Lessons From 1937

American railroads avoid another crisis... Lessons from 1937... These haven't been 'unprecedented' times... The similarities are too strong... Quit stocks to make money now...

We begin today with the latest 'from the tracks'...

I (Corey McLaughlin) wasn't planning to open today with a discussion about American railroads... And I have a completely different topic to share with you today. But we must start with the latest news about our railways...

You might remember our two "Trouble on the Tracks" reports from earlier this year. The trouble didn't go away since we last spoke about it... back when certain businesses were complaining that major railroad companies like Union Pacific were asking them to ship less product – because the railroads couldn't handle the volume.

As many of you with experience in the railroad industry shared, the problems stemmed from years of malinvestment, the pursuit of better profit margins, deteriorating working conditions and benefits, and a general lack of workers on American railways.

I remember one note in April from subscriber and current railroad employee Jason B. in particular. He said (and he wasn't the only one) that an alleged "locomotive shortage" stemmed from railroads that left their engines and cars in storage because of a lack of fiscal motivation or workers.

Plus, many shorthanded railroads had started new attendance policies "to keep people working crazy hours." They could, considering the major railroads and unions were bargaining since November 2019 on a new contract. Jason concluded...

I have seen a lot in 30 years and I'm a fourth-generation railroader. This is the worst it has been and we are far from bottoming out.

For the past week or so, the collective issues hit the mainstream…

Stalled negotiations between major railroad companies and three labor unions representing tens of thousands of workers have had the potential to cripple supply chains (again).

A strike could have started as soon as tomorrow... and could have idled 7,000 trains and cost an estimated $2 billion per day to the economy.

This morning, with the White House's apparent prodding, the sides agreed to a tentative last-minute deal to avoid a strike for now, at least, the worst-case scenario as railroads near their typically busiest season. As industry website Supply Chain Dive reported...

The agreement, which represents approximately 60,000 railroad employees, will now head to union members for a vote during which period they will not strike.

The deal includes a 24% wage increase over a five-year period, retroactive to 2020 and going through 2024, an immediate 14% wage increase, and five annual $1,000 lump-sum payments, according to the National Carriers' Conference Committee, which represents U.S. freight railroads.

On the surface, that sounds like leverage on the tracks. Of course, it only took a pandemic, supply-chain disasters, and more inflation fears for people to notice... then three years of workers not having a new labor agreement and deteriorating conditions to get there.

Moving on... back to eight decades ago...

This might feel like a hard right turn from railroad negotiations, but I think you'll see it's really not once we get into the details...

In 1937 and '38 – during what was the recovery from the Great Depression – the U.S. experienced its third-worst recession in the 20th century. And that period looks familiar today.

I'm an optimist. I really am. But I'm also a realist and a believer in history meaning something. That's because I'm also a believer that it's human nature to ignore or simply not care about history because we have more pressing everyday things to worry about.

But knowing history can help you avoid making bad decisions in the present. And to think about history during an important moment, you must know about it before the moment arrives.

Longtime readers may remember our research on 90-year cycles...

A few of our colleagues find this particular timing more than coincidental. Our Dan Ferris has written about the idea and talked about how we're living in a "Fourth Turning," a concept introduced by the demographers Neil Howe and William Strauss decades ago.

For different reasons, our Greg Diamond has been tracking a 90-year cycle for patterns in stock markets, too... and it influenced his call late last year that the end of the bull market could happen in 2022... He was spot-on.

And, admittedly, I wrote an essay on the idea of the 90-year cycle – or saeculum – based heavily on the work of Howe and Strauss as well. When I read their work in the throes of the pandemic summer of 2020, I found it incredibility enlightening and relevant.

Their book, The Fourth Turning, was published in 1997. Based on generational cycles that they've tracked over the past five centuries, Howe and Strauss theorized that America's next "crisis era" would peak exactly in 2020.

What they found was predictable eras or "turnings" – a high (or boom), followed by an awakening, then an unraveling, and a crisis – typically play out in order every 80 or 90 years, roughly the length of a long human life.

This is a "saeculum," an idea that traces back to ancient Italy. For example, the last "crisis era" or "fourth turning" of the previous saeculum lasted from 1929 to 1945, beginning with the start of the Great Depression and ending with the conclusion of World War II.

As we wrote in the July 29, 2020 Digest...

It makes a lot of sense when you think about it...

We're not born with the perspective of an 80- or 90-year-old who has lived an entire saeculum. So most of us will live our lives as we see fit, shaped by our circumstances, personality, and what we learn and see along the way...

