From Eric Janszen at iTulip.com
"As regular readers know, my background is in technology and finance, with experience as CEO of high technology companies and in venture capital management. It will not surprise readers to hear that many of my friends have similar backgrounds. You may wonder what they have made of my less than optimistic outlook on the US and global economy over the past several years. They had the option of hearing my opinions or the professional advice of an army of certified and well meaning financial planners and money managers, the vast majority of whom are trained to sell Wall Street’s main financial product: stocks. Armed with 'efficient market hypothesis' that claims that markets are all knowing and asset prices reflect all knowable information and charts and graphs that “prove” that buy-and-hold is the way to make money in the stock market, they carefully develop for their clients, my friends, portfolios heavy in stock assorted funds and indexes, various flavors of bonds, and perhaps a few commodity ETFs for the adventuresome. The mantra, delivered with the consistency of religious belief, is this: you cannot time the markets. Entrepreneurs are by nature optimistic, and busy, so they tend to go along with the traditional and rational sounding presentation of the official source for such opinion, a certified financial planner or money manager. Over the years, most of my friends have regarded my warnings about Wall Street and the stock market with skepticism, even amusement. Over the past few months, however, I have received calls and emails from friends I have not heard from in years. The tone is anything but humorous. The typical note goes like this: “I remember what you told me. I wanted to sell last year but my financial planner told me not to, that I can’t time the market. What should I do now?” Reminding my friends always that I am not a certified financial planner and cannot provide personal investment advice, I proceed to give my views on the markets and economy."
"That forecast back in 2001 was complicated by the housing bubble, the most idiotic and irresponsible act of government economic manipulation in world history and completely beyond me to predict. Not even in my darkest dreams did I think our Federal Reserve and banking regulators could be so stupid: bursting real estate bubbles bring down banking systems and economies. They did in the US in the 1870s and 1930s, in Japan since the 1990s, and many other nations as well. The US 2002 to 2006 housing bubble extended the tax cut, rate cut, dollar devaluation reflation boom by two of years longer than the 1930s version sans housing bubble. As you can see, that extension made the collapse we are seeing today considerably more severe. Now we have a post bubble reflation boom crashing around the fake boom created by the technology stock bubble- two crashes nested one within the other– thus the terrific cascading financial and economic collapse we see today. We wrote dozens of occasionally over-the-top, but always factual and data driven, warnings on iTulip.com since March 2006 to try to scare readers out of the stock market. As it turns out, we were able to determine and notify subscribers on Dec. 27, 2007 when the DJIA was trading at 13,365 that, if they were for some crazy reason still in the market, that was it: the last chance to get out. That forecast was informed primarily by two pieces of information. One, our research told us that US markets were likely to begin in 2008 to experience a bear market that more or less tracked the Nikkei during the first year of the Japanese debt deflation in 1990, off 40%."
"Yes, we know. “No one has a crystal ball” and “no one can foresee the future of the markets.” Is that what your financial planner told you? We hear that all of the time that no one can forecast the markets, certainly not to this degree of accuracy. But this forecast was uncomplicated if you understood the simple underlying dynamic: US households and businesses, and the government itself, had since 1980 built up too much debt. The rate of increase in debt was unsustainable.The credit bubble began in 1980 after the Fed raised short term interest rates to 19%. The 1975 to 1980 inflation that preceded that drastic action deflated all the debt in the economy, leaving US households and businesses with a clean slate. The “fat spread” between high but falling wholesale borrowing rates paid by banks and more gradual declines in rates paid by retail borrowers made lending very profitable and vastly expanded lending and, with it, increased debt. Once the fat spread effect ran out in the early 1990s, bank reserves rules were changed to extend the credit boom. Once those benefits ran out in the early 2000s, lower lending standards, low interest rates, and financially engineered debt products together enabled by newly deregulated debt markets, extended the credit boom for one final spurt of growth. At its height, the US credit machine was producing five dollars of new debt for every dollar of GDP growth, up from a ratio of one to one in the 1960s. The entire 27-year old edifice of debt came crashing down starting with the crash of the securitized debt market in Q1 2007. It was game over and 2008 was the first year of the American debt deflation. All credit bubbles end with a sudden withdrawal of purchasing power from the markets and economy that have become dependent on the massive flows of fresh credit. Debt deflations go on and on until the debt is deflated, one way or another, either by monetary deflation and debt defaults as in the 1930s or by monetary inflation as occurred between 1975 and 1980 in the US. The Japanese have since 1990 deflated debt the slow, hard way, siphoning off cash flow from households and businesses for nearly two decades to pay it all down, and in the process transferring mountains of private debt to the federal government through public spending programs. Our government is hoping to do that, too, except unlike Japan in 1990 our government is deeply in debt to foreign private and official lenders already. If somehow we manage to pay our debt down the hard way as Japan has over nearly two decades, what was Japan’s reward for toughing it out? The Nikkei is today at 8,273 after reaching 39,000 at the end of 1989, off 80% in nominal terms in 19 years. The first relevant fact in our Dec. 27, 2007 Debt Deflation Bear Market forecast was that the US is entering a debt deflation and that debt deflation is a bad investment environment for a buy-and-hold strategy. Two, contacts on Wall Street conveyed in many ways, some subtle and others not, that a last ditch effort was on to run up the market going into the end of the fiscal year in 2007 to collect the last bonuses that the current generation of bankers expected to see before Wall Street went down for the count in 2008. So much for efficient markets. Quite a few are unemployed now. Some of the analysts I know from Lehman landed at Barclays, a few bearish and therefore well-positioned hedge fund managers did well shorting stocks and are still active, and a few old contacts at JP Morgan and Goldman Sachs are still there, but I can’t imagine the industry will ever be the same. Huge imbalances in the US and global economy developed for over 30 years. Now they are rebalancing, as many non-mainstream economists have warned was certain to happen sooner or later, warnings which were argued as alarmist by mainstream economists. The global monetary system cobbled together in the 1970s after the US unilaterally abandoned Bretton Woods, and the unintended consequences of that -- the inflated purchasing power of the US dollar, buildup of gross external debt to 95% of GDP, and America's gigantic current account deficit -- started to come apart in 2007 following the crash of the securitized debt market, that followed the collapse of the housing bubble. It had to come apart anyway; the securitized bond market happened to be the proximate cause."
