to learn from history? Also, whilst history does indeed repeat there is one major difference that most people are forgetting: between post-1929 and this time around, the Central Banks have the capability to inject massive amounts of liquidity more efficiently than at any other time in history. In 1929 a deflationary collapse came about because of a lack of liquidity."
Go back and read those last two sentences. Read them over and over until the full impact sinks in. This is the main consideration the bears are failing to consider, viz., the tools at the Fed's disposal today to fend off deflationary collapse. Do you honestly believe the Fed would choose not to employ these tools at its disposal in keeping K-Wave deflation at bay for as long as it possibly can? Do you think the Fed will, say tomorrow, throw up their hands and say "Okay, we give up -- no more propping up the markets. Let come what will!" Nonsense!
Chart courtesy of BullandBearWise.com
As you can see, I get a lot of interesting feedback from readers and lately I've been the recipient of some extremely interesting market tales from long-time investors (my favorite type of e-mail!) Here is one story, from reader John in Australia, worth repeating since it parallels the current market situation:
"I remember going into the Tattered Cover Bookshop when I was visiting Denver in the early 1990s at the height of the then recession and looking at a wall of books in the investment section. There must have been over 100 investment books on display. They ranged from the most optimistic to the most pessimistic but the majority of them fell clearly into the latter category.
"I remember thinking that from a contrarian perspective this was telling me that the U.S. markets and economy must be heading higher. Yet I have to confess at the time that I was so under the influence of writers who took a pessimistic view that I found it difficult to believe what my eyes and my common sense were telling me.
"So I bought two books. One of them was the Rees-Mogg books (either "The Great Reckoning" or "Blood on the Streets") and the other was "The Coming Global Boom" by Charles R. Morris. I read them both and concluded the pessimists must be right. Five years later when the market was on the up and up I re-read Morris's excellent book and realized what a chump I had been.
"I have often thought one could compile a very useful contrary indicator by getting a complete list of books of investment advice published in the U.S. month by month and categorizing them as 'pessimistic,' 'optimistic,' and 'neutral.' A high preponderance of optimistic or pessimistic books would tell you which way to invest. Of course, one title like 'Dow 36,000' would probably be an indicator which would outweigh them all, but in fact it was just the extreme expression of the view put forward in the majority of investment books at the time [late 1990s]."
Thanks for sharing your market experience John, and I think you have an excellent idea for an "investment book indicator" which I am seriously going to look into constructing. Could be a very useful tool. (FYI, the current top 20 list of financial market books at Trader's Library online features titles mostly in the "neutral" category, with one prominent exception: A book on how to sell short is ranked number four. A sign of the times?)