The "secret sauce" of this demographic theory explains why certain generations behave the way they do.

Strauss and Howe say each generation has one of four "archetypes" or the way they see the world, which also appear in order, on schedule, for hundreds of years.

They are hero (meaning civic hero), prophet (idealist), nomad (reactive), and artist (adaptive)...

For instance, the "Greatest Generation" is a hero generation. The Republicans of the pre-American Revolution are considered the same. And today, believe it or not, so are Millennials.

Generation Xers are nomads. They came of age during a third turning. Their slogan was, appropriately, "Works for me." The Silent Generation, kids of the Great Depression and WWII, are considered "artists"... as are today's children.

And because these archetypes arrive, in order, they predictably interact with and view other generations in regular patterns, too. As Howe says, the theory considers "how generations are shaped differently and how on predictable timetables they shape history as mid-life parents and leaders."

Right or wrong, Millennials uttering the phrase "OK, Boomer" are like Republicans of the mid-1700s thumbing their noses at the King George lineage of England... Perhaps this is why the Broadway play Hamilton has been so popular today.

With those explanations out of the way, I think it's a good decision today to think about the relevant past. Because it keeps coming up again and again... eventually.

These haven't been 'unprecedented' times at all...

Over and over, we've been told things have been unprecedented the past two-plus years (and it has felt like it). But we've often found that if we just look at history, we see that this hasn't been the case at all.

How about the pandemic...

Before 2020, the last great worldwide pandemic – of the so-called Spanish flu – lasted about three years, from 1918 to 1920. There were at least four waves that spread around the world before the virus became considered seasonal influenza. This should sound familiar.

The COVID-19 pandemic will likely go down in the history books or Wikipedia pages or whatever comes next as lasting just about the same amount of time, with multiple waves. This isn't to say we shouldn't ever question "this time could be different," but so many times, it's not – so long as you are looking at the right history.

How about inflation...

We have no clue how many words we've written about inflation over the past two years, but it has been too many. Still, stripping away the nuances and day-to-day updates, the story is simple... When money supply rises, so does inflation. When it goes down, inflation does, too.

If you have paper money or digital money, it's really easy to control the money supply. If currency was tied to literally anything tangible – like rocks, or light bulbs, or the number of baseballs in existence today – we'd probably have less inflation.

Which brings me to the economy and markets today... and in 1937 and '38...

First, this recession was 85 and 84 years ago, fitting for our ideas about the relevance of 90-year cycles...

Second, both then and now fall in periods of recovery from a crisis.

And, most important, both cases involve the government taking major financial juice out of the punchbowl.

In 1937, the federal government had stopped the "New Deal" spending that stimulated the economy out of the four-year-long Great Depression... Today, we've stopped the direct-mail stimulus checks that kept consumers flush with cash during the pandemic.

Third, the Federal Reserve and other policymakers are behaving the same way that they did just ahead of the recession of 1937 and '38 – using different methods.

In 1936, the Fed – which was only 23 years old – was implementing "tighter" financial conditions. Dollars were backed by gold then (though President Franklin D. Roosevelt had manipulated gold prices a few years earlier), so the Fed couldn't "print" money. Instead, it doubled the reserve requirements for banks.

Six months after that decision, the U.S. Treasury Department "sterilized" gold inflows. According to the Foundation for Economic Education ("FEE")...

Its purpose was "to halt the inflationary potentialities [sic]" of all incoming gold. Beginning December 22, 1936, the Treasury placed its gold purchases in an "inactive" account.

Instead of issuing gold certificates and depositing them in Fed Banks to raise the necessary credit balance to pay for the gold, the Treasury paid for the gold by selling government securities in financial markets. By this means, it carried out its own open market operations – sales in this case – with its own "FOMC." This way the gold remained stockpiled but unmonetized in the Treasury.

This move also indirectly raised interest rates, according to the FEE, by making more government securities available.

Today, the Fed is tightening conditions and cutting back on money supply by trimming its $9 trillion balance sheet and directly raising interest rates to new highs.

In 1937 and '38, the Fed and Treasury's moves resulted in the century's third-worst recession...

Real gross domestic product dropped 10% and unemployment hit 20%, up from 15% at the start of the recession. Corporate earnings were crushed.

I hope we don't hit such numbers, but we have many of the same conditions in place. Even Fed Chair Jerome Powell himself is now saying businesses and people should expect "pain" ahead... The only hope is that he's wrong (which has been the case, notably on inflation).

