Inevitability. When I see a sequence of numbers like this: 42, 13, 4, 2, 1, 1 — I see inevitability.  These numbers correspond to the number of months between Greedometer® sequences.  A Greedometer sequence is a plot of values generated by the Greedometer algorithm (there is also one for the mini Greedometer algorithm). When a sequence initiates, the S&P500 is about to reach a secular (long term) peak. Sequences continue through the stock market meltdown until they’re truncated by some form of significant fiscal and/or monetary policy stimulus.    Here is an example:

As someone that has repeatedly identified US stock market peaks (within a couple weeks of it happening) as being secular, then seen a nascent meltdown truncated, I’m mindful of the perma-bear label, and of seeing Greedometer-generated forecasts trampled by government induced policy support.  Many contend this form of can-kicking can go on ad-infinitum.   This article will suggest that not only will the can kicking come to an end, it seems to have done so this month (or even this week).

With a lame and incredible (not credible) fiscal cliff patch in place, a relief rally has ended the previous Greedometer sequence and re-ignited a new one in record time.  Here’s the data:

 

Look at the red numbers. There is a shrinking amount of time between Greedometer sequences. For those that appreciate mathematical elegance, you’ll enjoy knowing that the decay rate of the function defined by this series is a near-constant 69%.

  • there were 42 months between the initiation of the 2007-2009 sequence and the one that preceded it (2000-2003).
  • 42 months minus a 69% drop = 13 months. This was the length of time until the next sequence initiated.
  • 13 months minus a 69% drop = 4 months. This was the length of time until the next sequence initiated.
  • The next number in the series is 2 months. However, the Greedometer algorithms are only accurate to within 2 weeks, so it is within the margin of error for the 2 month value to be 6 weeks, and the 4-month value could be 19 weeks. This yields another 69% drop.
  • The series terminates with values of 1 and 1. We’ve reached the limits of accuracy of my algorithms. And more importantly, we’ve reached the end of the series.

The data suggests this is a system in a constant state of decay since year 2000. This of course means the same problem has been plaguing the US economy since year 2000, and that it has not yet been fixed. The fact that the last entries in the series are 1 and 1 is interesting. It suggests the series is ending. There are three potential outcomes:

1)  There won’t be any more Greedometer sequences (not for another 35 years or so). The core issue facing our economy (too much debt) has been solved. The fiscal cliff patch solved everything! Stock markets are about to initiate another long bull market run.

2) We face non-stop build-ups then crashes at a very rapid pace like we’ve seen over the past 6 months. We’re in economic and stock market purgatory necessitating continued  unsustainable fiscal and monetary policy support. We’re destined to rise and fall for years to come, until the debt is finally rationalized.  Ugh!

3) There is a final Greedometer sequence about to initiate (this week or next). This one brings us to an ultimate secular stock market bottom.

Let me suggest option 1 is not likely. The currently proposed fiscal cliff patch involves $1.8T in so-called budget deficit cuts over the next 9 years. This is farcical. Here’s what our debt and GDP will look like, 9 years hence….

fig 10.2 1.8t cuts

Now I don’t know about you, but I’m betting we won’t be allowed to get this ugly. Our international bond buyers will stop showing up.  The chart assumes an annual average real GDP growth rate of 0.8%.  FYI: GDP growth  averaged 1.7% over the past 13 years -and that required $Ts in fiscal stimulus that is now going to be reversed. It also required $Ts in monetary steroids that are not likely to continue past this year because food & fuel inflation will cause QE to be stopped. And finally there was the GDP-beneficial aspect of Americans using their house as an ATM machine. Do you see that happening over the next 9 years?

On to option 2: purgatory. It has been happening in Japan since 1989. It definitely could  happen here too. But it would require continued fiscal and monetary goodies. Last I checked, the US and Europe, are embarking on what will likely be years of fiscal contraction. How long can central bankers man the printing press?  Probably until it is clear their actions are causing as much damage from inflation as the supposed “wealth effect” benefit.  How’d that work out with QE2?

As you can see, QE2’s $75B/month in Fed balance sheet partying caused real-world inflation to rise from just over 1% to nearly 4% in 10 months.  Granted QE3 & QE4 aren’t accompanied by the same level of helpful fiscal policy, but $85B/month could easily cause 5% inflation by some point in early 2014 since we’re starting from 2% instead of 1%.  I suspect the Fed will begin making noises about shrinking or stopping QE before this happens. The most recent Fed minutes seem to suggest there are some already thinking this way.  So, no I don’t see option 2 being viable because if something can’t continue for ever, it won’t.

This leaves option 3. Essentially this is a forecast for US stock markets, global stock markets, and all manner of risk assets to suffer another monumental drop — and that this drop would likely initiate with a peak this month.  How credible is this?  Let’s examine….

In the 119 years from 1881 to 1999 there would likely have been 3 Greedometer sequences.

Yet we’ve seen 6 Greedometer sequences since year 2000 and are about to initiate the 7th. Each of the previous 6 sequences were truncated by mammoth fiscal and/or monetary steroids that allowed for more kicking the can down the road. That these sequences were truncated at different points in their meltdown causes some (most) to misinterpret what’s happening. Each of the sequences was destined to reflect the damage inflicted by a stock market crash of 60% or more (the 2007-2009 crash saw the S&P500 drop 57% before it was stopped by fiscal and monetary support).  That some of these sequences were stopped when only 10% or 20% drops had occurred creates a false sense of security — that government fiscal and monetary policy measures will be able to continue kicking the can indefinitely, and that they have the ability to prevent another stock market crash and economic depression. The above chart suggests there’s a 130 year+ US stock market history wherein P/E ratios are mean reverting, and that we’re likely to see a cyclically adjusted P/E on the S&P500 drop to the 6-7 range in 2013 or 2014.

Let’s see what a 7-handle would look like. The current P/E is 22.5 while the S&P500 is at 1466 (Jan 10 2013).

1466 X 7/22.5 = 456.  Ouch!

133 years of mean reversion is highly credible. In fact, there’s an element of inevitability.  Hence option 3 has the highest probability.

Before I wrap up, let me leave you with these facts.  The S&P500 celebrated a new post-financial crisis high today. This is the highest the index has been since December 2007.  Great.  Now zoom-out a bit on your perspective. Here’s what you’ll see….

The S&P500 is where it was in December 1999. 13 years of epic volatility and no return other than dividends. You would have made more, paid less, and seen orders of magnitude less volatility with money market funds even though they’ve been paying virtually nothing since 2008. I suggest the S&P500 will see these levels again in several years time.  To those that think this 13-year stretch is a 1-off event, I have this to convince you otherwise….

The S&P500 delivered nothing but volatility and dividends from October 1968 through July 1982. Nearly 14 years of panic-filled treading water.  FYI: the Greedometer probably would have begun redlining in early 1966 when the P/E peaked at 24, and stopped redlining in the summer of 1968 — a few months before the S&P500 peaked. Since my data only extends back to January 1999, I cannot validate this estimate unfortunately.  For comparison purposes, the Greedometer began redlining 11 months prior to the S&P500 peak in October 2007 and stopped redlining 3 months prior to the market peak. In the 2000-2003 meltdown, the Greedometer began redlining in December 1999 — 8 months prior to the 2000-2003 stock market collapse initiated.

 

Welcome to 2013.

If you found this interesting, please buy my book – Greedometer 2.0. The Rats Are Jumping Ship. - when it comes out in April 2013. You may also consider becoming a paid weekly Greedometer Newsletter subscriber.