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The Debt Cycle gets a Stick in the Spokes

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I’ve written a fair bit about market cycles over the past few months.  In truth, I have touched on the equity market, the bond market and the real estate market.  In doing so, I have opined that all three are in a bubble and that all three are being driven by the same factors – unprecedented monetary and fiscal stimulus.  Friends and colleagues have taken to berating me and taunting me on social media because the concerns that vex me haven’t materialized yet.  Alas, even brilliant economists like Robert Shiller have repeatedly acknowledged that valuations are poor timing tools over weeks, months, quarters and even years, in some instances.

 

While this is undeniably true, it is equally true that the Shiller CAPE is eerily accurate in projecting the returns that investors are likely to realize over the forthcoming decade.  That number for the United States large cap market is hovering just barely above zero right now.  In other words, according to Shiller’s metrics, which have been astonishingly accurate in the past, we might reasonably expect the U.S. stock market to be at a similar level around the middle of 2031 as it is now.  Please take a moment to reflect on that.

 

In the post-COVID world, I have stopped buying books and have taken to downloading them from Audible instead.  One of the ones that I finished recently is “Mastering the Market Cycle” by Howard Marks, the billionaire head of Oaktree Capital with degrees from both Wharton (University of Pennsylvania) and Booth (University of Chicago).  What Marks mentioned is much like what I recently came across from Ray Dalio, the billionaire hedge fund manager at Bridgewater Associates.  Both experts (Marks generically; Dalio specifically) note that we seem to be in the very late stages of the debt cycle and that it cannot go on for much longer.  Debt monetization (central bankers printing money like mad to help governments provide liquidity as they, in turn, spend like mad) has been going on at a breakneck pace for over a year now.

 

The process inevitably leads to a guaranteed negative return on bonds.  Indeed, the return on bonds in Canada in Q1 was somewhere around -5%.  The experience south of the border has been similar. Dalio thinks rates will have to rise further and that that development will present a dilemma for central bankers.  Governments will be selling bonds to fund spending and investors will be selling bonds because they are poor investments.  As it stands, the 10-year U.S. Treasury bond has already moved from 0.6% to 1.7%.  Eventually (and I suspect this is not far off), this will begin to hurt the stock market.  Not long after that, the broad economy may be affected, too.  All that FOMO money and all those TINA investors will see that markets can go down, too.  Don’t shoot the messenger.  Trying to provide notice without causing a panic.  With great humility, I think we’re in for a rough ride that will not end as quickly or as easily as the 2007-2009 GFC or the laughably short and almost pain-free 5-week hiccup in February and March of 2020.  This time, there will be genuine pain.

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