Wednesday, 20 October 2021 — Gold Coast, Australia

By Vern Gowdie Editor, The Rum Rebellion

[4 min read]

• Everything old is new again
• The three Ps
• Picture story

Dear Reader,

‘Someone give Chicken Little the axe.’

‘Vern is like a broken clock.’

C’mon folks, can’t you get more original than this?

These same sticks and stones were thrown at me in 2007.

After a couple of years of writing about how all market parties eventually end badly, my weekly newspaper column became a lightning rod for ridicule.

Then came 2008…a time when mirth turned to misery.

Suddenly, no one was laughing anymore.

From my experience, the increased frequency of barbed emails is an excellent contrarian indicator.

I expect a fresh deluge this coming weekend.

On Friday, I’ll be backing up my warning with four sell recommendations.     

If you’re one of my detractors, these will likely fall on deaf ears.

If, like me, you sense a reckoning of some description is now closer than it has ever been, I hope you’ll find this research useful and enlightening.

These are four key risks capable of subtracting the maximum amount of capital from your portfolio.

Not only that…

These four Code Reds each have the potential to break the central banks’ spell.

Now, that’s a big call. Lehman Brothers was the last catalyst to cause financial contagion. Since then, central banks and governments have done everything they can to avoid another Lehman Brother-style Code Red.

In this new world, any crisis that would end a normal cycle is just a ‘blip’. Because Jerome Powell & Co will come to the rescue and make everyone’s dollar whole again.

And to be fair, that’s exactly what happened when the pandemic hit, right?

After a big scare, central banks stepped in, and prices soared to new records.

Confidence levels remain sky-high.

The ‘you can’t go wrong’ mentality remains…despite the slight downturn we’ve seen since mid-August.

Belief in ‘what has happened, is going to continue to happen’ is as unbreakable as it is unshakeable.

Nothing indicates the future will be any different to our past.

Onwards and upwards.

As reported in The Business Week:

‘This is the longest period of practically uninterrupted
rise in security [share] prices in our history.’

Did I mention the date of this extract?

2 November 1929.

In late 1929, only a handful could foresee how radically different the 1930s would be to the 1920s.

Over the course of the 1920s, conditions changed.

Geopolitically…growing discontent in Germany.

Market valuations had risen exponentially.

Social mood went from caution to cavalier…the decade started with the Spanish flu and was ending with Wall Street fever.

Margin debt levels rose in tandem with market values.

Extremes had been reached.

Expecting these excesses to continue unchecked, was the undoing of many.

Cycles always rotate…which, to state the obvious, is why they’re called cycles.

And it’s the repetition of the cycle which makes everything old, new again.

And we, dear reader, have had the privilege to live through the most prosperous cycle in history.

The upward phase in the rotation of this cycle has endured for 40-plus years.

The longevity of this phase is what’s lulled us into believing this is a ‘forever’ state of being.

To appreciate why this IS NOT the case, we have to understand how we arrived at this point.

The three Ps

According to the Productivity Commission, the basic ingredients for economic growth (as measured by GDP) are (emphasis is mine):

‘Economic growth, as measured by GDP, is jointly determined by the three Ps — changes in population, its rate of participation of the working aged in economic activities (also referred to as 'labour utilisation'), and labour productivity.’

The three key contributors to GDP growth are population, workforce participation, and productivity.

The following chart illustrates how the change in these three ingredients has impacted the economic pie.

Note, in 1000 AD the estimated Global GDP was US$210 billion (in inflation-adjusted terms).

In 1900, global GDP (in inflation-adjusted terms) was US$3.4 trillion…a 16-fold increase over a 900-year period.

This glacial growth — around 1% per annum — reflected the economic inputs. Slow population growth, stagnant level of workforce participation, and little improvement in productive output per workforce participant.

The ingredients changed dramatically over the course of the 20^th century.

In a little over a century, global GDP increased 30-fold…a near doubling of the growth rate in one-tenth of the time.

Why?

The conditions changed…

• Population growth…1.6 billion in 1900 to almost eight billion today.
• More people meant greater workforce participation (especially with women entering the workforce in greater numbers from the 1970s onwards).
• Productivity increases derived from the advancements achieved during the Industrial Revolution and to a lesser extent, the technology revolution.

And there was one other significant factor…the financialisaton of the economy.

The ability to turn $1 of savings into $10 of debt.

The multiplier effect of — more people, more workers, more productivity, and more credit — baked an economic pie that made the 20^th century the sweetest of all…especially from the 1950s onwards.

The momentum that began after the Second World War gathered speed once the boomer generation entered the workforce.

And that’s where we pick up our…

Picture story

These graphs relate to the US market; however, the trends are indicative of what’s transpired in the majority of the developed world.

Birth rates (green line to right-hand side) peaked in the early 1960s.

A couple of decades later, with male and female boomers entering the labour force, the employment participation rate (blue line to left-hand side) increases.

Declining birth rates combined with a steady stream of retiring boomers are now contributing to a decline in labour force participation.

Not a good trend for genuine economic growth.

The financialisation of the US (and other developed economies) is evident in this next chart.

Prior to 1980, US debt (blue line) and GDP were almost in lockstep…a dollar of debt delivered a more productive economic output.

Not now.

It takes around US$4 of debt to generate one dollar of GDP.

Debt has long ceased being a productive contributor to genuine economic growth.

This is the story the world over.

Every single major developed and developing nation is awash with debt.

These days, debt growth is a much-needed steroid injection for the GDP numbers.

The economy projects an image of strength, but it’s all artificial.

The three Ps — population, participation, and productivity — are no longer the principal drivers of economic growth.

Debt, debt, and more debt is the solitary pillar upon which continued economic growth sits.

For confirmation of this, look what happened in 2008/09 when US debt levels flatlined…we experienced the worst economic downturn since the Great Depression.

Which is why interest rates are at all-time historic lows:

The cycle of prosperity we’ve lived through for the past four decades began with solid foundations. However, the economic edifice we have today rests entirely on the unrealistic notion of compounding debt growth…forever.

Never, ever, in all of history, has this ever happened.

Yet, due to the decades-long duration of this phase in the cycle, people believe the blatantly absurd (not to mention, mathematically impossible) is entirely possible and sensible.

Society’s absolute belief in the powers of central banks to conjure growth out of thin air is reflected in the current pricing of the US share market.

It’s in a league all of its own.

Historically, the value of the US market (the mean) is around 77% of the US economy (GNP).

Here’s the maths.

US GNP is approximately US$22 trillion, therefore:

The ‘air pocket’ between current value and the mean amounts to a staggering…US$28.6 trillion.

For all those who think wealth destruction on this scale is not possible, please look at what happened after the dotcom and US housing bubbles burst…the blue line reverted to (and slightly below) the mean.

History invariably rhymes.

Remember what happened after this comment was made…

‘This is the longest period of practically uninterrupted rise in security [share] prices in our history.’

Is it five minutes to midnight on the broken clock?

Tick. Tick. Tick.

As with every previous crash, it takes bravery to take actions with your portfolio before everyone else.

When prices are still high.

It also takes bravery to put your money where your mouth is and make SPECIFIC sell calls.

I’m going to do that here in The Rum Rebellion this Friday.

Regards,

Vern Gowdie,
Editor, The Rum Rebellion

Vern is also the Editor of The Gowdie Letter and The Gowdie Advisory — investment services designed to help everyday Australians avoid the financial pitfalls of a volatile economy and make informed decisions to grow their wealth for generations to come.