Juggling Dynamite

Over the past 15 years, my partner Cory and I have had countless discussions about whether the present secular bear-that began off the tech wreck peak in 2000–was likely to take 3 or 4 cyclical bottoms before grinding equity valuations to the final generational buying opportunity that has marked the end of every prior secular bear in history.  The first cyclical low was in 2001-03 and the second in 2007-09.

When the 2009 cyclical recovery began in a sudden and rapid “V” formation, beginning from just fair value rather than deeply discounted values, we knew this suggested at least one more test of the prior cyclical low was likely for equity indices within 3 to 5 years.  Whether it would take a fourth decline after that remained to be seen, and depended on how much cleansing of the financial system was allowed to run its free-market course.

As it turned out, the cleansing was only skin deep, before bank-serving policy makers unleashed relentless programs to paper over management mistakes and prop asset prices quickly higher again.  As a result, since 2011 it has become more and more probable that the next cyclical decline was going to be another whopping -50%+ style bear for the history books.

While no one but a time traveler from the future can actually know when and whether this 3rd cyclical decline will prove the final plunge of this secular period, charts like the one below make me realize that the next mean reversion (amid central banks out of monetary bullets) may indeed be the last needed to finally crush reckless animal spirits and valuations to that much awaited generational-low buying opportunity.

The below picture captures the price moves of the S&P 500 ( blue) since ‘irrational exuberance’ began in 1995.  The orange line captures the highs and lows of margin use (borrowing to speculate) throughout.  The green circles mark the 2 lower low cyclical bottoms that have so far presented in the past 15 years.  The next green circle to be drawn is likely to present uncommon opportunity for those set up to capitalize on the third, and possibly final, cyclical decline of this secular bear…

As property values decline, and economic demand slows, cash flow quickly becomes insufficient to maintain debt payments and loans default. We saw a similar surge in bad loans heading into the 2007 debt crisis…

Another red flag from China as the number of bad loans jump the most since 2005 in the third quarter, fueling speculation that the economy may be slowing even more.  Here is a direct video link.

Yesterday Japan reported that its gross domestic product fell an annualized 1.6% in the third quarter, far worse than economists’ estimates of 2.3% growth, and throwing the country into its third recession since 2011.

Of course, in perennially optimistic form, none of the 18 economists surveyed by The Wall Street Journal had forecast a contraction.  See:  Japan falls into recession

After 15 years of near zero interest rates (since 1999) and wave after wave of Quantitative Easing by the BOJ (since 2001), the consensus view this morning is that the Abe government was wrong to increase its sales tax last April in an effort to raise much needed revenue.  Apparently the Japanese economy is far to weak to pay for its government spending and adding on even more and more debt to the most indebted country in the world is the only plan the consensus can imagine, even though debt levels have long past the realm of reasonably repayable.  As usual, debt is presented as the ‘have cake and eat it too’ miracle solution.

The truth is that fiscal and monetary policies the past 15 years have repeatedly saved reckless corporations, executives, bankers and bad debts at the expense of everything else.  As a result the real economy, workers, infrastructure, affordable education, proactive health initiatives, the environment, innovation–pretty much everything that actually improves and strengthens civilization–are all suffering from chronic underinvestment and lack of sufficient cash flow today.  It’s long past time to admit, repent, reform and recover.

Breakingviews’ Peter Thal Larsen argues Abenomics has even more to worry about. Here is a direct video link.