"Why did the credit markets crash? The credit market is best understood as a transactions network. One node or set of nodes crashes, and in the process transmit the information that caused the crash to other nodes. Entire sections of the network crash and become inoperative while others continue to function, which explains why credit continues to flow almost normally in some credit markets that function as more or less autonomous sub-networks. However, eventually the entire network may fail, with only a few isolated sub-networks functioning, and large sections of the US economy will devolve into operating on a cash-only transaction basis as has occurred in other instances of credit market breakdown in other places in the world."
"The stock market buy-and-hold era ended in 1998. In a world where the so-called business cycle is dominated by bubbles, inflation, crashes, deflation, recession, and reflations and all manner of government interference, stock market timing, and sector analysis, will continue to be the key to making money. In fact, across the broad stroke of American history, there is never a period when markets are not either largely or entirely influenced by the actions of government. For hundreds of years the US has either been at war, recovering from war, growing asset bubbles, crashing asset bubbles, recovering from asset bubbles, or mucking around with the monetary system–entering the gold standard, leaving the gold standard, entering into a new global monetary regime, leaving that regime– endlessly. How can markets possibly be efficient if they are perpetually driven by large-scale events produced by government policies? The idea is profoundly naive. On a final note, given what were to me and many others glaringly obvious risks with predictable outcomes for the stock market going back to 1998 when I got out of stocks and started iTulip.com, and the horrific advice that many certified financial planners have given their clients over the years, I wonder if the licensing of financial planners has operated for the last decade as a scheme to portray a unified Wall Street financial products sales force as an independent, disinterested, and expert -- and therefore unquestioned -- collection of investment professionals with only their clients’ best interests at heart. Except for the few renegade licensed financial planners who escape the indoctrination with an ounce of common sense, most doggedly stick to absurd investment theories like “efficient markets” that have no relevance in the real world, follow arbitrary portfolio balancing rules that just happen to favor a large stock market position no matter that a large cash position is warranted by clearly observable risks, and express antagonism toward asset classes such as precious metals that, unfortunately, have a legitimate place in the portfolio of any citizen of a government that has a printing press and knows how to use it, that is, all of them. The financial mayhem the majority of financially planners have unleashed upon the portfolios of millions of Americans over the past year informs my view that the entire financial planning licensing system should be abandoned and replaced with a simple referral system that qualifies financial planners entirely on performance based metrics, not abstract theory that favors one asset class over another. No one expects a perfect crystal ball, but going to cash to dodge a 40% correction in 2007 was not rocket science. All you had to do was look at all the debt: there was and is too much of it, and there is no way that the unwinding of all that debt can possibly be good for stocks. That’s just common sense."
"You can interpret this either as the bond market smelling a repeat of 1930s deflation or late 1970s inflation times two or three. Hoover or FDR? Pick your poison. I expect Hoover then FDR, disinflation then inflation ala late 1970s but more extreme, to deflate the debt. Will these market and economic anomalies diminish, the markets recover, and the economy return to normal within the timescale of the 50 or 60 year old buy-and-hold stock investor? Perhaps, but more likely a transformation of the entire structure of the global markets and economy is starting that will take decades to resolve. In my view, these historic events will next year be complicated by political responses to high unemployment globally, and it is reasonable to expect that some of these responses will not be entirely constructive."
"Last year we warned you of the start of the Debt Deflation Bear Market. It will continue in 2009 but with rallies driven by cycles of fiscal stimulus optimism and disappointment, fear of deflation and fear of inflation. For the next several years, economies and therefore markets will be largely driven by ebbs and flows of sentiment driven by government spending or expectations of government spending, as well as fears of unintended or intended consequences–inflation. Political confusion expressed as policy paralysis over the cause and cure for the root of the problem–the credit bubble debt overhang–will dominate the markets this coming year. "
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