Two
questions that I’m commonly asked are: “Do you still expect the market to correct next year,
even with all this liquidity?” And, “Can
the Fed mute the effects of the cycles bottoming in October 2014?”
The first question can only
be answered provisionally. If the stock
market melts up heading into 2014, the odds of a crash will increase
dramatically at some point before the Kress cycle bottoms toward the end of the
year. The market has certainly shown
signs that investor optimism is increasing on Wall Street, even if small retail
traders haven’t quite yet joined in on the exuberance.
There are already a growing number of
indications that investor optimism is reaching climactic levels among the pros,
a trend that will likely only grow heading into 2014. Should this continue it’s something that
could exacerbate a market correction next year.
As an example, Yahoo Finance recently published an article entitled, “The
Next 10% Correction Could Be 5 Years Away” by Jon Markman of Markman Capital
Insight LLC, an advisory service in Seattle.
Markman wrote:
“There has been a lot of concern that stocks have gone too far
lately without a 10% correction. The fear is that, if the market goes on too
long without losing at least a tenth of its value off a high, any pullbacks to
come in the future will be a lot more dramatic.
“The analysts over at Bespoke
Investment Group took a look at
that question this week and came up with an interesting study. They observed
that the S&P 500 has now rallied 59% over a period of 515 trading days
since Oct. 3, 2011, without logging a 10% decline from a high. And while it is
certainly unusual, it is by no means unprecedented, or even close to the
longest such streak.”
The above graph, created by Bespoke, shows all past rallies
without a 10% correction since the index was created in 1928. The current streak of 515 days is well above
average, but the article emphasized that there have been two periods over the
past 25 years that were more than twice as long: the first was from March 2003
to October 2007 (the length of the previous bull market). The S&P 500 went 1,153 trading days
without experiencing a 10% correction, according to Bespoke. The longest streak on record was from October
1990 through October 1997, a total of 1,767 trading days.
“The current streak would have to extend all the way out to Oct.
1, 2018 — five years from now — to match that record,” Markman observed. He concluded that “as long as a low-growth
environment also features low inflation and an accommodative monetary policy,
the price/earnings multiples of successful companies can rise a lot higher than
most people think.”
Articles like this one are commonly seen near major highs in the
major indices. As such, they can be
viewed from a contrarian perspective which suggests this rally is living on
borrowed time.
As far as the Fed, I think it's safe to say it
has already provided enough liquidity to prevent a 2008-type "super
crash" scenario in 2014. This will eventually backfire, however,
once the 120-year cycle bottoms next year and a new inflation cycle begins.
In other words, inflation will likely be the next problem in the years
following 2014, as we’ll discuss in the paragraphs that follow.
30-Year Cycle
As
the final months of the long-term deflationary winter wind down, our thoughts
keep turning to the coming spring of a new 30-year inflationary cycle. This cycle is set to begin after the late
September/early October 2014 period based on the methodology of the Kress
cycles.
For
a picture of what will likely happen in the U.S. in the coming years, look no
further than Japan. The income gap is
widening and the difference between the haves and the have-nots has never been
more conspicuous. The monetary policy of
Japan’s Prime Minister, Shinzo Abe, are the driving force between this gap.
Deflation
was a blessing in disguise for consumers in Japan, but the blessing of
deflation is now being replaced by the curse of inflation. Deflation was especially beneficial for the
country’s aging population for some 20 years as low consumer prices helped the
elderly and underemployed get by during times when the economy was
sluggish. With the advent of Abenomics, however,
Japan is finally starting to see signs of inflation after more than 20 years of
falling prices.
Consumer
prices increased 0.8 percent in August compared to a year ago, the fastest pace
since November 2008 according to Bloomberg
Businessweek. Economists expect that
Japan’s inflation could rise 2.8 percent in 2014 due to a sales tax increase. Barclays correctly predicted Japan’s
inflation rate would rise earlier this year (see graph below from the International Business Times). That rate is only expected to increase in the
coming years.
Bloomberg also points out that land prices in
Japan’s three largest cities – Tokyo, Osaka, and Nagoya – rose for the first
time in five years. Mizuho Securities real
estate analyst Takashi Ishizawa believes land prices will continue to rise in
the larger cities, where rents will also expected to increase.
To
help households cope with the growing problem of inflation, Prime Minister Abe
is encouraging companies to raise wages.
The problem is that wages aren’t cooperating: they fell 0.6 percent in
August from a year ago, keeping a 15-month downward trend intact. This is another point of contention for the
U.S., for the coming long-wave inflationary cycle could be much more malicious
than the previous one that ended around 1980.
At that time wages were rising along with prices and interest rates,
which made it easier for consumers to absorb the price increases. The coming inflationary cycle could witness a
continuation of the stagnant-to-falling wage trend as prices and rates
rise. This would be positively
catastrophic for America’s middle class.
As
I pointed out in the previous commentary, Japan was the first major nation to
feel the effects of the long-term deflationary cycle and is also first to
emerge from the long-wave deflationary winter.
What is now happening to Japan is instructive, for it will also happen
to the U.S. once the cycle has bottomed next year.
The
growing income disparity in Japan is being exaggerated by Abe’s ultra-loose
monetary policy and has already become evident.
While the country’s upper-middle class wage earners are enjoying its
benefits through the proceeds of their stock investments, lower-income earners
are struggling to make ends meet. Prices
are rising and with it the cost of living, which is squeezing workers at the
margins.
To
put Japan’s economic picture into perspective, the average income of the
country’s richest 10 percent is 4.5 times higher than the lowest 10 percent,
according to the United Nations’ 2007-2008 Human Development Report. By contrast, the gap between the richest in
the U.S. is 15.9 times higher than the poorest and 13.8 in the U.K. This gap is expected to widen in the coming
years once the new long-term inflationary cycle kicks into full gear.
Banks
and governments never seem to learn from history that refusing to let the
cycles take their natural course can only create greater problems down the
road. Unfortunately, America seems
doomed to learn this lesson the hard way.