Unemployment (below 4% today) also isn't nearly as close to what it was in 1937. The U.S. economy, in fact, has millions of job openings, though labor-force participation is lower than it has been since the 1970s.

Despite the significant differences to consider in this comparison, there are also enough similarities, including when we look more at the even bigger picture: those 90-year cycles...

The beginning and the end of a crisis...

The financial crisis of 2008 and 2009 appears to have been the trigger point for the current "crisis era." It resulted in Great Depression-like "rescue" reactions and may have well led to one of the biggest financial bubbles the world will ever see...

We tacked on massive stimulus at the end of a record bull market and economic "expansion" for good measure – in response to the pandemic panic and uncertainty. Those moves avoided a recession in the moment, but likely kicked it down the road until right about now, with more debt and inflation to deal with.

And remember also, the last crisis era of the 1930s and early '40s only ended with a world war... The recession of 1937 and 1938 was the last one before the start of World War II.

Today, the U.S. is not in a "conventional" world war... But the world's most influential nations are falling into what seems like two camps.

We see the U.S. and its friends... and China and its allies. Both have large problems at home but are the world's two largest economies.

Plus, we're probably already in a "currency war," tied most directly to oil and natural gas – natural resources that hundreds of millions of people rely on and take for granted.

In other words, the battle lines are being drawn in another great era of global conflict...

For example, just this week, Chinese President Xi Jinping's first foreign in-person trip in about 1,000 days (now that he's not scared of catching COVID-19) was to chat with Russian President Vladimir Putin in neutral-site Uzbekistan.

They met today. According to global news service Reuters...

At their first face-to-face meeting since the war [in Ukraine began], Xi said he was very happy to meet "my old friend" again after Putin said U.S. attempts to create a unipolar world would fail.

That should tell you a lot.

Listen, I'm not saying history is going to repeat itself exactly...

If I knew what was going to happen in the future, I frankly probably wouldn't be writing to you today. I don't take joy in a bad recession... or a potential World War III... And it would be nice if this bear market would end sooner rather than later, too.

But when thinking about the world today, it's helpful to consider the context of previous eras of crisis to gauge the possible outcomes in the months and years ahead.

So, first, history tells us to expect this volatile period to continue until further notice. (In their book nearly 30 years ago, Howe and Strauss also predicted the next "crisis era" would start in the mid-2000s – check – and end in 2026.)

I would be surprised if our crisis era is not reflected more in the stock markets and other investible assets in the years ahead. Some of these might benefit tremendously, like commodities that become more valuable because of their availability.

We're living in what might be a mashup of the high-inflation 1970s and the "pull back on stimulus at the end of a crisis" late 1930s... One outcome is that the conventional 60/40 portfolio that worked for the past 40 years is failing in 2022.

In 1937, the predecessor to today's S&P 500 Index lost 38.6% of its value. That's its second-worst yearly performance, trailing only 1931 (down 47%, following a 28% loss and 11% loss in the previous two years in the Depression) and worse than 2008 (38.5%) by a hair.

If you're a believer that the next recession hasn't been "priced in" yet – and based on this week's market behavior, it probably isn't – consider my comparison today a warning that stocks could have lower to go before finding a bottom.

This era might feel completely different than anything anyone has ever experienced before... because no one has in nearly 90 years. Unless you were an adult back then, which nobody was (so much as I know), it might be a good idea to heed the lessons we see.

If I've scared you enough today, here's a solution...

Despite the gloomy comparisons, with a well-diversified portfolio of high-quality businesses that can generate steady cash flow, you're probably in good shape to weather whatever comes next.

Remember also that stocks were down about 40% as the recession began in mid-1937. That might not sound good if you have a short time horizon for your investment portfolio, but if this year's sell-off isn't finished yet, more lows could create spectacular long-term buying opportunities.

In 1938, when the economy started to recover mid-year (helped by a new $3.75 billion spending bill and government subsidies for farmers), the S&P returned a 25% gain... This is to say, the worst for stocks came before the recession, as is usually the case with the forward-looking stock market.

In any case, with interest rates on the rise and financial conditions getting tougher, be wary today of the garbage, like "zombie" companies that can't even afford to pay their own interest payments. And if something or someone is offering you what sounds like a too-good-to-be-true yield on your cash, make sure you really explore what risk they're paying so much to take on.

Secondly, there are many ways you can protect and even grow your portfolio even if stocks or bonds fail to provide what many people have come to expect.

As I mentioned just yesterday, a one-year Treasury bill is offering a 4% return today. That might not be keeping pace with today's inflation rates, but it's low-risk money and far better than the near-zero yield it was offering at the start of the year.

