Fri, May 22, 2020|Dan Ferris

The Ominous Parallels Since Yesterday

A Second Great Depression or not?... 'No one really knows'... A far more prudent way of thinking... Studying 1929 to 1945... The ominous parallels since yesterday... Saeculums and turnings... How you can start preparing right now...

These days, it seems like a lot of folks want to reassure us that our economic future is not grim...

Sure, I (Dan Ferris) have read a lot of stories full of doom and gloom since the coronavirus crisis started. But I've seen just as many people downplaying our dire economic situation...

For example, on April 10, a MarketWatch headline declared, "No, we're not heading toward the next Great Depression." The same day, a headline on Forbes' website explained, "Why COVID-19 Won't Trigger Another Great Depression." The headline of an April 27 article on CNN said simply, "Great Depression comparisons are depressing but this time is different."

On May 5, a Harvard Business Review headline concluded, "The U.S. Is Not Headed Toward a New Great Depression." And just last weekend, National Public Radio published a story on its website under the headline, "Crisis Seen As Historic, Not Another Great Depression."

And of course, the money guys in the government are acting like everything will be OK...

On May 7, Federal Reserve Bank of Minneapolis President Neel Kashkari admitted in an interview with NBC's Today Show that the damage has been "devastating." But in the next breath, he said, "I don't think we're actually headed for another Great Depression."

(You might remember Kashkari from a couple of months ago... He's the guy who said without irony that the Federal Reserve had an "infinite amount of cash" at its disposal.)

And then, on CBS show 60 Minutes last Sunday night, Fed Chairman Jerome Powell gave little thought to a Second Great Depression. He said it wasn't a "likely outcome at all."

I'm not predicting another Great Depression...

But I'm suspicious of those folks expressing certainty about an unknowable future.

Even Powell admitted as much during the CBS interview. As he acknowledged...

[The downturn] could stretch through the end of next year. We really don't know. We hope that it will be shorter than that, but no one really knows.

There's something odd to me about Powell's juxtaposition of "another Great Depression is unlikely" and "no one really knows."

It doesn't make a lot of sense to pretend you know where either the economy or the stock market will wind up in one, five, or 10 years. We're living through an unprecedented global economic shutdown. I don't believe anybody has much of an idea of what will happen next.

It seems far more prudent to entertain a wider-than-usual range of possible outcomes when attempting to think about and prepare for the future today.

Longtime Digest readers might recognize the words "range of likely outcomes." I've used the phrase in these pages before to describe risk. The wider the range, the higher the risk...

For example, U.S. Treasury bills are likely to help you make a little bit of money and more likely to cause you to lose nothing. That's a narrow range of likely outcomes... Low risk.

The S&P 500 Index is riskier than T-bills... In any given year, the index could fall 50% or rise 30%... or anything in between. A wider range of outcomes than T-bills... Moderate risk.

And microcap mining and biotech stock speculations could cause you to lose everything... make 100 times your money... or anything in between. An extremely wide range of outcomes... High risk.

The period from 1929 to 1945 was filled with crisis, change, and of course, risk...

Anybody who entertained the widest range of possible outcomes – which included the Great Depression and the biggest war in world history – might have had an advantage over those who were blindsided.

If any chance at all exists that such a period lies before us, it makes a lot more sense to entertain – and prepare for – a wider range of outcomes right now. To do that, we should look for how the present period is similar to the era from 1929 to 1945, not different...

It may be unlikely that history will repeat itself by delivering the Second Great Depression and World War III. But we all know cycles happen, and history has a way of rhyming.

We'd be fools to ignore the possibility.

So with that in mind, I've started collecting and reading books about this time period...

(By the way, if you have suggestions... I'd love to hear them. Send us an e-mail at feedback@stansberryresearch.com with your favorite books that you think I should read.)

Earlier this week, I read Only Yesterday... Frederick Lewis Allen's informal history of the 1920s. Then, I immediately started Allen's Since Yesterday... his history of the 1930s.

The parallels to our own time leapt off the pages. For example, here's what Allen wrote in Only Yesterday about the mood across the U.S. just prior to the 1929 crash...

On every side one heard the new wisdom sagely expressed... 'Be a bull on America.' 'Never sell the United States short.' 'I tell you, some of these prices will look ridiculously low in another year or two.'...

