This Chart Might Make You Rethink The Adage "Stocks Always Come Back"

Authored by Jeff Clark via GoldSilver.com,

It was a pretty simple inquiry on my part: Mike Maloney predicts the stock market is facing the mother of all crashes - if he’s right, then how long before the average stock investor would get back to even?

I wanted to know not only for myself, but because I have a daughter just starting in her career. I also have a wife with a 401k and over a decade to retirement. I have a son in college. I handle my retired parents’ money. And I have other family and friends who follow traditional brokerage advice and have 60% of their portfolios in stocks (or more in some cases).

So, if the stock market crashes, how long does history say it’ll take for their stock holdings to return to pre-crash levels… months? Years? Or—gulp—decades?

It’s an important question, because the answer will tell you how to invest depending on your timeframe. And if the answer ends up being “a long time”, well, you might consider sidestepping the stock market altogether if you, too, are nervous about its frothy nature.

At this point the average stock broker will pull out a looong term chart of the S&P and show that over time—despite numerous crashes and corrections and bear markets—the stock market ultimately marches higher. History does show this to be true on a nominal basis, further bolstered by the investor who is dollar cost averaging and reinvesting dividends (though these charts always exclude commissions and fees).

But when I saw one of those charts from my broker many years ago, I did notice one thing: over the past 100 years or so, there were a handful of crashes that not only looked like the Grand Canyon, they took a long time to recover. “What if that happened to my portfolio?” was the question I immediately muttered to myself.

Years later, after recalling my Dad’s grumbling about inflation in the late 1970s, I had a second question: if the Dow did end up taking a protracted time to get back to even, wouldn’t inflation erode my real rate of return? If it took a portfolio-killing ten years, for example, I might have earned back that $20,000 I lost, but now the car I’d planned to buy with that money cost not $20,000 but $30,000. Or $40,000. Show me all the long-term charts you want but I still can’t afford to buy that car.

So here was my inquiry: in the biggest market crashes, how long has it historically taken the S&P to return not to its pre-crash price, but to the inflation-adjusted level? By asking this question, I felt like I’d be better equipped to not just handle a major downturn but decide if I should be in the market at all.

Here’s what I discovered. In the four biggest stock market crashes since 1900, the inflation-adjusted recovery periods were all measured in decades.

Inflation rates obviously varied during each period, but even low inflation adds up over time. So even when the nominal price of the S&P climbed back to the prior peak, it had taken so long that that amount of money would no longer buy as much. Your brokerage statement might show a gain, but in real terms you’d still be underwater. It’s a sobering realization, one that dawns on most people only when they go to actually spend the money.

Here’s the breakdown of each recovery period:

• Beginning in 1906, it took the S&P 500 index 20 years to get back to its inflation-adjusted, pre-crash level. No wonder; the total amount of inflation during that time period was 74.0%.


• Deflation was the name of the game in 1929, of course, with inflation readings registering as low as -10.3% during the Great Depression. But the S&P had fallen so far that inflation returned before it could recover… inflation totaled 48.7% during the 26-year time span, resulting in the S&P not reaching breakeven until 1955.


• From 1973 to 1987, inflation totaled a whopping 104.0%. High inflation rates combined with the depth of the crash made stocks “dead money” during that 14-year span.


• And those “low” inflation readings we’ve had since the new millennium? It totaled 35.2% over the first decade and a half, and led to the S&P taking 14.5 years to regain its full purchasing power. This silent erosion kept unsuspecting investors in the red, on a real basis, until 2015.


• It’s worth pointing out that the Nasdaq still has not recovered from the bursting of the internet bubble. It lost 78% of its value in the crash, and adjusted for inflation is still down 17.6% (as of 6-30-17) from its March 2000 peak! In other words, almost two decades later, tech stocks are not back to the same level of purchasing power, despite the index being higher on a nominal price.

Clearly, the biggest stock market crashes in history have been big enough that inflation played a key role in their recovery.

So, if you think the stock market is at risk of a crash—and there are plenty of signs pointing to that being the case—then you may want to consider stepping aside for a time being, and look to start buying again after the crash.

Perhaps a more effective solution is to buy the one asset that is not just inversely correlated with stocks (meaning it tends to rise when stocks fall), but is also one of history’s best inflation hedges, even in hyperinflation.

If the stock market crashes and inflation kicks in, this asset just might be one of the few offensive weapons left in your portfolio. History says now is a good time to put that hedge in place.