If interest rates keep going up and inflation comes down even somewhat more, Treasurys become even more attractive place to park some cash. Beyond that, even in a bear market or a tough market, you can use the stock market and the wisdom of our editors and analysts to your advantage to make money...

One way is to "quit stocks" completely. Yes, this might sound strange given our business, but it's true. That's what our colleague and Stansberry Research partner Dr. David "Doc" Eifrig suggests doing. As he said in a recent note...

I want you to quit buying stocks. Not forever. Just for the next 30 days. And I'm not suggesting you put your money into a mutual fund, ETF, CD, option, crypto, precious metal, or piece of real estate either.

Instead, for the next month or so, all I ask is that you follow an investment strategy that, over the 12-plus years I've been using it here at Stansberry Research, has been successful an incredible 94% of the time.

In this unstable market we're living with right now, including for all the reasons we laid out today, Doc says using this strategy is the No. 1 thing he'd advise everyone to do... to protect your money and keep it growing at the same time.

He shares more details about this "stock free" strategy in this video. Check it out.

In Pursuit of The Edge

In this week's Stansberry Investor Hour, Dan Ferris talks with Jim Osman – founder of consulting group The Edge. Osman takes a deep dive into managing risk analytically and behaviorally... and explains why he considers it the ultimate solution to investment success...

Click here to listen to this episode right now. And to catch all episodes of the Investor Hour and all the videos and podcasts from the Stansberry Research team, be sure to visit our Stansberry Investor platform anytime.

New 52-week highs (as of 9/14/22): Cheniere Energy (LNG) and the short position in Capital One Financial (COF).

In today's mailbag, more feedback on energy... and Mike DiBiase's Tuesday Digest about an economic "winter" on the horizon... What's on your mind today? Let us know. As always, send your notes to feedback@stansberryresearch.com.

"As a Washington state resident and an energy engineer in the mid-1990s, I watched the green state legislature reclassify hydro as non-renewable. The tremendous hydroelectric power of the Columbia River dams was producing electricity at 1-2 cents/ KWH. Then the greenies by way of regulation shipped that 'nonrenewable' electricity to California for 25 cent/KWH renewable wind generated electricity. So I question the US energy 'information' administration.

"One closing thought. I was with a local rancher on the Columbia River and below a wind generator field. He asked a question that I couldn't answer. 'I don't understand why that wind stuff is renewable. Isn't [it] true that once the wind goes by it, it's over with, right?'" – Paid-up subscriber Tim B.

"I enjoyed Tuesday's Digest on the upcoming economic winter. It matches well with data that I am seeing. I work at a fairly large chemical company in a business unit that produces raw materials for manufacturers across the globe. We have seen softening demand for our products through the year but demand has significantly dropped through the mid-summer and especially in September. As a result, my company has recently reduced their third quarter earnings estimate and held a meeting today with employees to let us know of significant challenges moving forward. The picture painted was not rosy and was to prepare us for hard times ahead.

"This business unit has historically indicated the direction of the overall economy. When manufacturers are reducing raw material orders and depleting inventories, it means tough times are ahead. I have been with the company for over 30 years and have never seen a drop in our production as such as what has happened over the past few weeks. Time to bundle up for that upcoming economic winter!" – Paid-up subscriber Robert E.

Mike DiBiase comment: This is a particularly interesting data point. Of course, every business will experience the slowing economy on different timelines. But I'm reading and hearing more and more stories like this.

A few months ago, companies were freezing hiring or cutting open positions. Now, more and more companies are laying off employees. That's a big pivot. It's one thing to cut open positions. That means you think future growth will be lower than you budgeted. But when you start laying off real employees, that normally means you expect your business will shrink.

In corporate finance lingo, it's "rightsizing" the business for the new economic realities. And some of these cuts aren't small. A 5% reduction is one thing. But I'm seeing 10% to 20% reductions. Those are not numbers to take lightly.

"Mike, I truly enjoyed reading your essay today. Not that I'm happy our economy is in such a fragile state, but it is appreciated the way you covered all the bases in such a straightforward and no punches pulled manner.

"I was a dryland wheat farmer and suffered through the Volcker 1976 to 1982 interest rate fiasco... 22% farm loans not only get you down but the only way to recover is make damn sure you make your personal credit rating Priority One. My suggestion is that everyone should get to know their local banker on a personal basis." – Stansberry Alliance member H.S.

All the best,

Corey McLaughlin
Baltimore, Maryland
September 15, 2022