Crisis Progress Report (12): Zero Will be King, by Robert Gore

THERE IS A NEW TAB AT THE TOP OF THE PAGE: DEBTONOMICS ARCHIVE. IN RESPONSE TO POPULAR DEMAND, READERS WILL HAVE A LINKED LIST OF ALL OF ROBERT GORE’S ARTICLES ON ECONOMICS SINCE SLL MOVED TO THE WORDPRESS PLATFORM LAST YEAR. AS YOU MAY SUSPECT, IT IS NOT BEING POSTED BECAUSE HE HAS BEEN WRONG.

“Markets make opinions” is a psychological truism. Current financial turbulence is putting investors and speculators on notice of economic perturbations that can neither be ignored nor remedied with the standard debt-based pixie dust. Even the permabulls are hedging their public comments and predictions, especially after both dovish and hawkish utterances from ringmaster Yellen sent markets reeling. The punditry and media deal in stories, which the unfolding debt deflation and depression are throwing off abundantly: China, Brazil, crashing commodities, big moves up and down (mostly down) in stock markets, credit spreads blowing out, bankruptcies, possible bankruptcies (Glencore) and Wise Men and Women from finance and governments opining on developments.

What the punditry, with some exceptions (see Blogroll), and the media don’t do is offer much in the way of analysis that either explains causes or predicts effects. They are a mirror into prevailing crowd psychology and emotion, but their so-called causes are generally superficial and don’t stand up to empirical verification. Their predictions are usually straight-line projections of more of whatever happens to be the current same.

That is not because the root causes of the present turmoil are too complicated and complex to ascertain. Quite the contrary, the explanation is simple. As SLL has stated since last year (see “Debtonomics: Robert Gore’s Economic Archive,” SLL) an unwind and contraction of a massive and unprecedented multi-decade debt expansion is underway. It takes no acuity to reach that conclusion, indeed it requires more effort to avoid reaching it.

Complex mental gymnastics are performed and transparently fallacious public statements are made, either to explain why what is obvious to many is not really happening, or to divert attention to irrelevant considerations. People tie themselves up in mental knots to evade reality for psychological reasons. It is not hard to understand why most avoid the debt contraction conclusion. Debt contractions, especially those that run their full course, are economically, financially, socially, and politically painful.

Debt contraction has not been allowed to run its full course since the Great Depression. Governments and central banks shot their wads rescuing the global financial system from the last one, consequently, this one will run its full course. Markets, at least in the short term, are exercises in crowd psychology. Two virtues are required for successful longer term investing: independence and patience. Although the crowd is starting to question, albeit not discard, what has passed for wisdom the last few years, the abandonment of complacency and capitulation to fear won’t happen until markets are much closer to an ultimate bottom. Indeed, such a herd reversal will be one of the telltale harbingers of that bottom. Independent and early recognition of what is transpiring—a full-fledged debt contraction—entails recognition that it will be a lengthy process.

One of the best analysts of stock market dynamics is John Hussman, of the Hussman funds. SLL has posted some of his weekly letters, most recently, “Valuations Not Only Mean-Revert; They Mean Invert,” 9/29/15. The upshot of his analysis is that markets not only revert to a mean, or average, level of valuation after a period of extreme overvaluation (e.g. the current stock market, even after it’s recent fall), but that they overshoot to a state of undervaluation, what he calls mean inversion. Markets being markets, their paths are not straight lines, but rather jagged, negatively-sloped progression within which there are substantial bear market advances, subsequently reversed. Historically, the entire progression from extreme overvaluation to extreme undervaluation can take almost two decades.

The recent demise of former market darlings health care and cable—industries encased in the government cocoons of Obamacare and net neutrality respectively—confirms that even the “best” companies, which in the crony capitalistic economy means most succored by the government, will succumb to the burgeoning debt contraction. However, both the dynamics of such contractions and Hussman’s analysis suggest that we are a long way from anything approaching a true “buying opportunity” for long-term investors. Prices have fallen and an estimated $13 trillion of global wealth has vanished. However, as Hussman notes, prices have not fallen nearly enough in percentage terms to create undervalued bargains, and there are more bankruptcies to come in commodities and across the rest of the economy. Any price above zero is too much to pay for companies whose equity is wiped out.

At this point, assuming your selling is done and you sit mostly in cash, with perhaps a little on the side for speculative shorts, the best investment advice is to be patient. It will probably take appreciably more opinion-making market downside before prominent permabulls switch to the bearish camp, the mainstream media proclaims a long running bear market, and the news is filled with dire headlines. The gloom will get so thick and one-sided that when nobody expects it, a rally will ignite. It won’t be a one-day or one-week wonder, either, it will span a month or two and will recoup a substantial percentage of the losses. The last crisis is instructive. The S&P index topped in October of 2007 and dropped for five months until a rally began, in March of 2008, that retraced half the drop. Such rallies are almost universally disbelieved when they start and almost universally embraced as the beginning of a new bull market when they end. Bullish belief had been restored in May of 2008 when that rally ended. The rest of the year was tears.

Catching the falling dagger has skewered more speculators than Vlad impaled Turks. If you are positioned correctly, stay away from nonstop news and market updates. Obsessing on the short term and watching screens tick by tick will distort or destroy your essential long-term thinking and planning. Use the time and psychological energy saved to write that great novel that everyone has inside them, or get to know your wife and kids. Assume a rally like the one in 2008 is in the offing. If the 2008 rally’s timing is any guide, this one will start between now and New Year’s, but there are no assurances; it may begin next year. While you will want to take profits on your speculative shorts, use the rally as an opportunity to reset those shorts at higher levels and avoid the temptation to try to scalp a few trades from the long side.

We are still at the beginning of this debt contraction and the first big move down is incomplete. Not until the next big move down, after the coming head fake rally, will recognition become almost universal that we are in a severe bear market. If you patiently preserve your fire power by ignoring the day-to-day squiggles and jiggles, your virtue will be rewarded. The invested herd will discover that there is something worse than the zero returns they so decry when they mock cash: negative returns. Deflationary depressions reprice virtually every asset class, real and financial, bestowing jaw-dropping bargains on those few who can plunk down cash on the barrelhead when the time is right. In the land of negative returns, zero will be king.

WHEN WAS THE LAST TIME YOU STAYED

UP ALL NIGHT READING A NOVEL?

AMAZON

KINDLE

NOOK