RBC Explains Why The Market Is Dumping, Adds "This Is Not The Big Short"... Yet

Having yesterday revealed what he believes is the single biggest risk to the buyside in general, and hedge funds in particular, in today"s market (the answer, for those who missed it, is the strong dollar suddenly turning weak, as it is continues to do today), here is the follow-up note from RBC"s Charlie McElliggott, explaining where we stand now.

* * *

Where We Stand

As laid-out in yesterday’s Big Picture note “THE SINGLE LARGEST MACRO INPUT RISK TO THE BUYSIDE,” as asymmetrically ‘long US Dollar’ positioning ‘tips over,’ so too should we expect a drawdown on consensual macro and thematic-equity trades.

Tactical cases are everywhere for an extension / acceleration of mean-reversion trades, largely based-upon positioning excess and reversing technicals.

As the case has been built over the past month and a half in the “RBC Big Picture,” reversal strategies are a regular feature in the January landscape—especially after such clear trend developed in the back half of ’16 with regards to ‘reflation—those being:’

• Long USD, stocks, small cap / domestically levered, value factor, cyclicals beta, inflation, high tax rate, HY / high beta credit (CCC over BB), CNH, curve steepeners, copper


• Short USTs / ED$ / duration, euro, yen, EMFX / EM eq / EM bonds, growth, defensives, low beta / low vol, VIX, gold

As some of the reversion was ‘pre-traded’ in the back-half of Dec, it made sense to us that this January wouldn’t be an outright repeat of the violent VaR shocks experienced in a number of recent Januarys as ‘momentum’ reversed hard and everything from ‘bonds vs stocks’ to equity factors turned upside-down.

That said…the driver for the acceleration of ‘reversal trades’ yesterday into the overnight was the Barnum-esque circus of a press conference yesterday from President-elect Trump. 

Expectations were built for a more “Presidential” tone, with more granular ‘policy talk’--especially as it pertained to the nuances of the tax plan, fiscal stimulus, and the Obamacare unwind.  Needless to say, we got a “goat rodeo” instead, and it spooked a lot of the TACTICALLY long reflation crowd.

Reflationary growth expectations have clearly been a significant driver of the USD ‘bull case’—but the tax component (overseas profits $ repatriation / border-adjusted tax (BAT) system theoretically driving ~15% currency appreciation) has been a massive-input as well.  As stated yesterday, any resetting of expectations there (“watering down” of the BAT) will see a lower Dollar concurrently.

Sure, spec net Dollar positioning is at 1 year highs.  But even more than ‘just’ the cumulative FX positioning itself is the observation that the Dollar is the “grand unifying asset” of the “domestic growth / reflation” trade theme.  So in that sense, “long USD” is a factor embedded in nearly every one of the aforementioned popular macro longs and shorts.

The idea I have to again stress here is this: nearly all of the gains from these “reflation” trades were “last year’s business.”  Point being, YTD, most of these trades are moving from “not great” to now approaching “REAL negative PNL.”  As risk-managers are highly-sensitive to such start of year drawdowns and we near the ever-present “tight stops,” you have to BOLO for capitulatory flows (perhaps as best expressed by yesterday’s mega-impressive $20B 10 year UST reopening auction which saw a blistering 70% indirect bid, which caused a very significant squeeze in USTs across boards).

It should be noted that thus far, the ‘least’ relatively effected trades have been the thematic and factor trades within the equities-complex.  Reasons for this are ‘three-fold’:

1. The very tactical nature of discretionary macro (making generalizations here but…) is concentrated on the FX, rates and commods side of the ledger as opposed to equities per se.  Thus, we’re seeing much of the reversal ‘profit-taking’ or ‘unwind’ concentrated in those ‘pure macro’ assets. 


2. Equities flows are still being largely dictated by the slow-moving rotation of ‘real money’ as they reallocate portfolios after living under the old “slow growth / slow inflation” narrative.  Now we currently see said ‘sticky long-term money’ reallocation into cyclical sectors like financials, industrials and energy, as again evidenced by yesterday’s NYSE MOC with the largest notional sector buys being #1 Financials and #2 Industrials… by a wide margin (“pros on the close”), and has been that way a majority of days in ’17 YTD. 


3. From a more tactical perspective, with the USD at the center of this unwind, the Dollar weakness has driven WTI higher, which in turn has kept the Energy sector and more importantly inflation-expectations “BID” (per the Quant-Insight macro factor PCA model, higher “inflation-expectations” continue to show as the largest positive price input driving SPX).

The US Dollar index (DXY) has now cracked lower through its 50DMA for the first time since the immediate period post- Election.  The 100 ‘psychological level’ also has some technical significance and is very much ‘in play’ now.  From there, we would have a looooong way to go down to the 100DMA (98.94) and the 200DMA (97.03). 

