Juggling Dynamite

Further to my points in Fun with S&P 500 snakes and ladders, Lance Roberts offered similar evidence yesterday in You should never time the market? and the below chart of  the real S&P 500 total return, over complete secular bull and bear cycles since 1900.

The time noted each cycle (dotted green horizontal lines), is the time it took for markets to recover their losses and return to prior, leverage soaked, secular peaks: 26, 29, 23 years, and the most recent– not yet finished cycle–16 years from 2000-2016. We won’t actually know how many more years full recovery will take in our present cycle, until we have bottomed once more in the next bear market and then counted the years thereafter that it takes to make back the year 2000 price peak.  Who can afford to spend decades just waiting for their capital to make back losses–financially or emotionally? Working to 100 are we?

Lance offers the bottom line: “Markets spend about 95% of their time making up previous losses and the time lost getting there can’t be recovered.”

MOREOVER,  as I have explained, the above chart of total returns over previous secular cycles actually greatly overstates the real life experience of investors, because total return numbers assume no withdrawals are ever made for fees or taxes, pension distributions or ‘living on your dividend income’–no, total return numbers assume that every dividend is fully reinvested in more shares every single quarter, forever.  No lump sums are ever assumed added near tops, and no panicked selling near bottoms.

In short, the above noted decade+ of zero returns are actually a best fantasy-case scenario from present levels.  Buy and holders beware.  Patiently preserving liquidity now, so as to be able to buy income producing assets at the next cyclical bottom clearance sale though? That will finally be ‘investing’ once more.

Using high leverage–borrowing to ‘invest’ or spend–is like driving 200 miles an hour everywhere that you go. So long as weather is perfect, there are no turns, no judgement or mechanical problems, and nothing ever comes into your path, you will undoubtedly get to your destination faster.  But as soon as anything does occur, you have a huge probability of wiping out yourself and your surroundings.  After 9 years of record leveraging, a recent report from MacQuarie Capital Markets reminds of a timeless truth now haunting many countries, and Canada in particular. See: Hyper-leveraging risks Bank of Canada policy error:”

The unprecedented rise in consumer debt means the Bank of Canada’s rate-hiking cycle is already the most severe in 20 years and further increases will have far graver consequences than conventional analysis shows, Macquarie Capital Markets Canada Ltd. said.

Assuming just one further rate rise, the impact would be 65 percent to 80 percent as severe as the 1987 to 1990 cycle, according to Macquarie, which took into account five-year bond yields, household debt and home buying. Canada’s housing market slumped in the early 1990s after that rate-hike cycle and a recession.

Although a distinction I would make here: the policy error that has been replicated by central banks around the world, is not increasing rates off the zero bound over the past year, but rather, the error was in leaving rates near zero for the unprecedented 8 years before that.  It was this madness that encouraged and enabled the self-destructive financial decisions now ailing us.

It is necessary to try and raise policy rates as well as lending standards from what has been years of recklessly low levels–although there is little room to continue much further this cycle, before the slowing economy prompts cries for cuts and easing (!) again.  In the meantime though, asset prices that have been ramped up unreasonably on rising leverage, will come back down to reconnect carrying costs with free cash flow.  Falling asset prices will also compound problems for those needing to refinance or sell into strength.

For real life examples of household financial stress already in motion, watch ‘Digging out of debt, real life scenarios’ with Canadian trustee in bankruptcy Scott Terrio.

Danielle was a guest on The Financial Survival Network with Kerry Lutz, talking about recent developments in the world economy and markets, you can listen to an audio clip of the segment here.