Has 1929 Arrived?

As bad as markets were the week before last, they were even worse last week.

While the Coronavirus has been the pin that has popped the bubble, I have been forecasting a big decline in stocks for a couple years.  Admittedly, at times over the past couple of years, my calls for a major stock market decline in the near future were reminiscent of the boy who cried wolf.  But, going back several years, I put out the forecast of the Dow to Gold ratio reaching at least 2, but more likely 1.

          Given where stocks are today, that forecast still sounds more like fantasy than reality, but when looking at the facts, I am holding firm to that forecast.

          For the uninitiated or new reader, the Dow to Gold ratio is the value of the Dow Jones Industrial Average divided by the price of gold per ounce in US Dollars.  The Dow to Gold ratio currently stands just under 13.  That means I am of the strong belief that there will be more downside for stocks (probably much more) and more upside for gold.  It’s important to note that it’s quite possible we could see a bear market rally before the downtrend continues but, from a technical perspective, this still looks like a classic Elliot Wave 3 move.  If you’re not familiar with Elliot Wave analysis, it’s a method to interpret market movements.  A wave 3 down (or up in a bull market) is a strong and often long move.

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          The chart compares the current decline in stocks to that of 1929 and 1987.  Notice that the current decline is now worse and more dramatic than the decline of 1929 at this point.

          As the country plummeted into depression in 1929, economic contraction was huge.  The Federal Reserve induced bubble known historically as the “Roaring Twenties” burst in 1929 as the economy contracted severely.

          A CNBC article (Source:  https://www.cnbc.com/2020/03/20/goldman-sees-an-unprecedented-stop-of-economic-activity-with-2nd-quarter-gdp-contracting-by-24percent.html) reports that Goldman Sachs is forecasting an economic decline of 6% in the first quarter of this year and 24% in the second quarter of the year.  Should that occur, it will be the biggest quarterly decline in US history including during the Great Depression and the Civil War.  These are historic times in which we live.

          The government is promising stimulus.  Over the past week, stimulus plans have been floated from $850 billion at the beginning of last week to about $2 trillion over this past weekend as I am writing this week’s post.

          Meanwhile, there also appears to trouble brewing in the banking sector as I have also been discussing over the past couple of years.  The Federal Reserve has been supporting or propping up the repo market which is the overnight lending market between banks since September.  The Fed announced on Friday they would make up to $1 trillion per day available to big banks through the end of the month.  (Source:  https://www.pbs.org/newshour/economy/federal-reserve-to-lend-additional-1-trillion-a-day-to-large-banks)

          Read those last two paragraphs again.  We are talking trillions and trillions of dollars in an attempt to reinflate the bubble.

          Here’s my forecast – it won’t work.  As I have often stated, you can’t solve a debt problem by creating more debt.

          It didn’t work in 1929 and it won’t work now. 

          The reality is, when looking at the fiscal condition of the government in 1929, the government wasn’t broke.  Government debt was about 20% of economic output or Gross Domestic Product.  Today, government debt is well over 100% of GDP, and that’s before the massive economic contraction hits this quarter and next.  This could likely be far worse than 1929.

          For readers who think that the stock market will come roaring back once the coronavirus situation gets under control – you may want to think again.  Despite this massive and painful sell-off, stocks are still extremely overvalued.

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          This chart, from Bloomberg, shows total market capitalization compared to Gross Domestic Product.  The important thing to note from the chart is that stock valuations, after the recent huge decline, are back to where the decline started prior to the financial crisis of 2007 and 2008.

          In other words, the recent decline has now gotten us back to valuations were when the financial crisis began.  That’s stunning.  And, it also makes the case for my Dow to Gold forecast stated above.

          A salient comparison point is that during the financial crisis, the 4th quarter of 2008 saw GDP decline 8.4%, that’s about 1/3rd of what Goldman is forecasting for the second quarter of this year after a 6% estimated decline in GDP during the first quarter of this year.

          Doing some rough math, if GDP contracts by 30% from here and the economy recovers in the 3rd quarter (which is pure speculation at this point), the economic decline stands to be three times worse than in 2008.  GDP will fall from about $21 trillion to under $14 trillion.

          In 2008, stocks fell more than 50% from these current levels when using the market capitalization to GDP ratio.  It’s reasonable to hypothesize that a bigger decline from these levels is likely given that the economic decline will be three times worse.

          With the Dow at about 19,000, a 50% decline from here puts it at 9,500.  An 80% decline, which in my view is more likely given the projected economic contraction, puts the Dow at about 4,000.  That would be in the neighborhood of my longstanding Dow to Gold ratio forecast of 2 at a minimum.

          It is my strong conviction that this is not a ‘buy the dip’ correction.  There will be more downside and I believe that forecasts for a rebounding market and economy at year-end are far too optimistic.

          If you are using the two-bucket approach to manage your assets as many of my readers are, the assets in your deflation bucket have remained constant and stable.  You have experienced no losses.  That’s good and will keep many retirement plans on track.

          If you are not using the two-bucket approach but would like to discover how to potentially implement it in your situation, feel free to give my office a call.  We would be glad to schedule a phone consultation to give you details.  The office phone number is 1-866-921-3613.  Rest assured, the phone consultation will be informational only, and we’ll get you some educational handouts prior to the call.  If you have dreams of retiring and you’re concerned about your retirement nest egg, get educated.  And, as I’ve outlined here, time is of the essence.

          But there’s another piece of this puzzle that I should discuss.

          Inflation.  All this new government spending cannot be funded by tax revenues.  In a period of economic contraction, tax revenues decline.  Prior to the current crisis, the US was already running $1 trillion deficits as far as the eye could see.  Now, in light of the current situation, government operating deficits could be triple that number.

          While there are strong deflationary forces presently, I believe these forces will be overtaken at some point by inflationary, even hyperinflationary forces.  That’s why having assets in the second bucket is essential.  To preserve purchasing power.

          While it is hard to imagine inflation, given the massive decline in the value of many financial assets presently, I believe the current policy response can likely lead to no other outcome at some future point.

          Exactly when this inflation will appear is tough to predict, but there is a tipping point that we will have to reach given the massive new money creation by the Fed.

          As I wrote in last week’s blog: “…after the financial crisis, the Fed engaged in quantitative easing to the tune of $85 billion per month, or about $1 trillion per year.  Last week, in one day, QE totaled $1.5 trillion.”

          Get educated. 

I am in the process of developing additional educational materials to keep you informed as these anticipated events occur.  Look for more information by next week.

          Blessings to all of you.

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