Logical Limits of Growth and Market Performance

No.: 
22

The Brimelow & Rubenstein argument that the bottom may be in sight deserves further attention. After all, 200 years of stock market price trend history should not be ignored, especially when a graphic of the history suggests a strong correlation between the trend line and market prices. History does repeat itself — for awhile. It repeated itself each year in the Grecian and Roman empires, until both fell. A trend can endure robustly for two or more centuries, then collapse. Such was the case of Tsarist capitalism in Russia, until capitalism turned into communism with the Bolshevik Revolution of 1917.

There are plenty of reasons that the U.S. stock market has enjoyed a 200 year run. For starters, we have seen a remarkably persistent (although sporadically irregular) growth of population, knowledge, bureaucracy, the federal budget, technology, natural resource development, money supply, immigration, paper based speculation, and widespread credit usage. Each of these considerations is consequential enough to warrant an entire argument as to the plausible impact on equity prices. Furthermore, when the effect of the considerations is aggregated, there is likely an averaging of the individual impacts, smoothing the overall effect and producing an outcome that tracks with the 7% uptrend line discussed by professor Jeremy Siegel in his book, “Stocks for the Long-Run.”

Beginning with Republican control of the U.S. Congress in 1995, there has been a tremendous emphasis in America upon preparation for retirement by means of investment in Wall Street managed capital instruments. This emphasis altered the psychology of savings and produced a Middle Class and Upper Class retirement preparation ethos that has channeled many hundreds of billions of dollars of salary income into the stock market. This growth in the “base” of market funding stimulated the development of derivatives, the value of which is determined by movements in the value of associated securities. The effect has been to turn the tail of the dog (i.e., derivatives) into an engine with sufficient power to wag the dog (i.e., securities markets). Now, the markets are at the mercy of the tail.

The Brimelow and Rubenstein thesis may be at the cusp of becoming obsolete because it does not give due attention to recent dynamics that are sufficiently consequential to disrupt the 7% two century uptrend. The most notable dynamic is the de-leveraging of the collateral that banks and hedge funds used to game financial markets and generate outsized stakes. The partial extraction of this leverage could remove one of the reasons for the stock market’s continued levitation over the last ten years, even in the face of dramatically increased debt loads worldwide. Granted, central banks and government treasuries are infusing markets with massive amounts of debt stimulus, potentially replacing much of the lost leverage. The effects of this bad debt socialization is yet unknowable. Plausibly, we could go “Roman” and experience a decline in institutional viability.

In addition to the effects of de-leveraging our financial markets we must consider other critically important prospects. The mid-term prospect for crude oil prices is up from $75 a barrel, regardless of near-term considerations. Productivity gains and improved efficiencies in commerce stemming from technological advancement appear to be losing momentum. The same is true for economic gains for the West resulting from globalization. There is little room for additional federal budgetary stimulus without spawning an equivalent reaction in inflation.

Money inflation is growing obsolete as a means of discounting government debt, largely because the rapid approach of growth in the social security and health care entitlements will raise the obligations of government impossibly beyond what can be funded with revenues. Thus, inflated federal obligations will be paid for with accelerating federal debt. This phenomenon will enormously burden not only the good faith and credit of the nation but the stock market as well. If this were not enough, we face for the first time in stock market history a situation where withdrawal demands from the market will become heavy, reflecting the needs of a growing base of retirees to finance liberal lifestyle retirements. These outflow demands will dampen the bid pressure on securities, reducing the prospect that a quasi-Ponzi style system of rewarding stock investment through price growth can thrive. Indeed, globalism’s check upon American wage growth will provide a further complication.

It is possible that the Brimelow and Rubenstein thesis, based upon professor Seigel’s data, may continue to have predictive value. Indeed, this period of weak stock market prices may prove to be a remarkably attractive time to enter the market, providing late-comers to the stock market an opportunity to make up for many lost years. I do not take a position on this question. I am staking out a position on the issue of risk and on the continued robustness of the long-term investing thesis. It is not rational in current circumstances to argue that the 200 year trend is a predictor of the future trend. The current trend could as easily predict that the move is exhausted and a recovery to former market highs will not occur in the next ten years. If so, the buy and hold practice may be irreparably damaged for this generation, especially in light of alternative uses of money.

In closing, it is reasonable to wonder what might happen to stock market prices if we were to see a world war, an acceleration of climate effects from global warming, and a (possible) loss of population worldwide. Dependent upon circumstances it is conceivable that investment prices for many asset classes, including raw land, could retreat substantially. While the bias of democratic governments is to deal with financial crises by inflating the money supply, it is possible to wreck financial systems with inflation, thus undercutting the relative value of investment assets when monetary values are eventually reset. In other words, when times are difficult people tend to allocate capital for survival and security, not for investment. Hence, the valuation of paper assets going forward will be a journey across uncharted terrain. If we live our lives prudently and benevolently — putting our families, friends and communities ahead of speculative dreams — the journey will have its fair rewards regardless of asset prices.