Everybody heard how many millions a man would have made if he had bought a hundred shares of General Motors in 1919 and held on. Everybody was reminded at some time or another that George F. Baker never sold anything.

Sound familiar?

I don't know how anybody could say stocks are cheap today...

Businesses are shut down... Earnings are getting bludgeoned by the worst recession since the 1930s... And the S&P 500 is looking expensive again, within 13% of its all-time high.

And yet, Bank of America (BAC) reported yesterday that stocks haven't been this attractive relative to bonds since the 1940s. In other words, stocks are cheaper relative to bonds than any time in 70 years. It's typical Wall Street – touting relative cheapness at a time of absolute expensiveness!

George F. Baker was the Warren Buffett of his day... Born in 1840, Baker made a fortune in railroads and banking after the Civil War. He was the third-richest man in the country (behind Henry Ford and John D. Rockefeller) when he died in 1931.

Allen could just as easily have written about Buffett... whose favorite holding period for investments is forever, and who has often said it doesn't pay to bet against America.

Of course, one big difference exists between Baker and Buffett right now... Though Buffett is once again touting American strength, he's not buying stocks today... He's selling them.

Buffett sold $6.5 billion worth of stocks in March. He sold all his airline stocks... and it has recently come out that he also sold 84% of his stake in banking giant Goldman Sachs (GS). Berkshire Hathaway (BRK-B) sold stocks in 19 companies during the first quarter.

Anybody who watched Berkshire Hathaway's annual meeting this year knows Buffett isn't feeling much like buying anything today, despite his endless touting of American strength.

It's enough to make you wonder if you've stepped into a time machine.

Now, even I will agree that accumulating and holding good assets is a time-honored path to wealth. And betting against America has often been a bad idea since our 1776 founding.

But I'm more interested in the effect on the average investor of the idea that the richest man in finance "never sells anything," and that you "can't go far wrong" betting on America.

It's a great story, the type that makes both individuals and professionals more comfortable in taking risk. It helps them drop their emotional guard... forget about the wide range of possible outcomes... and leads them to believe we're not careening toward another Great Depression or another similarly dire scenario.

I'd rather tell stories that encourage you to entertain the possibility of a wide range of outcomes...

That brings me to a quote from Allen's 1930s book, Since Yesterday...

Quickly the ripples of uncertainty and retrenchment widened and unemployment spread. Moreover, the collapse in investment values had undermined the credit system of the country at innumerable points[,] endangering loans and mortgages and corporate structures which only a few weeks previously had seemed as safe as bedrock.

Unemployment has certainly spread today. And we're all retrenching for a world in which it's highly likely that many folks will travel less, eat out less, and spend a lot less than they did before.

Plus, given the plunge in oil and other commodity prices... and the decimation in the airline, restaurant, travel, and retail industries... it will surprise no one that enormous stresses have already built up in the debt market as a direct result of the coronavirus-related lockdowns.

A recent Bloomberg article says the amount of distressed debt in the U.S. has surged more than 161% over the past two months... to more than half a trillion dollars.

Derek Pitts, head of debt advisory and restructuring at investment bank PJ Solomon, uses a color-coded system to track hundreds of indebted companies. As he told Bloomberg...

Everyone's distressed watch list has become so big that it doesn't even make sense to call it a watch list – it's everyone. You turn page after page and it's all red. It's a sea of red.

Famous investor touting America. Check.

Wall Street touting stocks as "cheap." Check.

Market crash weighing heavy on the big debtors. Check.

Just like it was around the time of the 1929 crash. History is rhyming...

In Since Yesterday, Allen lists 'remarkable changes which could not continue indefinitely'...

He's talking about changes that occurred across America in the late 19th and early 20th century. But you tell me if any of these sound familiar to the times we're living in today...

The rapid progress of the industrial revolution – which [made many workers] increasingly dependent upon the successful working of an increasingly complex economy.

Today, we're learning how globalization – specifically our dependence on Chinese manufacturing – has created massive systemic risks for the U.S. economy. The more connected we all become, the greater the risks.

Among other big changes, Allen also notes...

A rapid improvement in communication – which in effect made the world a much smaller place, the various parts of which were far more dependent on one another than before.

Nowadays, the combination of the Internet and mobile phone technology has connected the most distant parts of the globe as never before...

