If history repeats itself

A few days ago, I looked at the Dow over the past 40 years and concluded that, on average, the real growth rate was very close to the very long-term historical norm.

What I didn't think to do then, is to illustrate the shape of the Dow if it continues to be as volatile as in the last 40 years. So here goes - same average growth, same inflation rate etc:

It's the volatility that does you in. As Keynes said, "In the long run..."

Matter of fact, if history repeats itself, there's a point around 2021 where in real terms, we're behind where we were in 1967. This time, I will buy beads and wear flares. I'd still be younger than Robert Graves was last time round.

Chirpy

Don Boudreaux is an economist, yet although an expert in the "dismal science", he is an optimist, which makes a very nice change. He claims it's because he's a professional in the field.

Here he says that America's freedom and creativity will overcome present problems, as they have in the past; here he says the housing market can't be too bad if workers are unwilling to sell their houses in a falling market; and here he claims to love America's trade deficit.

Is he right? Or just seeing affairs from the point of view of a man who's had a good dinner and is assured that, in his case, good dinners will never stop coming? I've often thought that war movies should end prematurely and at different points for a random selection among, say, 20% of the audience, to remove the Olympian perspective.

But it is nice to read someone who thinks it's not all gloom and doom.

Banks, usury and slavery

In the UK, GDP is said to trend long-term to an increase of around 2.5% per year, hence also the Monetary Policy Committee's figure for inflation target-setting.

Since 1963, the M4 money supply has grown by an average of slightly under 13.5% per year. So that would be about 11% p.a. relative to GDP.

This means that bank lending, as a proportion of GDP, doubles every 7 years.

How long can this continue? How long before we are completely robbed and enslaved? Or am I asking a fool's question?

Awaiting the caning

Karl Denninger reports here that the Dow's price-earnings ratio may be overestimated by a factor of 4. And here, that financial institutions will have to bring Structured Investment Vehicles back onto their books within 12 months.

The reckoning - the painful correction - approaches.

Doug Noland (April 4) agrees:

It is my view that our economy will require a massive reallocation of resources. We will have to create much less non-productive (especially mortgage and asset-based) Credit and huge additional quantities of tradable goods. In the “services” sector, there will no choice but to “liquidate” labor and redirect its efforts. Throughout finance, there will be no alternative than to “liquidate” bad debt, labor and insolvent institutions – again in the name of a necessary redirecting of resources. After an unnecessarily protracted boom, there will be scores of enterprises that will prove uneconomic in the new financial and economic backdrop. “Liquidation” will be unavoidable.

Will our wise leaders in the UK learn from this?

P.S. How come (Denninger, here) the Dow p/e appears out of whack by 53:13, but the S&P 500 only 20:14? The latter implies only a possible 30% drop, which is a bit less apocalyptic than the 75+% of the Dow!

Generally the Dow and the S&P have followed similar trajectories over various periods, with a little widening in the last 12 months:

The enemy, part 2

Fishy business in the gold market

Contrarian Investor reports that gold is being loaned out at negative rates of interest, which he thinks is in order to help short the gold market. There's a manicured thumb on the scales, it seems.

Does asset inflation help support stock prices?

An anonymous comment on the preceding post has set me speculating further. The commentator says:

You are right, but I believe that this time around it will be equities, rather than commodities or real estate that will provide the hedge against coming inflation. Tobin's Q will prevail due to the juxtaposition of equity prices vs. the other two asset classes (which already had their surges) and the market's increasing valuation sophistication compared to the last time we saw hyperinflation in developed economies (i.e. the 1970s). So I've been buying stocks as an inflation hedge, despite the statistical evidence that this is foolish...

Wikipedia offers an explanation of Tobin's Q here. Essentially, Q is a measure of the relationship between the value of all a company's shares, and the value of the company's assets. If Q is greater than 1, there is some reason (real or imaginary) why the company has extra value to offer; if less than 1, a share investor could buy a company's underlying assets at a discount.

In 2006, Michael Alexander wrote a series of articles for Safe Haven, about stock cycles. Below, from the second in the series, is his graph for Q in several bear markets, including the one which he suggests began in 2000:

According to this, Q was already below 1 in 2006, and since the market is now back to about where it was a couple of years ago, that would suggest that shares are now fairly valued in relation to company assets.

But if history repeats itself, the current bear market has a long way to go, since the other three lasted 15 - 20 years. And in each of the previous cycles, Q slumped below 0.4.

Another complicating factor, thanks to the lending boom, is the real estate bubble. Steve Moyer is firmly of the opinion that real estate is very heavily overvalued, even now. So a collapse in that market would push Tobin's Q back up for many companies, a technical indication that share prices would have to drop steeply to get back to fair value (let alone overshoot to below Q=0.5).

In this context, it's worth noting that one of Mike Alexander's books, published in 2000, is titled "Stock Cycles: Why stocks won't beat money markets over the next twenty years".