Juggling Dynamite

As I wrote last September when stock markets were rising and macro data weakening, bear markets with loss cycles greater than 20% are inevitable and recurring, but it’s not necessary that individuals lose along with them.

The last decade has seen the longest financial market expansion in history to some of the most extreme valuation measures ever, and still, most participants and professional asset allocators have no plan other than to hold and hope that price appreciation continues indefinitely.  It never does.

Most stay long and wrong even though minimizing losses and having cash to buy assets near cycle lows are the most defining imperatives of compounding positive returns over an individual’s life cycle.  It’s for this reason that Warren Buffett’s long proclaimed number one investment recommendation is Don’t lose money!  And yet, most continually ignore this to their great detriment.

Riding rising markets during expansion cycles requires no skill.  Effective management has rule sets to help anticipate down cycles and position to benefit through them.  As Hedgeye CEO, Keith McCullough, put it today:

“Almost anyone can run money on the long side of Equities, in any country, when the equivalent of the VIX is trending and trading in the range of 8-16. That would be the equivalent of driving a car in London without anyone to pickup/dropoff and/or having any risk to manage. Not everyone runs money well in a developing or ongoing bear market (VIX 20-80 range).”

If you were shaken at the drawdowns in your savings from February 20 to March 23 and relieved by the rebound into early May, you have entered this bear market wrong-footed, and probabilities are that the pain is far from over.  It’s not too late for self-preservation, but time is of the essence.

A study from the University of Antwerp, Belgium surveyed 11,000 shoppers in 11 different countries, including Canada, and found that during the pandemic shutdown shoppers have cut spending on ready-made meals and snacks, are cooking more of their own food and using more fresh fruit and vegetables.  In the process, most report lower food waste and spending.

In the end, the pandemic is a health and financial crisis, and eating fresh, home-cooked meals better bolsters health and resilience on both fronts.  Hopefully, these new habits will stick.  See Locked down shoppers turn to vegetables, shun ready-made meals.

Moreover, teaching children how to prepare food from scratch at home is part of how parents pass on love, culture and self-sufficiency training.  Beats time on Netflix and social media by a country mile.  This clip made me smile this morning.

Thirty years of progressively higher consumer spending and debt have coincided with rising corporate profits, low savings rates, gambling preoccupation and boom-bust asset cycles.  All were deleterious to present resilience as we encounter the first economic depression since the 1930s.  Case in point:  a decade long economic expansion, with record corporate profits and rock-bottom unemployment and interest rates, ended this year with the majority of households and businesses unable to withstand even a month of lost income.

Financial discipline is deficit just as expected returns for most investable assets are nil to negative and further capital losses untenable.  Adding more household debt and risky assets at extreme valuations to try and reboot spending will not work this time.  That trick is done.  The last decade was all about boosting the income statement at all costs the next will be all about improving balance sheets.  This is an entirely different way of thinking.

The way forward dictates spending less, paying down debt and building up savings again.  Frugality and proactive measures are coming back in vogue.  For the economy overall, this means lower spending from the consumption sector that has driven about 60% of Canadian and 70% of US GDP over the last two decades.

It also suggests a secular downturn in sales and profits for most businesses (always reliably mean-reverting through history) with a reduction in debt, share buybacks, dividend payout ratios and a laser focus on improving efficiency and productivity.

Governments will have to pick up on spending as the private sector rebuilds its balance sheets.  But what we spend on will make all of the difference in the world.  Spending to fund consumption or elongate dying business models will not cut it.  Tax dollars will need to be invested in big picture improvements, infrastructure and innovation that will reduce waste and illness, increase health and productivity–New (Green) Deal thinking, not old.

To pay for all of this, tax rates are headed up across the board and blood doesn’t come from stones.  Those who have income and property will be tapped to pay the lion’s share, obviously, while consumption taxes will move higher for everyone.  It’s just the math of it.  There is no government benefactor, there’s only us.

In the decade of the 1930s, corporate and capital gain tax rates nearly doubled while personal income tax rates rose about 150%.   We should expect similar trends ahead, along with a tightening of loopholes and reinvigorated prosecution of tax evaders and their helpers.  This is long overdue.  Our next war effort has arrived.