Crosscurrents and Caution

10/10/2018 5:00 am EST


Alan Newman

Founder, Crosscurrents Publications, LLC

History is a stern taskmaster and provides ample evidence that not only do corrections occur, bear markets occur as well, cautions Alan Newman, editor of CrossCurrents.

For the record, a century of data shows a 10% correction should occur about every 1.44 years, a 20% drop every 3.77 years and a 30% drubbing every 8.91 years.

From print high to print low, the Dow Industrials were down 12.2% early in the year and we were close to 20% down in the late summer of 2015, but we are overdue for a 30% decline.

There are ample reasons to expect another monumental decline. Besides valuations, sentiment is also at a mind boggling extreme. Our best gauge is margin debt because it represents a bet with borrowed money. You cannot invest borrowed money. You can only speculate with borrowed money.

Total margin debt, which we measure using the NYSE & NASD totals, equates to over 3.2% of the country’s GDP, as high as anytime since 1929, and net liquidity remains near the all time low recorded in January 2018. It makes perfect sense to extrapolate that this trend will soon reverse.

In the last decade, GDP has more than doubled but any positive impact of additional debt on GDP has substantially declined. From 1988-1998, each dollar increase in the federal debt was accompanied by $1.33 growth in GDP.

Over the next ten years, each dollar increase in the federal debt was accompanied by growth of almost $1.17 in GDP. However, in the last decade, each dollar increase in the national has fueled only $0.46 in GDP growth. The pattern could not be more clear.  The more that is borrowed, the less there is to be gained.

Our “point of no return” is where federal debt begins to accelerate sharply upwards, coinciding with roughly the last ten years. Although the five year growth rate has indeed increased modestly in the last five years, the pattern suggests that the best we can expect for the economy for the decade ahead is perhaps 2.6% per annum.

At worst, we will suffer another recession and in fact, we are overdue. Since the end of WWII, there have been 11 recessions and their arrivals have averaged roughly five years after the previous recession. The last recession ended over nine years ago.

While we have maintained a target downside of Dow 14,719 (down a ghastly 43.5% from today), a 50% decline matching those we suffered from the 2000 tech peak and from the 2007 “double bubble” peak is quite possible.

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