Total Private Market Debt’s Decline Should be a Glaring Warning Sign
By Comstock Partners
As the nation experienced the Great Depression beginning in 1929, Total Credit Market Debt as a percentage of GDP rose substantially before eventually collapsing. The years following the ’29 crash were characterized by the most dramatic rise in public debt (and decline in private debt) the nation has ever seen. Beginning in the 1980’s total debt began to expand dramatically until the Total Credit Market Debt hit 380% of GDP in early 2009. Subsequently (just like in the Great Depression), the private debt started to decline while the public debt was rising. (See chart by Ned Davis Research).
The decline in debt/GDP from this level is a signal that we are headed for another period of apprehension about investing, apprehension about borrowing, apprehension about the markets and apprehension about the direction of the country. Extended periods of apprehension, disinvestment and caution lead to deflation and deflation is much worse than inflation or disinflation because the economy, if history is our guide, will enter a severe recession or depression. Prices going down and the consumers waiting to buy is treacherous for the economy.As you can see, the debt/GDP rose to 260% in the Great Depression, before eventually declining to 130% 15 years later. We believe we entered a secular bear market in 2000 when the dot com bubble burst. The debt-to-GDP rose to 380% as we entered the financial crisis in 2008 and, so far, that has been the peak as private debt has dropped more sharply than public debt rose, and the debt to GDP ratio rolled over to 350% currently. Why wouldn’t that be a glaring warning sign that the deflation that we continually warn our readers about is right in front of us?
We think that another cause of concern should be the way the stock market has rolled over with the latest three significant rallies of the S&P 500 filled with "froth" as described below. As you can see from the second chart attached, created exclusively for Comstock by Ned Davis Research, each major component of the economy is retrenching except the Government. But the Government, traditionally the "investor of last resort," is tapped out. Not just tapped out, but the country is trapped in an ideological struggle regarding how to move forward. Can you say"impasse"?
We see a vicious downward spiral operating here. The commercial private sector is not investing, or borrowing, because it does do not see increasing demand for goods and services, broadly speaking. Quite the reverse; in fact, they fear declining demand and, as a result, are sitting on record levels of cash. So why are we surprised that they are not hiring!! The consumer sector sees a stagnant or declining job market and is retrenching and repairing its balance sheets. State and local governments will have to continue to retrench (read: lay off additional staff) and that will add to the unemployed. This leaves the Federal government in a major dilemma.
We will use excerpts from a prior Comstock Report to explain the second reason (besides the rollover of debt described above) we are so concerned that we are in the midst of a deflationary secular bear market. The latest Comstock "Special Report" titled "Stock Market Volatility since 1994" showed the huge volatility since 1994 and described how the swings to the upside were clearly speculative, debt ridden, and bear market traps. The upswings began with the mid 1990s to 2000 led by the dot com mania, where virtually all stocks traded at valuations levels that were more than extreme. Then the S&P 500 (S&P) started the bear market that we had been expecting since the late 1990s, finally occurring in early 2000 from the 1555 level.However, instead of letting the market fall to attractive levels naturally, accompanied by deleveraging and consumer balance sheets being repaired, the bear market was interrupted by the Fed, the Administration, Congress, Wall Street, greedy realtors, and overly ambitious home buyers. This free market intervention created the second bubble and drove the S&P up from 800 in early 2003 (we had expected it to decline to much lower levels since it was trading at 26 times trailing 12 mo. earnings) to almost double to 1575. That upswing was even harder for Comstock to believe than the dot com mania rally. In fact, we mentioned the housing bubble in almost all of our comments during the period from 2003 to 2007.
Then the "Financial Crisis" hit in 2008 and the market crashed to 666 on the S&P in early 2009. The latest rally took the market back to 1370 on the S&P from the oversold 666 level. Technically, this looks like the market is rolling over and declining from a triple top formation with three bear market rally traps (see chart from MarketSmith). We will be shocked if we have another speculative rally like the last three -investors just can’t be fooled four times in such a short period of time.
If you take a look at the MSCI World Market chart attached (courtesy of Ned Davis Research) you will see that world markets have a similar pattern to the S&P 500 chart.Both of these charts (S&P and world markets) look like triple tops
This triple top formation that started with the end of the greatest bull market in U.S. history from 1982 to 2000 (even with a crash in 1987) also followed an enormous increase in debt during this same bull market. Then the total debt, both public and private combined, really accelerated and more than doubled from 2000 to 2008 (going from $26 trillion to $53 trillion). The Public debt increased because we experienced two unfinanced wars, and an unfunded Medicare Part D drug program (with demographics working strongly against us). The Private debt increased because the Fed lowered rates and created a housing bubble and the investment banks securitized anything and everything with a cash flow. Lending standards completely collapsed as zero equity (and worse) loans became the new standard based on the fictional concept that the value of everything would continue to rise, especially housing and real estate. Until it didn’t! While government debt continues to explode, the private sector debt has "hit the wall" and is declining even more with the consumer deleveraging. This decline in private sector debt we would have thought would engender trepidation to outright fear or even panic with investors, but so far this is not even mentioned in the financial media.
The implications for the markets are clear. The earnings estimates on the S&P must go down significantly. With the problems in Europe, and then the potential slow-down in China (after building more residential and commercial construction than presently needed) we would have to think that declining investment (debt) would be even more cause of concern. In our opinion, the stock market is headed to much lower levels, and as we stated before, any upswing will not exceed the 1250 resistance level of the S&P, and any rally should be sold.