News doesn't travel fast. It doesn't travel at all. It is everywhere instantly. A news item in Hong Kong can cause a sell-off in London... instantly. A press release in Japan can cause a jump in commodity prices in the U.S... instantly.

Allen also notes...

The rapid development and refinement of capitalism on a bigger and bigger scale, as new corporate and financial devices were invented and put into practice.

Who can forget the complex collateralized debt obligations ("CDOs") of the Great Financial Crisis? They were piles of sliced and diced mortgage securities – often rated "triple A," the best of the best – that made the financial crisis worse and lured many investors to take risks that they had no clue they were taking.

Once again hungry for yield in a world of low interest rates, investors have turned to collateralized loan obligations ("CLOs"). The great financial engineers have put out $700 billion of CLOs – which like CDOs, slice and dice risky loans and bundle them up in a way that earns them a higher credit rating. It's 2008 all over again.

In addition to studying the history of the period from 1929 to 1945...

You might also gain an appreciation for the cyclical nature of human endeavor through time by reading The Fourth Turning: An American Prophecy by William Strauss and Neil Howe. The authors' generational theory of historical cycles will fascinate you...

They break Anglo-American history into periods called "saeculums." Each saeculum consists of four "turnings," which are each one generation long (roughly 18 to 25 years)...

First Turning: The High
Second Turning: The Awakening
Third Turning: The Unraveling
Fourth Turning: The Crisis

As Strauss and Howe write, "Each turning comes with its own identifiable mood. Always, these mood shifts catch people by surprise."

Here's where it gets interesting...

The Fourth Turning of the last saeculum lasted from 1929 to 1945.

In the current saeculum, the First Turning encompassed the Truman, Eisenhower, and Kennedy years. The Second Turning stretched from the campus revolts of the mid-1960s to the tax revolts of the early 1980s.

The Third Turning started with Ronald Reagan's "Morning in America" and ended with the financial crisis of 2008. And the Fourth Turning started in 2008... and is ongoing today.

According to the authors...

The Fourth Turning is a Crisis, a decisive era of secular upheaval, when the values regime propels the replacement of the old civic order with a new one.

No wonder hedge-fund mogul Ray Dalio named his latest work, "The Changing World Order."

Will the current Fourth Turning end with a war, like the last one?

Historian Graham Allison writes about wars in his recent book, Destined For War: Can America and China Escape Thucydides's Trap?... According to Graham, the trap is that, "When one great power threatens to displace another, war is almost always the result."

For an example of war risk, China seems determined to take over at least part of the long-disputed Spratly Islands in the South China Sea, despite territorial claims of several other countries.

It's the sort of off-the-radar ongoing development that can suddenly cause a major conflict and become front-page news overnight. I'm not predicting it will happen, but I'm aware of the risk that it could happen. That's probably more than many other investors can say.

It's not necessary to buy into Strauss and Howe's theory about the Fourth Turning. And it might be a mistake to take it too literally... or use it to make predictions. They're telling a story about history... It's one that I find useful to study, but it's just a story, nonetheless.

More than stories (useful or otherwise), you need a healthy respect for the wide range of possible outcomes... the cyclicality of human history (including market cycles)... and the need to prepare, due largely to the impossibility of predicting how it'll all work out.

Last Friday, I told you that three assets would help you prepare for what's coming...

Cash, gold, and bitcoin.

Just remember, the point isn't that you know those three assets are likely to perform well for the next several years. It's that holding them increases the likelihood that you'll persevere and grow your wealth despite a wide range of potential outcomes.

History and economics don't seem to matter to most investors. They wake up one day, and they're all that matters. Don't be like that. It's best not to get caught off guard...

Learn history (especially the era from 1929 to 1945). Learn to appreciate historical and economic cycles. Hold cash, gold, and bitcoin.

Prepare. Don't predict.

New 52-week highs (as of 5/21/20): DocuSign (DOCU), NetEase (NTES), Intellia Therapeutics (NTLA), Flutter Entertainment (PDYPY), Sea Limited (SE), Scotts Miracle-Gro (SMG), and Spotify Technology (SPOT).

The mailbag is quiet as we head into the long holiday weekend. That reminds us... The markets and our Stansberry Research virtual offices will be closed on Monday in observance of Memorial Day. After this weekend's Digest Masters Series, we'll resume our normal coverage on Tuesday.

Good investing,

Dan Ferris
Vancouver, Washington
May 22, 2020