What can arrest this unwind from ‘metastasizing’ further?  The thing that drove the “true” basis for the “reflation trade” long before Trump won in the first place—the continued-ascension of cold hard global data.  As listed yesterday, the collective trajectory higher of the data has been nothing short of breath-taking, from global PMIs to Chinese inflation to US average hourly wages and ‘animal spirits’ confidence metrics. 

The data still makes a very real case for higher rates in the longer-term, and with it, more US hikes / quicker exits from say the ECB than the market is currently anticipating. Obviously this would be USD- positive.

Tactically-speaking in the ‘now,’ the Dollar reversal lower in this case is helping reignite the commodities bid as well, and with it, inflation expectations remain very strong (see Breakevens ‘strong like bull’).

And of course too, flow will be a massive driver of this: still being told that some in both the ‘overseas real money’ crowd and leveraged fund community would look to fade the rates move at say ~ 2.20 level.  In conjunction with the US varietal of real money rotating “growthier” in equities as well (‘turning the Titanic’ slowly), stocks can remain bid over the coming months (not for nothing, but I’ve had discussions with 3 large distressed credit funds in recent weeks who are concentrating much of the ‘going-forward’ within the equities universe—point being stocks continue to have that ‘best place to be’ perception). 

It still feels like there is another meaningful stocks rally to come, especially after the “positioning excess” is cleared through this “mean-reversion wobble” period.

* * *

Only then can we begin talking about “the big short” around say a “stagflation” or “real rates” financial-tightening trade.

U.S. REAL RATES AND U.S. DOLLAR INDEX SINCE ELECTION:

Central Banks Have Broadcast What is About to Hit...

The biggest problem for the financial markets is not stocks nor is it the economy.

It’s the Bond Bubble.

Globally the bond bubble is now over $199 trillion in size. The world taken as a whole is sporting a Debt to GDP ratio of over 250%.

This is a systemic issue.

Once the bond bubble became large enough, Governments themselves are at risk of beingCentral insolvent. At that point, there were only three options:

1)   Stop spending as much money.

2)   Increase revenues (more on this shortly).

3)   Make the debt loads easier to service.

Governments/ politicians will never push #1 because it is political suicide (the minute someone pushes for a budget cut the media and his/ her political opponents begin attacking the candidate for being “heartless” about some issue or other).

Option #2 is the so-called “growth” option. When Central Banks talk about focusing on “growth” what they’re really hoping to do is increase taxes (higher incomes, higher GDP growth=more tax money).

Remember, taxes=revenues for Governments. And revenues are what the Government uses to make debt payments. However, at some point, once you are deep enough in debt, the growth option becomes impossible.

This leaves options #3= make the debt load easier to service.

There are two primary ways to make debt more serviceable.

They are:

1)   Lower interest rates.

2)   Inflation.

We’ve already had #1 for seven years. Central Banks have been at ZIRP if not NIRP for years. This policy has failed to result in any deleveraging of note. If anything, it has allowed Governments and Corporates to make the bond bubble even larger (everyone has been taking advantage of astoundingly low rates to issue even MORE debt).

Which leaves only one option: INFLATION.

In the last 12 months every Central Bank has made major admissions that they WANT inflation and are willing to do anything to create it.

In the US, FIVE of the six inflationary metrics the Fed uses to measure inflation have all reached their targets.

The Fed still refuses to raise rates.

In Japan and Europe, Central Banks are already spending a record amount of QE per month ~$180 BILLION per month. And both Central Banks have just announced that they will fail to hit their inflationary goals (setting the stage for even more aggressive monetary policies).

Gold has figured it out. While everyone is worrying about whether or not stocks have topped, Gold has broken out or is about to breakout in $USD, Yen, and Euros. 99% of investors have missed this, but it is the biggest "tell" in the markets today.

This is a MAJOR signal. Inflation is coming. And the biggest opportunities will be in the precious metals sectors, NOT stocks.

On that note, we just published a Special Investment Report to our clients concerning a unique play on Gold that less than 1% of investors know about.

In its 8 pages we detail a single play that gives you exposure to 25 million ounces of Gold. The market is completely mispricing the value here, valuing the entire resource at just $273 per ounce.

Our report is titled The Gold Mountain: How to Buy Gold at $273 Per Ounce…

…and we are giving away just 50 copies for FREE to the public.

To pick up yours, swing by:

http://www.phoenixcapitalmarketing.com/GM1.html

Best Regards

Graham Summers

Chief Market Strategist

Phoenix Capital Research